LNG, Crude Oil and Coal: Dark horses in the US-China Phase 1 Trade Deal
On January 15, the US and China signed “Phase 1” of a trade deal. The US agreed to cut some tariffs on Chinese goods in exchange for China pledging to increase by $200bn its purchases of energy and agricultural commodities, as well as manufactured goods and services from the US in 2020 and 2021.
As widely reported energy commentators and analysts have interpreted the energy part of the two-year deal to mean that China has undertaken to buy $27.6bn worth of energy products from the US in 2020, increasing to $42bn in 2021. The trade deal does not remove China’s current punitive tariffs on US energy imports; examples being 5% on crude oil and most petroleum products and 25% on coal, LNG and LPG. Energy commodities can also be subject to additional Chines import taxes such as the 3% tax universally applied to imports of coal.
The main energy products or commodities to be included in the purchases China has committed to make are likely to be LNG, propane and butanes (LPG), crude oil including condensate, petroleum products and/or coal. It is understood the energy part of the deal includes petrochemical products such as methanol. However, petrochemical products although they could potentially represent an important contribution towards US energy exports to China under the trade deal, are not discussed further. The Phase 1 trade deal also includes fuel ethanol, but this commodity is classed as an agricultural product by China and thus will form part of the $32bn increase allocated to purchases of US agricultural products.
Even for a major economy such as China, the largest energy importer in the world, and even if the punitive import tariffs on energy commodities currently applying to US imports were to be all removed, annual purchases of $27.6bn and $42bn worth of US energy products will represent formidable tasks. Energy purchases of such a magnitude are likely to disturb current trade flows considerably and have consequences for shipping rates.
At the same time the “Phase 1” deal is unlikely to give the world economy a bust, since most punitive tariffs imposed by the US on Chinese imports and by China on US imports are likely to stay in place until a “Phase 2” trade agreement has been entered into, which is likely to happen only after the 2020 US presidential election.
Based on US energy exports to China in 2017 and Chinas imports of energy commodities from third party countries in 2017 to 2019, how realistic are the new energy trade targets?
China and US LNG supplies
China's gas demand was 280.3bn m³ in 2018 and has been forecast to reach some 300bn m³ in 2019, representing a growth rate of around 7%. This compares with 18.1% growth in 2018 and can be explained by economic growth, warmer than normal weather and pressure on the country's gas production, storage, transmission and distribution networks following the very rapid growth in gas demand during 2017 and 2018.
In 2019 China’s natural gas imports (pipeline and LNG) stood at 96.56mn metric tons (mt), up 6.9% year on year, according to Chinese customs department data.
China imported a record 7.2mn mt of LNG in December, surpassing Japan. China's LNG imports in 2019 were estimated at 60.3mn mt, a 6.5mn mt increase, equivalent to 12% over 2018 when Chinese companies imported 53.8mn mt of LNG.
China is concerned about its energy import dependency and energy security of supply. This has led to active support of the country’s oil and gas upstream industry. State-owned oil and gas producers have in response been eager to ramp up production to replace imports. These efforts are bringing positive results: China’s natural gas output rose to 173.6bn m³ in 2019, up 9.8% on the previous year.
The latest Chinese oil and gas upstream development is that the country has opened up the industry to foreign companies and investors to access foreign technology and produce more gas at home (NGW Vol 5/2).
In addition to LNG imports, to achieve gas supply diversification, China is also importing more by pipeline from Myanmar, the former Soviet central Asian republics and Russia.
The Russian-owned Power of Siberia pipeline system started gas deliveries in late 2019 and is scheduled to deliver 5bn m³ of gas to northeast China in 2020. The pipeline system is expected to increase gas deliveries gradually to 38bn m³/yr by 2025. However, this pipeline system supplies a part of the Chinese energy market currently not supplied with gas from LNG import terminals so these supplies should not impact China’s LNG imports.
China is due to commission new LNG terminals this year that will add 14mn mt/yr import capacity. The country’s uncontracted LNG demand is estimated at some 15mn mt this year increasing to 23mn mt in 2021. As part of the Phase 1 trade deal, US LNG exporters are already targeting this demand.
Sinopec, officially named China Petroleum & Chemical Corp, is the state-owned LNG importer that has shown most interest in signing new long-term LNG supply agreements including with US LNG suppliers. The company has plans to more than double its LNG receiving capacity to 41mn mt by 2025. In 2019 Sinopec was China’s biggest spot buyer of LNG; hence this company is in a good position to be an important buyer of US LNG under the Phase 1 trade agreement. The two other large state owned LNG importers, PetroChina China National Offshore Oil Corp (Cnooc) both have a high percentage of their future LNG import needs covered under long term contracts.
Sinopec is known to be in contract negotiations with Cheniere Energy for a potential $16bn supply deal from this latter company’s LNG plants on the US Gulf Coast. However, it is reported Sinopec is planning to review the terms of this potential deal in response to the latest sharp drop in LNG prices. This LNG price development together with the 25% punitive import tariff which still applies to US LNG imports are likely to delay the execution of a deal that would help China meet its ambitious targets under the US energy purchases part of the Phase 1 trade agreement.
Based on current prices being offered by some suppliers for new long term LNG supply agreements for delivery ex-ship (DES) to markets in northeast Asia, a 15mn mt annual supply would have a value in the range $5.3bn-$6bn. Based on the current S&P Global-assessed Japan Korea Marker (JKM) spot price for delivered cargoes, the value would be some 35% lower.
If US LNG producers manage to secure contracts for all of China’s uncontracted LNG demand in 2020 – some 15mn mt – these deals would be worth no more than some $6bn today, equivalent to some 22% of China’s target energy imports of $27.6bn for the current year. In 2021, 15mm mt would only represent some 14% of the required $42bn of energy imports. And were the US to supply the whole uncontracted 23mn mt of LNG in 2021, that would be worth $9.2bn, using the same price assumptions as for 2020. That would represent 22% of the energy import target for that year.
For LNG to play a meaningful part in meeting China’s energy obligations under the Phase 1 trade agreement, one can therefore assume US LNG exporters will have to displace a portion of Australian, Malaysian and Qatari volumes and become China's largest LNG supplier after Australia, despite the greater shipping distance (see below).
Australia in the 12 month period from 1 July 2018 exported 26.3mn mt of LNG to China, mainly under long term contacts. To achieve such a position US LNG supplies would need to undercut Qatari LNG prices. This could mean a price war which US liquefaction plants potentially could lose even with feed gas below $2/mn Btu at the plant gate. Shipping costs from the US Gulf or Atlantic costs could be the critical factor.
A structural capacity deficit is developing in the LNG carrier (LNGC) shipping market. Large exports of LNG from US plants to China would add substantial ton-mileage to LNGC shipping requirements likely to result in increased day rates for LNGCs and therefore increased LNG shipping costs for the US to China trade. It should also be mentioned that there is a shortage of LNGC crews developing. If this were to force some of the older LNGCs into retirement, the shipping market would grow tighter still.
Is LPG the bright spot?
Propane and butane could potentially be a bright spot in US-China energy trade as they are a third cheaper than in the Arabian Gulf. Associated wet gas (liquid petroleum gas or LPG) from US shale oil production is increasing rapidly, and has high yields of ethane gas as well as the heavier hydrocarbon gases propane, isobutene and normal butane. Chinese LPG importers have not been able to access the US market owing to China’s total 26% tariff on US propane and 31% tariff on US butanes, and the US LPG export infrastructure which has insufficient capacity.
China’s main suppliers of LPG are the UAE and Qatar under long-term contracts. To obtain non-US supply China has also imported LPG from Norway. But the landed price in China of LPG from these suppliers can reportedly be as much as $100/mt above the price in the US (some $8.50/barrel). However, US LPG export capacity is due to double over the next two years; hence large-scale LPG imports from the US could potentially be arranged resulting in a balancing of US and Chinese prices.
In 2017, before tariffs were imposed, China imported nearly 3.6mn mt of US LPG. Industry sources do not expect China's punitive tariffs on US propane and butanes to be removed soon, despite the Phase 1 trade deal.
Chinese LPG imports are at a level of some 20mn mt/yr with a value of some $7bn. Assuming the US can double the actual US LPG exports to China in 2017 this would have an export value of some $2.5bn, or just 6% of China’s 2021 US energy import target of $42bn.
Day rates for large LPG tankers are high because the shipping market is tight. If China switched from Arabian Gulf to US suppliers, LPG shipping rates likely could also increase substantially.
The world’s largest crude oil importer
China imported 10.16mn b/d of crude oil last year to supply its growing refining industry as well as to fill up its strategic crude oil reserves. CNPC forecasts demand rising by just 2.4% in 2020, less than half the 5.2% growth in 2019.
Chinese refineries have been built for medium and heavy crude oils with a medium- to high-sulphur content. As a result China receives some 40% of its crude oil supplies from the Arabian Gulf. It is also understood China still might receive some quantities of crude oil from Iran and Venezuela. The country’s largest supplier is Russia.
Light, low-sulphur crude oils from US shale oil production do not produce optimum product yields for Chinese refineries; hence the US had difficulties in selling these crude oils to China even before the 5% punitive tariff on US crudes was introduced. However, it would be possible for China to increase its imports of crude from the US, but this would likely have a negative impact on the economics of Chinese refinery operations.
In 2019 China bought some 700,000 b/d of light sweet crudes from the UK, Malaysia and African producers. Based on a free on board price of $58/b for 2020, this supply would have a US export value of some $14.8bn, or some 54% of the 2020 US energy import target. It is unlikely that Chinese crude buyers can switch out of all these supply arrangements at short notice. China is also unlikely to reduce its purchases of Russian crudes.
Furthermore, increased refining of light sweet crudes from US shale oil production would increase the yields of petrol and diesel, products now being exported at low prices that reduce refining margins.
A switch by China from Arabian Gulf, North Sea, Malaysian and African to US crudes would also impact trade flows in a major way, adding substantially to the ton-mileage the world’s crude oil tanker operators would have to supply. A crude oil supply of 700,000 b/d delivered to China over a period of one year corresponds to 128 supertanker cargoes of 2mn b each. Since the crude oil tanker market is in relatively good balance with profitable rates for ship owners, a major switch by China to US crude oils which would require supertankers to sail from the US Gulf coast via South Africa’s Cape of Good Hope to China, a voyage of some 34 days, crude oil tanker day rates would probably rise significantly.
China an exporter of petroleum products
Petroleum products are also on the list of commodities the US would like to export to China. In anticipation of continued high economic growth and rapid growth in the consumption of petroleum products, the Chinese have built up a large and modern refinery industry. The slowdown in Chinese economic growth, at least in part the result of the trade dispute with the US, means that China now has a surplus of refined products which it exports to other Asian countries. It is therefore unrealistic to assume the US can export large quantities of bulk petroleum products such as petrol and diesel to China as part of the Phase 1 trade deal. Although China does need speciality petroleum products, the US export value of these will be insignificant in the context of the Phase 1 trade deal.
Chinese and coal imports
Although China has a large and again increasing coal mining industry, the country is a substantial importer of coal with the largest suppliers being Indonesia, Australia, Mongolia and Russia. Coal imports can be split into two categories:
- coking or metallurgical coal mainly used by steel mills; and
- thermal coals mainly used in power stations and in other steam rising plants.
Australia and Mongolia supplied 88% of China's metallurgical coal imports in 2018, while the main suppliers of thermal coal were Indonesia, Australia and Russia. Together they supplied 94% of China’s thermal coal imports during 1H 2019.
China is unlikely to import less Mongolian and Russian coal. At current seaborne prices, low grade and low sulphur Indonesian thermal coal is likely to keep finding buyers in China since it can be mixed with higher-sulphur Chinese domestic coal. But Australian metallurgical as well as thermal coal is likely to be switched out under the Part 1 trade deal.
During the 2H 2018 and 1H 2019 the total value of China’s coal imports from Australia and Indonesia has been estimated to be some $18bn, much of which is on long-term agreements. This makes it impossible to switch all of these imports to US suppliers in just two years but it might be possible to switch up to $6bn worth of coal imports to US suppliers in 2021 representing some 15mn mt of metallurgical coal and some 60mn mt of thermal coal, provided the US railway system and coal export terminals can handle such large increases in export tonnages. However, the value of such major switches of coal supplies represents only some 14% of China’s 2021 US energy import target of $42bn. This is a clear demonstration of the scale of China's commitment.
It should also be noted that the switching of some 15mn mt/yr of metallurgical coal from Australia to the US and in total some 60mn mt/yr of thermal coal from Australia and Indonesia to US suppliers will add very substantially to seaborne shipping distances and hence the total ton-mileage to be supplied by the world’s bulk carrier fleet. Bulk carrier shipping rates are likely to go up very substantially as a result. It is even questionable if the world's shipping industry could handle such a substantial increase in ton-mileage over the next two years. If not, this will also have major implications for the transportation of other bulk commodities such as iron ore, bauxite and grain with potentially a negative impact on the world economy.
Who could benefit from the energy part of the Phase 1 of the trade deal?
The Chinese president Xi Jinping was not present at the signing ceremony, but he said, in a letter read by the country's top negotiator and vice premier Liu He, that the deal was "good for China, the US and the whole world."
The energy part of the deal, if implemented, potentially could be good for some categories of US energy exporters. To what degree, if any, it will be good for Chinese energy markets and therefore Chinese consumers and also global markets for coal, crude oil, petroleum products, petrochemical products, LPG and last but not least LNG, remains to be seen.
One conclusion which already now can be drawn is that the shipping industry likely will benefit substantially, but likely at the cost of end consumers around the world.
Furthermore, if China has to give preferential treatment to US energy suppliers to meet these high US energy import targets in 2020 and 2021, how will this impact on the country’s standing within the WTO?
China could miss the targets: $42bn of US energy imports in 2021 is in particular ominous. Even the 2020 target of $27.6bn means that China will probably have to import between $6bn and $10bn of petrochemicals from the US, if supplies of such a magnitude could be made available. For petrochemicals, as for LNG and LPG, the bottleneck could be the availability of shipping.
If China did fail to hit the 2020 or the 2021 US energy import target set in the Phase 1 trade deal, what will the consequences be? Under this scenario is the US likely to escalate the trade conflict? The clearly challenging energy part of the Phase 1 trade agreement between the US and China and its imminent implementation has so far generated more questions than answers. But as always, only time will tell! It is not only possible, but likely, that we will only know if the 2020 target has been met after the US presidential election on 3 November 2020.
Parties involved in any aspect of energy projects and/or related commercial activities and/or operations along any part of any energy chain will themselves need to assess and analyse how energy commodity markets develop at any point in time as part of their daily project and/or commercial decisions and operations. The US-China Phase 1 trade deal and its implementation have highlighted the need for such actions by energy decision makers and operators.
Morten Frisch is the senior partner of Morten Frisch Consulting (www.mfcgas.com ). He has been working with strategic and commercial oil, LPG, pipeline gas and LNG issues for more than forty years. Throughout his career he has followed and analysed the global LNG market giving special emphasis to Asian LNG since the early 1990. The import and consumption of LNG in China has been part of this work since Guangdong LNG (GNLNG) as the first LNG importer in this country agreed to enter into an LNG Sales Purchase Agreement (SPA) with North West Shelf Australia LNG Venture in 2002. He has also followed and analysed US shale gas and shale oil developments since 2002, and the emergence of US LNG import terminal projects in 2003 followed by their subsequent conversions to LNG liquefaction plants and export terminal. The first such development started around 2009.
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