China's LNG industry and its development in many ways acts as a snapshot of the energy space in China more broadly. Although it is a relatively young market, the participants and their infrastructure are remarkably sophisticated and resilient against broader issues in the global LNG space. Despite the anticipated slowdown in China's economic activity and energy consumption in the coming years, the country's renewed focus on cleaner alternatives to traditional fuel sources coupled with new supply sources coming online present a unique opportunity for China to take its LNG market to the next level.
State of the Market
In 2016, global trade in LNG reached a record 258 million tons (MT), an increase of 13 MT over 2015. The Asia Pacific region remains the largest market for LNG, taking in 53.6% of global supply. However, while Japan and South Korea retain their titles as the largest buyer markets, demand in both of these countries appears to be plateauing, as the energy mixes of natural gas, nuclear, coal and renewables find balance.
The story in China, however, remains one of growth. As a buyer of LNG, China experienced a year-on-year increase in demand of around 35%, taking the total amount consumed in 2016 to 27 MT. A significant amount of this new LNG was supplied from Australian LNG projects, in which Chinese companies are significantly invested (both as shareholders and off-takers). From a contracting standpoint, it is interesting to note that while the vast majority of China's 6.9 MT of year-on-year import growth was satisfied by new long-term contracts, over 1 MT of LNG was supplied under new spot or short-term contracts.
Likewise on the infrastructure side, regasification capacity in the country currently sits at 49 million tons per annum (MTPA), making China the world's fifth largest regasification market by capacity. Last year saw Sinopec bring online its new 3MTPA Beihai terminal in Guangxi Province, while CNPC completed a combined 6MTPA of expansion at the Rudong terminal in Jiangsu Province and the Dalian terminal in Liaoning Province.
Opportunities for Growth
There remains, however, significant potential for LNG demand growth, considering China's economic scale, current policy concerns and population size. A number of commentators have sought to identify the factors driving LNG market growth in China. These can be broadly distilled into three broad areas:
Environmental Concerns and Increased Role for Gas in China's Energy Mix: In January of this year, the National Energy Administration published the power plan for the thirteenth Five-Year Period (2016-2020). This plan specifies that power demand is expected to grow at 3.6% to 4.4% to reach around 7000 TWh by 2020, and sets a 15% minimum target for the share of non-fossil energy to its overall consumption over the same period. The plan further pledges to invest CNY 2,500 billion (USD 364 billion) in the renewable energy sector (based on the country's economic blueprint for the next five years). Natural gas is targeted to have a 10% share of the country's energy mix (in effect doubling China's installed capacity for gas power to 100 GW by 2020), while coal's share to overall energy consumption should fall below 58% by the end of the decade. All of these initiatives are shaped by China's goal of minimizing reliance on coal as its main energy source, as laid out in the State Council's thirteenth Five-Year Plan (2016-2020) which was released on 5 January 2017, and broader concerns about the role played by traditional fuel sources (namely coal but also oil) in China's air pollution situation.
Pro Buyer Market Conditions: The current market for LNG globally is favorable to buyers. Buyers currently enjoy significant bargaining power with sustained surpluses, increased supply liquidity, and ample access to short-term supplies, and this is expected to continue into the medium term future. Such an environment presents buyers and sellers with important strategic and commercial options regarding the optimal balance between the use of long-term contracts and short-term trades, contractually flexible terms, and LNG price formulae.
Third-Party Access and Market Liberalization: Although China does not have a universal third party access regime, the Chinese Government has pushed for market liberalization in the gas industry and issued several initiatives since 2014 to encourage third-party access to existing LNG terminals and participation in gas infrastructure by private companies and local state-owned companies. Following the NEA's recent directive to all state-owned oil and gas companies, announced in September 2016, each of CNOOC, CNPC and Sinopec have established official websites for gas assets, including LNG terminals and gas pipelines. However, while many people expect the Chinese Government to push for further market liberalization and more meaningful participation by the private sector (through greater access to LNG terminals and simplified terminal approval processes) and potentially a spin-off of the downstream assets of the major national oil companies, there remain significant obstacles to achieving this (as discussed below).
Nonetheless, against this broadly favorable backdrop, a number of current and aspiring participants in China's LNG industry are seeking to consolidate, diversify or initiate their position in the market. Importantly, while the traditional players are expected to continue to lead the business, their currently over-contracted positions means that the greatest opportunities arguably lie with participants other than the national oil companies, including gas distributors, city gas companies, power generators and traders.
What's holding development back?
There are a number of factors preventing China from reaching its full LNG potential. At the outset it should be noted that these are not necessarily negative in nature; on the contrary, most energy secure and efficient nations seek to have a balanced energy mix that draws from a deep pool of energy types and sources. However, it is necessary to be aware of the restrictions operating in a country (whether they be structural, commercial, political, infrastructural or market-based) before one can accurately assess any such energy mix and its appropriateness.
China's Economic Outlook: According to the National Bureau of Statistics, China's economy expanded at a rate of 6.7% in 2016, the slowest pace in 26 years, and while the first quarter of 2017 witnessed a slight improvement in this rate to 6.9%, the IMF is forecasting a steadily decreasing growth rate over the coming years (from 6.2% in 2017 to 5.8% in 2021). While such growth rates remain impressive by global standards (the US Treasury's stated domestic GDP goal is for 3% growth in 2017), this 'new normal' for China represents a significant deceleration from the China growth model of the past quarter century. In terms of the impact on the energy space, total energy consumption is planned to increase 2.5% year-on-year in the thirteenth Five-Year Plan period, approximately a third lower than the year-on-year growth stipulated in the twelfth Five-Year Plan period. The key impact of this slowdown in economic activity and energy consumption in the short-term is that many Chinse buyers are already over-supplied with LNG under existing long-term contracts (which were entered into on the assumption of much higher rates of activity and therefore energy consumption). To further complicate the situation, a number of these long-term contracts were entered into in a much tighter market with relatively high prices (and, due to lags in the pricing formulae, contract prices have dropped more slowly than relevant spot prices). However, in the medium to long-term, even with these revised rates China will have a supply shortfall and will (accordingly) need to be active as a buyer in the global market.
Pace of Market Liberalization: The liberalization of gas markets is a multi-layered and interconnected process which rests on three key elements: access to gas supplies, access to infrastructure and access to customers. At present, the major obstacle in China is with the second of these limbs. Notably in an LNG context, until recently there were no regulations that made it possible for parties other than the three large national oil companies to access the country's regasification terminals. In 2014, however, the National Development and Reform Commission (NDRC) issued third party access guidelines for the first time, primarily in response to requests from new participants pushing for access to the LNG terminals of CNOOC, CNPC and Sinopec. Notwithstanding this general policy supporting third party access, and the interest shown by new participants (including domestic gas distributors and suppliers like ENN, Guanghui and Jovo; city gas companies like Beijing Gas and China Gas; and power generators like Guangdong Development, Huadian and Huaneng), and average LNG terminal utilization rates hovering around 55%, the pace of progress for a formal third party access regime is frustratingly slow – as at the end of 2016, only ENN Holdings and Jovo had concluded spot LNG purchases, using the only two terminals which had made such capacity available on an ad hoc basis (CNPC's Rudong and Dalian terminals). Unsurprisingly most of the blame for this delay is attributed to the national oil companies which, having developed these terminals, are said to be reluctant to see their market share and revenues reduced for the benefit of new participants. However, as the liberalization process has shown in other places (namely Europe), mechanisms can be put in place to maximize utilization of key infrastructure like these terminals, while at the same time adequately rewarding those companies willing to invest their significant time and energy in such infrastructure.
Regulatory Issues for New Infrastructure: In light of the low utilization rates at the existing LNG terminals, it might seem inefficient for new participants to be developing their own new terminals. However, given the slow pace of development of the third party access regime, this is what a number of such companies are doing, and what the NDRC would appear to be encouraging. In 2014, Jovo became the first Chinese privately owned company to construct, own and operate an LNG receiving terminal (in Dongguan, Guangdong Province), while ENN is currently building a terminal (in Zhoushan, Zhejiang Province). However, there are significant regulatory, permitting, environmental and other obstacles to pursuing such an endeavour, not to mention the significant capital expenditure required. Moreover, the relatively more rapid and (developmentally) cost-effective floating storage and regasification unit model, which is being embraced by a number of new developers around the world, is increasingly difficult to implement in China due to high taxes and a lengthy approval process by maritime authorities and the NDRC.
Competing Sources of Fuel: Natural gas makes up a very small portion of China's current energy mix, approximately 5.5% of the country's total primary energy consumption. The largest share of the energy mix continues to sit with coal, which at 66% of total primary energy consumption leads by far all of the other sources combined. There is no doubt that coal is out of popular favour, both among ordinary people and the government, the combination of domestic urban air quality concerns and global environmental commitments made by President Xi and others. And while non-carbon-emitting energy sources (solar, wind, nuclear, etc) have a particular appeal, especially in light of China's 2015 United Nations Climate Change Conference (COP 21) obligations, natural gas represents something of a sweet spot between the reliability and cost-effectiveness of traditional energy sources and the cleanliness of renewables. Whether or not the current low price of LNG can help spur that growth further is unclear – interestingly, during the last period of low LNG prices (2015) falling prices did not particularly stimulate demand in China because competing fuels (both coal and renewables) were more attractive from an economic and policy perspective.
Alternative Sources of Gas: Notwithstanding that gas makes up a small portion of China's energy mix, China remains the third largest consumer of natural gas in the world. However it is a relative newcomer to the LNG business, having imported its first cargo of LNG in 2006. The primary reason for this is the significant domestic natural gas reserves of the country (both traditional onshore and offshore, and unconventional reserves). In addition, China has significant pipeline interconnectivity with neighboring countries which allows it to access significant volumes of natural gas. On the production front, natural gas output reached 13.6 billion cubic metres (BCM) in March of this year, while shale gas output surged more than 50% year-on-year to 1.15 BCM. The EIA estimates that China has shale gas reserves greater than 31,500 BCM, although there are significant technological and logistical obstacles to full exploitation of such resources. On the pipeline front, China has three main channels through which it can or will import natural gas, namely: (i) the Central Asian Gas Pipeline in its northwest region, which brings natural gas to China from Turkmenistan, Uzbekistan, and Kazakhstan; (ii) the Sino-Russian Pipeline in its northeast region which brings natural gas to China from Russia; and (iii) the Sino-Myanmar Pipeline in the southwest region which brings natural gas to China from Myanmar. LNG must compete with all of these sources, not only on pricing but also on a geopolitical policy basis.
Bridging The Gap
China is the world's most populous country with a fast-growing economy that has led it to be the largest energy consumer and producer in the world. Notwithstanding that its rate of economic growth and energy consumption is expected to decelerate in the coming years, it will continue to have significant and complex energy needs moving forward. The place that natural gas occupies in China's energy mix should only grow in the coming years, given that it would appear to satisfy a number of the goals set down by the Chinese Government domestically (including in the thirteenth Five-Year Plan (2016-2020)) and internationally (including in the context of COP 21). The role which LNG will play within the natural gas mix will ultimately depend on the viability and cost-effectiveness of alternative sources of natural gas and the ability of the national oil companies and the new participants (both from the private and public sector) to come together to develop and more efficiently utilize the infrastructure that is currently available to them and will need to be developed in the coming years. If managed properly, such a move should position China well to exploit the surge in LNG supply from the US and Australia that will come online in the coming years.