Introduction
On August 3, 2018, the Chinese government announced a plan to implement tariffs against the United States, including a 25 percent penalty on Liquefied Natural Gas (LNG) imports. The question facing the market is, will the escalating “Trade War” put upcoming U.S. liquefaction projects at risk?
Some might say yes; China is an enormous market facing unprecedented LNG demand growth amid comprehensive energy transition programs backed by environmental policies. Thus, some may think China is key to U.S. LNG development.
Despite China’s strong influence, worldwide forward demand growth is likely robust enough to absorb any U.S. supply displaced by a lack of Chinese buyers. Ultimately, these tariffs will be minimally impactful to North American LNG development.
China's Involvement in the U.S. LNG Market:
China has limited involvement in the U.S. LNG landscape, aside from the partial financing of the upcoming Corpus Christi Liquefaction project, and a sale and purchase agreement between Cheniere and China National Petroleum Corporation that will commence toward the end of 2018. It is unknown if a Chinese import tariff will impact this contract, but Cheniere claims it will not be affected. The global distribution of American LNG (the U.S. ships to 28 countries) shows that American producers are not entirely dependent on Chinese contracts to support upcoming liquefaction capacity. However, while there are currently no active long-term LNG agreements between China and the U.S., approximately 10 percent of total U.S. LNG cargoes go to China on the spot market. China now has supply optionality among rapidly expanding LNG industries in Australia, Russia, Qatar, and Southeast Asia, meaning that Chinese buyers could shift away from these American volumes and still maintain strong portfolios.
If the tariffs materialize, China may move away from American supply in favor for more competitive, unregulated rates. In this case, upwards of 2 million tons per annum (MTPA) that the U.S. delivered to China last year could be displaced. This substantial amount of unaccounted fuel will grow as more U.S. LNG production comes online. An absence of buyers could cause upcoming projects, especially those that have yet to reach final investment decision, to ultimately withdraw. However, growing worldwide demand and the flexibility of rising one-off spot charters will provide the liquidity needed to bring these volumes to market.
Spot Charters Facilitate Liquidity
Spot charters are singular transactions not tied to prolonged contracts which are now an increasingly prevalent delivery method for LNG. The spot market is beginning to encroach upon more traditional term-based contracts, which are binding agreements that typically last for 20 years. The market share of this delivery method grew from 16 percent of total LNG shipments to 28 percent between 2009 and 2017.
This shift is occurring at a time when buyers are less reliant on long-term agreements with a single producer to guarantee consistent and reliable energy imports. As more liquefaction terminals come online globally, buyers can continue to diversify their LNG portfolios, and utilize more economic spot transactions without compromising their supply lines. Consumers will continue to engage in long-term contracts to secure a baseline supply, while using spot cargoes to optimize pricing and adjust for demand fluctuations.
Even if a tariff detracts Chinese buyers from doing business with American suppliers, the growth of spot charters around the world will provide enough liquidity for U.S. producers to compete in other markets. However, for this to work, worldwide demand must continue to grow.
Maturing Markets Promote Growth
To stay competitive in an environment where China is disincentivized from purchasing American gas, U.S. LNG suppliers must maintain relationships in other markets. These include regions with mature infrastructure and demand, such as Europe and India. Additionally, U.S. producers can expand to emerging markets in Northern Africa and South America that may seek term-based contracts to guarantee supply for their developing infrastructure.
Regasification utilization, meaning total LNG imports relative to capacity, is low in Europe, while capacity expansion is high in India. This is a good indicator that demand will continue to grow in these two prime consumer bases. Mature markets already have room to import more LNG, and emerging markets are investing in the infrastructure necessary to do so in the near future.
Asia is still the premier LNG demand region, consuming over 40 percent of total U.S. exports, but demand is quickly growing in more accessible shipping centers in Central and South America, and already make up 32 percent of total U.S. exports. Additionally, major Asian economies like South Korea and Japan are still the largest and third largest importers of U.S. LNG, respectively. Consequently, most U.S. cargoes economically displaced from China will be absorbed by a diverse selection of LNG players both new and old.
Ultimately the impacts of a Chinese tariff on U.S. LNG cargoes will not be completely insignificant, as trade flows may shift with Chinese buyers pursuing alternative suppliers, forcing U.S. producers to seek out other markets. However, robust demand growth around the world will provide U.S. gas with a sufficient amount of marketable destinations. As more liquefaction projects come online around the world, the real risk to U.S. exports lies in whether demand will keep up with this rapidly expanding supply.
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