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Energy

Tariff on US imports would add to price pressures on LNG from weak yuan and global market gain

A tariff on imports of US LNG would add to the rising cost burden for Chinese natural gas importers and consumers, already suffering from the impact of a weaker yuan and higher international market prices.

PUBLISHED : Wednesday, 08 August, 2018, 1:02pm
UPDATED : Wednesday, 08 August, 2018, 10:06pm

A potential 25 per cent tariff on imports of US liquefied natural gas would add to the rising cost burden for Chinese natural gas importers and consumers, but it is not their biggest worry, since they are already suffering from the impact of a weaker yuan and higher international market prices, according to analysts.

But higher prices are unlikely to dampen rapidly rising Chinese demand, as the government pushes ahead with its plan to switch much of the country to the cleaner-burning fuel from coal to reduce air pollution.

“In the short term, the tariff would likely raise [regional Chinese] LNG prices,” said Giles Farrer, research director of global gas and LNG supply at commodities consultancy Wood Mackenzie.

In the longer term, the potential tariff will allow developers of new gas projects outside the US to push for higher prices in new long-term contracts, he added. This would cement higher prices into the years ahead even if the factors pushing up prices ease.

The immediate impact on domestic prices from a tariff on US imports is likely be minimal, given US LNG accounts for less than five per cent of China's total gas supplies, said Elaine Wu, head of Asia ex-Japan power utilities and environmental equity research at JPMorgan Chase & Co..

The cost implication of a tariff on downstream distributors and consumers of the cleaner-burning fuel is uncertain, since wholesale and retail prices remain tightly regulated.

But for Chinese importers, they have more immediate and bigger worries to deal with than the potential tariff.

“The impact of the potential 25 per cent tariff on LNG is relatively modest compared to the recent cost escalation borne by Chinese importers from the yuan’s weakening and gas price rise,” said CIMB senior vice-president Keith Li, who covers China’s gas distribution sector.

The price of LNG on Singapore’s cash market surged almost 62 per cent from US$6.8 per million British Thermal Units (mmBtu) in late March to a high of US$11 per mmBtu in mid-June, before easing back to US$9.67 as of Tuesday.

The price surge, despite growth in overall supply, has been paced by stronger demand from mainland China, whose LNG imports surged 50 per cent in the 12 months to June this year, according to a JP Morgan report. Australia accounted for 44 per cent of those imports, followed Qatar at 20 per cent.

The mainland, which last year eclipsed South Korea as the world’s second largest LNG importer behind Japan, had to import 39 per cent of its gas needs last year, up from 29 per cent in 2012. That ratio is expected to rise further in the years ahead as domestic output growth will not be able keep pace with surging demand.

Chinese gas demand grew 17.5 per cent per cent in this year’s first half from the same period last year, faster than the 15.3 per cent gain during the whole of last year and the 6.6% rise in 2016, according to NDRC figures.

Demand jumped last year after Beijing’s “war on air pollution” accelerated plans to eliminate coal-fired boilers at factories and coal stoves in homes, replacing them with cleaner burning gas-fired units.

But during cold snaps, many villagers were caught out by a major shortage of gas supply and had no heating alternative as their coal-fired units had already been dismantled, forcing local governments to abruptly suspend gas supply to commercial and industrial users to divert it to households.

The global LNG market continues to enjoy a surplus supply of gas despite robust China-led demand growth, but that surplus is expected to disappear soon. If Chinese current strong import growth is maintained, and assuming demand elsewhere remains steady, current LNG production facilities globally would have to be run at full capacity to meet demand, which is not sustainable, according to a JP Morgan research report.

As the China government undoubtedly knew when it picked US LNG imports as a prime target is potential retaliatory tariffs, the US is expected to see the world’s largest new LNG export capacity expansion next year – more than doubling to 48.6 million tonnes per year in 2019 from 22.9 million tonnes in 2018. A higher price for US gas in China would mean the extra US capacity would be directed elsewhere, particularly to Europe following the agreement by the European Union to buy more US LNG as part of a deal to defuse their trade conflict with the US.

Alternative sources of gas for China buyers include Australia which is expected to see annual export capacity rise 10.4 per cent to 82.8 million tonne next year from this year, and Russia, where capacity is projected to increase 30.7 per cent to 23.4 million tonnes, according to a Sanford Bernstein research report.

In addition to the upwards pressures from rising global market prices and a potential tariff on US imports, China importers have had to contend with a weaker yuan exchange rate The offshore yuan has depreciated more than 9 per cent against the US dollar since it hit this year’s high on March 26, raising the yuan cost of imported LNG, which is priced in dollars.

The exact additional cost burden on PetroChina – the China’s largest gas importer – is not clear, since the energy giant does not make public the formulas at which its long-term import contracts’ gas prices are calculated, although it is widely known that they are partially linked to oil prices, which has risen substantially this year.

It has suffered tens of billion of yuan in import losses in previous years, since being a market dominant firm it bears the “social responsibility” to keep prices at an affordable level to help China meet its emission reduction and air quality improvement goals.

“For distributors and consumers, how much impact they will be hit with will depend largely on negotiations between state-backed PetroChina, the largest importer, and the regulator, the National Development and Reform Commission, on city-gate price hikes this winter,” Li said.

Dennis Ip, head of Hong Kong and China utilities equities research at Daiwa Capital Markets, said distributors are likely to have to absorb some cost increases and see moderate profit margin erosion in some markets this year.

The bulk of China’s natural gas is consumed in the winter and prices are typically settled once a year in late fall or early winter on annual volume allocations.

PetroChina was allowed to raise prices charged to distributors on previous year’s delivery volumes by 10 per cent in the 2016-17 winter season and by over 10 per cent in the 2017-18 season.

Additional volumes were sold at higher prices, subject to a 20 per cent cap above the city-gate prices.

Residential price discounts were eliminated earlier this year, boosting revenues for PetroChina and helping to offset its import losses.

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