China Succumbs to the Market Over LNG

Relevance: The key significance of the two LNG import deals announced in September 2007 by PetroChina are the prices agreed with Woodside and Shell. The implied prices for the deals are in the range $10-12/MMBtu (according to publicly released data and various commentaries). This is far in excess of the Chinese National Development and Reform Commission (NDRC) sanctioned price for gas imports to China of approximately $5.30/MMBtu, and much closer to the range of prices agreed by Japan, Korea, Taiwan and others in the region for import of LNG. Either the NDRC is now willing to sanction higher price imports, or PetroChina is betting that the “free market” sector of the Chinese gas industry will be strong in the years to come. 

AnalysisChina is hungry for gas: to reduce its dependency on oil and to reduce its emissions of greenhouse gases. Unfortunately its (largely) centrally determined gas prices are too low to ensure a fair return for gas producers and too high to be competitive with domestic coal (whose price is also centrally set). Domestic coal faces a similar problem in that it is expensive to extract and in the wrong place (the north west of the country, away from the markets), with producers struggling to make an adequate return. 

The result has been a political standoff (domestic coal jobs versus the environment versus security of supply) and an LNG import industry that has struggled to become established. Chinese projections for 5 new LNG regas terminals by 2010 and a ramp up in the medium term of LNG imports from the current 3.7MTPA to around 60MTPA always looked unrealistic in the face of strong Asia LNG prices.

The role of the National Development and Reform Commission (NDRC): Historically, the NDRC has set end user prices for natural gas, electricity and gasoline. Pre 1995 China had a quota based system for gas volumes and regulated prices. The NDRC would allocate gas to priority customers at very low prices. Any surplus gas could be sold freely with a NDRC price bracket.

A change mandated in 1995 meant that for all new developments post 1997, gas contracts could be negotiated freely between the producer and consumer, but they would have to be approved by the NDRC. There was a further requirement that the NDRC has to provide licenses for all imports and exports of gas.

The result is a system where most gas (price and volumes) is under the control of the NDRC with a small “free market” sector. The NDRC import price limit is in the region of $5.30-5.50/MMBtu.

Chinese Intransigence in the Face of Rising LNG Prices: the first Chinese LNG import contract was from the NWS to Guangdong Terminal (CNOOC) for 3.7MTPA over 25 years. First deliveries in the 05/06 time frame were at, by today’s standards, a very low $3.8/MMBtu.

The second terminal in Fujian is currently being built. There is a 3MTPA, 25 year contract for a start date of 2009 between CNOOC and Tangguh (Indonesia). The price is reportedly $4.30/MMBtu.

The latest sanctioned project is the CNOOC (again) Shanghai import terminal. This started construction in Jan 2007. The supply is from Petronas (Malaysia) for 3MTPA at a price of $5-6/MMBtu.

With legacy contracts at such low prices, and a willingness by Petronas to sell at less than market to achieve “breakthrough” into the Chinese market, it is easy to see why the Chinese were reluctant to consider the new reality of prices in the Asia region of $10-12/MMBtu (now regularly being agreed by the Japanese).

China Gets a Reality Check on LNG Prices: The result of this intransigence by the Chinese was a dearth of LNG supply contracts. CNOOC’s experience with Chevron in 2006 over supply from the Gorgon project, where CNOOC refused the asking price of $8/MMBtu and Chevron promptly sold at the same price to 3 Japanese utilities, must have been instructive.

China Shows Flexibility over LNG Prices: With strong support for high LNG prices in Asia in the medium term (including the scarcity newly sanctioned LNG liquefaction projects – Nigeria, Angola, Indonesia and Peru are, for example, all faced delays) it was natural that China would rethink.

Proof of this rethink came earlier in 2007 when the NDRC (most likely) sanctioned spot imports to the Guangdong terminal at, reportedly, $8/MMBtu.

Significance of Woodside and Shell Deals: The Woodside deal (3-4MTPA from Browse for 15-20 years and $29-37B revenues) implies an LNG price of around $10/MMBtu. The media reports a slightly higher price for supply from Shell’s interest in Gorgon (1MTPA, 20 years).

This is significant because it means that either:

  1. The NDRC is now sanctioning higher prices for LNG import to regulated markets, or
  2. PetroChina believes that there will be strong growth in volume and price for the (small) unregulated sector of the Chinese market. At the minimum PetroChina will be setting a “free market” benchmark that puts pressure on regulated prices.

14 September 2007

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