Alexander Sobko
In a recent article, we discussed that our im-portant competitive advantage in the difficult negotiations over future gas sales to China would be the guarantee of supply that the pipeline could provide, as opposed to the uncertainties of buying LNG.
This argument is very important, but it can be considered by critics as “propaganda”, and therefore the disclosure of this thesis requires detailed consideration. Two aspects immediately appear here. The first is questions of geopolitics and energy security, the second is economics. However, they are closely related.
On the first aspect, different interpretations are possible, and for a particular reader, of course, everything depends on their own vision of the development of the political situation in the world and, accordingly, the possible risks for China. But the naval blockade of the PRC in the event of a significant deterioration in relations between China and the United States ten years ago from time to time became a topic for theoretical discussions. In the context of LNG, the growing role of America is now added to this – the United States now accounts for over 20 percent of this market. And recent events in the world are a good illustration of the fact that the risks of LNG supplies, as well as other goods, are much higher than it might seem.
Let’s move on to the economic aspects. It’s easier here: less speculation and more facts. First, let us briefly recall how the LNG market was supposed to develop over the next ten to twenty years. Average annual demand growth rate of about four percent, with the bulk of the increase coming from developing countries. Among the proposals are mainly new factories in the USA, also Russia, East Africa, Qatar.
What changed? Factories in Qatar will be commissioned according to plan, but these volumes are already scheduled in the future balance of demand growth. At the same time, almost all planned LNG plants in Russia are falling out or strongly shifted “to the right” due to recent sanctions on equipment. In East Africa (with the exception of a relatively small floating factory), major projects have also stalled amid the intensification of militants in Mozambique. And even in the US there are questions. Yes, some new factories will be built, but will there be enough of them. Recall that some forecasts assume that by 2040 two hundred (!) million tons of new LNG plants in the United States will be operating – this is 2.5 times more than in the country now. Obviously, this is a very optimistic forecast. And all these volumes are taken into account in the global balance of supply and demand.
At the same time, the United States now has record domestic gas prices at thirteen-year highs. Against the backdrop of growing LNG exports, prices have more than doubled from their usual levels. Of course, quotes (about $300 per thousand cubic meters) are still much lower than in the world. But all this creates opposition to a new wave of large-scale LNG exports.
With regard to global demand for gas and LNG, the pace may temporarily slow down against the backdrop of high prices, but in general we should expect growth close to the planned one. Bottom line: there will be no additional LNG to Europe to replace Russian gas supplies to Russia. Under these conditions, only the transfer of pipeline gas from Russia, previously destined for Europe, can ensure the growth of demand for gas from China. Actually, this is why China is interested in new supplies of pipeline gas. LNG is simply not enough to even partially replace Russian gas in Europe, while maintaining the previously planned volumes in Asia.
But what’s interesting. Against this background, it is China that is very actively contracting new LNG under long-term contracts. Last year – 22 million tons. Among these contracts are future deliveries from the United States.
Moreover, already this year, at the end of March and beginning of April, the Chinese ENN concludes new long-term contracts with the owners of the US LNG plants that have not yet been built in the amount of another 4.2 million tons. Even Western observers are ironic: Europe is talking about replacing Russian gas with American LNG, but China is making real agreements.
We will immediately answer a possible objection. And why does China massively conclude such agreements with the United States, if there are risks of non-delivery in the event of any conflicts. We repeat: there are simply not so many other LNG in the world, so China takes everything that is available. Moreover, you only need to pay upon delivery.
Let’s make a small generalization: what are the options for buying LNG – from the most unreliable to the most reliable?
The easiest option is to buy from traders in the spot market. This is what Europe is doing now, as a result of which most of the American LNG is now getting to it. The cons are clear: the buyer accepts the current price and, moreover, has no guarantees of delivery. On the plus side, there are no obligations.
Second option. This is a medium or long term contract. Here you can negotiate the price and there are at least some guarantees. Although not 100%, as we saw quite recently, when LNG sellers to Pakistan under oil-pegged contracts simply canceled these contracts, paying a penalty and selling fuel at spot market prices to other buyers.
For long-term contracts, two options can be distinguished. Contracts on the principle of “self-delivery” by the buyer and delivery by the seller to the point of consumption. Accordingly, in the first case, the buyer owns the fleet or leases it. As a rule, contracts for American LNG are concluded on the terms of “self-delivery”. And in the second option, the gas carriers belong to the seller. A good example here is Qatar, which owns the largest fleet of LNG carriers and usually delivers LNG itself. Of course, traders also have a fleet. It is clear that “self-delivery” gives more guarantees to the buyer, since the seller does not have the opportunity to independently redirect LNG to another point. But there are risks everywhere, in a critical situation, the seller may simply not ship the goods.
And the third option: direct participation of the buyer in the LNG project. It would seem that this is the most reliable option. By and large, there is not much difference with a long-term contract for the buyer, but there are more guarantees, the investor actually owns his share of LNG in production. But there are also risks, because the investor invests his money immediately at the construction stage, and the buyer under the contract pays for the deliveries after the fact. Therefore, this option is more common between companies from countries with a high level of mutual trust. For example, Japanese companies invested in the first wave of American LNG projects in this way. But not the Chinese, which are now signing the usual long-term contracts.
And here it is impossible not to recall the recent news. Chinese CNOOC announced that it wants to sell its mining assets in Canada, the US and the UK, which it got a few years ago when buying the Canadian company Nexen. Among the reasons directly mentioned is the risk of sanctions due to the growing tension in relations with the West.
Let’s summarize. Additional LNG (to replace Russian gas in Europe) in excess of the forecast is not yet visible, on the contrary, there are risks that the supply will be lower. But against this background, Europe is in no hurry to conclude contracts with American manufacturers, although China does. In order for the total gas balance on the global market to converge, it is necessary that the unclaimed volumes of Russian gas on the European market be redirected to Asia. It is difficult to predict the further development of events in the military-political vein, but so far the tension is rather growing. Recall that we are talking about the development of events in five years and beyond, during which time new LNG plants and a new gas pipeline in China will be built.
In the most toothless scenario, Chinese companies will act as traders and resell American LNG to Europe if it turns out to be superfluous for them. By the way, this is important in the context of pricing for our pipeline gas for China. Perhaps it would be reasonable to include a peg to US LNG prices, since the possibility of interchange is already being looked at. How events will develop if Europe really needs all American LNG, and China and other buyers want to take their part for themselves, is still difficult to say.
But a more tense scenario is not ruled out, when the US decides who to ship LNG to and who not. In this case, the position of other major players will play an important role. After all, if the problem is only in American gas, then it can be “exchanged” for other supplies, as was the case three years ago during the trade war between the US and China. We generally leave out the options for a naval blockade.
How events will develop, we do not know. But in any case, in the current circumstances, the importance of Russian pipeline gas for China is growing: there are no plans for excess LNG on the market, and the one that will be associated with risks. And because Europe may really need it, and in the event of an aggravation of the confrontation betw-een the two superpowers.
