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Chinese oil companies try to renegotiate import deals

Sinopec is negotiating with Origin amid weak gas demand and oversupply on their own soil

Chinese national oil companies (NOCs) are desperately trying to renegotiate term liquefied natural gas (LNG) import deals as they face weaker gas demand and oversupply at home. Talk of reneging on deals, seems just that, but such a move could trigger the collapse of long-term contract pricing formulas, especially if an established Asian buyer followed suit, analysts reckon.

Sinopec, China’s second-largest NOC, is attempting to renegotiate its term deal with the Origin-led Australia Pacific LNG (APLNG) scheme, resorting to various negotiating tactics, sources close to the project told Petroleum Economist. This include potentially forced delays in the construction of its Guangxi LNG import terminal, originally scheduled to be finished by October 2015. But the APLNG partners are unlikely to buy such rationale as China has excess regasification capacity. Only 20m tonnes of LNG were imported last year, much less than its receiving capacity of 32.5m t/y, which is expected to jump nearly three-fold by 2018.

Sinopec is likelier to seek to delay the ramp-up of LNG production, as well as try to resell cargoes in the Asia Pacific markets. 

Still, the main challenge will be to market the very lean gas, which the larger LNG buyers may not want to buy without a big discount on price, Liutong Zhang, a consultant at the Hong Kong-based Lantau Group told Petroleum Economist.

Rich-gas cargoes have traditionally supported North Asian markets, but lean stems – high in methane but lacking gas liquids – are more likely to support the newer markets.

“The NOCs are over contracted as domestic demand has slowed down so far in 2015. As supply ramps up this year it's likely they'll almost be choking on LNG,” David Brown, a Beijing-based gas specialist at energy research company Wood Mackenzie told Petroleum Economist

Japan gas price forecasts

Data from Wood Mackenzie shows the Chinese NOCs will be over-contracted by about 13m t of LNG – almost a third of the total 48m t/y of term deals already in place – from 2015 till 2017. Brown estimates the Chinese NOCs could be seeking to resell considerable volumes of LNG over the next two to three years.

As gas demand wavers, new contracts, largely from Australia, will ramp up through 2015, ultimately supplying an addition of around 16m-17m t/y into the domestic market by 2018.

Gas demand growth in China has been cut significantly. Demand is now expected to hit around 360bn cubic metres (cm) – roughly equal to 261m t of LNG – in 2020, compared with 420bn cm previously, as short-term and structural drivers bite, estimates from Wood Mackenzie show.

Given the significant downward revision in demand the NOCs are pursuing numerous channels to cut volumes, including scaling back domestic investment in more costly developments; managing rising pipeline imports using take-or-pay revisions, and renegotiating term LNG deals. 

Still, with average city-gate gas prices in parts of eastern China higher than long-term LNG prices it makes economic sense for the NOCs to offload some LNG at home. But even at times of higher demand it is unlikely that all contracted LNG will find a market in China, said Gavin Thompson, an Asian gas expert at Wood Mackenzie.

An oil price recovery, which would encourage fuel switching, ought to stimulate Chinese gas demand and hence create more space for LNG, but the timing is unsure.

A recent note from consultancy Facts Global Energy (FGE), citing the changing dynamics of the LNG market, highlighted that LNG contract sanctity is not what it used to be.

Jeff Brown, president of FGE, based in Singapore, expects long-term LNG contract renegotiation pressures to grow.

With surging supplies out of Australia and the US, Asian spot prices are likely to track well below term contract prices for several years. Low-priced spot cargoes are already likely backing out long-term cargoes at the margin in China and India, he said.

Aside from the Chinese NOCs, India’s Petronet is seeking to renegotiate a major LNG contract and is reportedly taking less than contracted volumes. 

In future, legacy buyers, such as Japan, South Korea and Taiwan, might more openly pursue a strategy of buying low-priced cargoes, while backing out of long-term contracted volumes. This may seem unlikely, but given the challenges many Japanese utilities face, it is not implausible. 

And if an established buyer follows this approach, others could follow, says FGE. As a result, the sanctity of price formulas in long-term deals could begin to unravel, with buyers, sellers, and – perhaps more importantly – financiers starting to question the value of the price clause in long-term LNG contracts, added Brown.

If this happens, both buyers and sellers may seek out a spot LNG price linkage that more accurately reflects short-term market conditions, thereby limiting the incentive to either take or deliver less than contracted volumes.

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