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Trade war spills over

US-China tensions likely to prompt shift in crude, LNG flows

The escalating trade conflict between Donald Trump's US Administration and China overflowed into energy markets in August, as China announced that it's prepared to impose tariffs of up to 25% on US energy exports. Analysts and industry officials believe the tariffs, if imposed, could have significant longer-term effects on the US oil and liquefied natural gas industries.

Since the US renewed large-scale exports of crude oil in 2015 and LNG from the Lower 48 States in 2016, China has emerged as a significant importer of both. The US Energy Information Administration (EIA) says that, in 2017, China took in 224,000 barrels a day, or 20% of US oil exports. By May of this year US exports to China had risen to 427,000 b/d. China is also the world's third-largest importer of US LNG, taking in nearly 14% of all LNG exports since exports from the US Gulf began.

Immediate reaction to China's announcement focused on the Chinese tariffs' threat to LNG sales. Analysts thought that the near-term effect of Chinese tariffs might be limited. "In the short term, the tariff would likely raise LNG prices. Chinese buyers would bear the burden of the tariff because there is enough demand outside of China for US LNG", says Giles Farrer, Research Director of Global Gas and LNG supply at consultancy Wood Mackenzie. Any decline in deliveries of US LNG to China would likely be offset by imports from other producers, including Qatar, Papua New Guinea, and Australia. Ironically, US oil companies are heavily invested in LNG projects in all three countries.

Longer term, however, growth in US LNG exports could be slowed by tariffs constraining access to the Chinese market, the world's second-largest. While US LNG projects that are operational and under construction likely won't be affected, development of later projects could be slowed as developers try to find long-term purchasers. Canadian LNG projects could receive a boost. It isn't clear whether existing sales contracts with Chinese buyers will be affected. Cheniere Energy's contract with China National Petroleum Corporation, announced in February, won't reach full export volumes until 2023. Chinese and portfolio buyers of US LNG could shift cargo destinations, so FOB US gas won't be discharged in China. Chinese domestic gas prices, which aren't directly linked to LNG, likely won't be affected, says Wood Mackenzie's Farrer.

The effect of tariffs on Chinese imports of US crude is hard to quantify. Oil industry officials note that it's unclear what grades of crude China imports from the US. If, as many assume, these are mainly light tight oil, then US LTO producers may face further difficulties in getting their crude accepted by a market which has so far been reluctant to risk the quality variations and high light product yields of LTO. Backing out of purchases of LTO and light conventional US crudes would pressure sweet-sour crude spreads in the Atlantic Basin and increase the competitiveness of other sweet grades. But if China's imports are weighted towards heavier, sour grades such as Mars or Southern Green Canyon, then substitute crudes will be readily available from traditional Mideast suppliers and price effects are likely to be minimal, industry officials say.

Such processes may already be underway. Sinopec, China's largest refiner, has reportedly delayed committing to any purchases of US crudes for September loading, and China's independent refiners are widely said to be reducing throughput. Oil industry officials say that after a runup in Chinese purchases of US crude earlier this year, they haven't heard any overt declarations from Chinese companies regarding reduced US crude acquisitions, but note that such decisions are likely to be taken away from the limelight, particularly given the uncertainties of the current trade war rhetoric.

Away from mainstream products, analysts say Chinese buyers could substitute US propane imports by buying more from traditional Gulf liquefied petroleum gas suppliers. Many US propane sellers had hoped to increase sales to the Far East, with China as a key target market because of the rise of propane dehydrogenation technology in its petrochemicals industry.

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