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Will Trump’s Beijing trip kick-start US LNG exports to China?

Will Trump’s Beijing trip kick-start US LNG exports to China?

Fresh from his 19th Party Congress triumph, President Xi Jinping will roll out the red carpet to welcome US President Donald Trump to Beijing on 8 November. The eyes of the world will be closely watching the state visit for any signs of progress on thorny issues in US-China relations, such as North Korea, the South China Sea, and – perhaps most prominently – economic relations.

Having chalked up few wins on the ‘America First’ front to-date, Trump will be keen to sign off on a series of commercial agreements that would enable POTUS to portray himself as a master dealmaker. One issue Trump is sure to champion is the ramping up of US LNG exports to China, which his administration has identified as a means to deliver on the president’s key campaign pledge – reducing the US’s large trade deficit with China. Of the 29 business leaders joining the US trade delegation, several will also be keen to promote increased LNG trade, most notably Jack Fusco (Cheniere), Langtry Meyer (Texas LNG), Fred Jones (Delfin), and Keith Meyer/Governor Walker (Alaska LNG).

Verisk Maplecroft has therefore teamed up with its sister company, Wood Mackenzie, to analyse the political, commercial and strategic factors that will influence the prospect of US gas exports to China, both now and over the longer term.

Political dynamics look conducive

US trade deficit with China

Despite the flow of protectionist rhetoric emanating from the White House, the Trump administration has steered clear of its campaign pledge to impose 45% tariffs on Chinese imports. While a less confrontational approach to trade with China has reduced the immediate prospect of a trade war, it means Trump has so-far failed to rein in the deficit (See Figure: US trade deficit with China). An increase in US LNG exports to China could help narrow the gap, although will realistically only represent a drop in the ocean.

From the get-go, the Trump administration has been championing American energy exports as its preferred instrument for narrowing the deficit in the wake of the US shale boom. A combination of rising export capacity in the US, LNG import demand growth in China, and political cheerleading has underpinned an uptick in LNG exports to China this year via third party, spot trades (See Figure: US LNG exports to China). An action plan agreed between Trump and Xi in May 2017 welcomed Chinese entities to buy US gas and enter into long-term supply deals with American operators. It was the clearest signal to-date of the two leaders’ mutual support for increasing bilateral LNG trade, although China’s importer have yet to commit to long-term supply directly from US projects.

The fact that Trump will arrive in Beijing with a large business delegation in tow, including a sizeable contingent from the energy sector, indicates that the White House is looking to secure concrete commercial agreements from the upcoming trip. In the wake of the 19th Party Congress, Xi Jinping is arguably the most powerful Chinese leader that an American president has faced across the negotiating table. Yet despite this position of strength, Xi may well calculate that it is in Beijing’s wider interest to allow Trump tweetable trade ‘wins’ during his first state visit to China. A headline-grabbing LNG deal or two would provide Beijing with leverage when negotiating on contentious issues – such as North Korea and the South China Sea – and deflect from a lack of concessions in areas such as easing market access for US firms.

Although gas supply deals are usually signed between commercial entities, Xi has the political power to cajole China’s big three oil companies (CNPC, Sinopec and CNOOC) into aligning with his political objectives. We would not be surprised if the trip results in several non-binding agreements with US operators for LNG supply. Any deals that are inked will most likely be in the form of a memorandum of understating (MOU) rather than a concrete sales purchasing agreement (SPA). Such an arrangement would be politically expedient, yet give Chinese buyers the flexibility to quietly back away from the deal down the line.

US LNG exports to China

China needs gas, but is US supply commercially attractive?

Politics aside, China’s gas demand is booming: Wood Mackenzie estimates that demand could reach 330 bcm by 2020, up from 206 bcm in 2016. Underpinning this uptick is the government’s aim to increase the role of natural gas within the country’s energy mix from 6% in 2016 to 8-10% by 2020. This policy objective is driven by Beijing’s attempt to shift towards a greener economy that is fuelled by a cleaner energy mix. China's rapidly growing demand will be met by a combination of domestic supply, pipeline imports and LNG. Wood Mackenzie estimates that LNG will capture a third of China’s gas demand growth.

The US is rapidly expanding its LNG export capacity and is set to become the third largest exporter by the early 2020s (Wood Mackenzie, 2017). However, greenfield US LNG is only one of many options on the market as LNG suppliers sell down well-stocked portfolios. Crucially, the economics of US supplies to China may be challenging and Chinese LNG buyers might find cheaper deals elsewhere. Making a commitment to US LNG means exposure to US gas prices, which may not be that attractive to buyers in China. Liquefaction and shipping from the US to China involve large fixed costs. US LNG developers also have to compete with the threat of lower cost expansions in Qatar and Australia, the current LNG export giants.

It is worth noting that US LNG supply does have some commercial benefits compared to more traditional export models. The deep and liquid nature of the US gas market means that LNG developers can offer more volume flexibility than is typical. Moreover, some US supply deals are being been sold without destination restriction, allowing buyers to sell-on their purchases when and where the economics makes sense. These benefits could be attractive to Chinese players seeking to grow their global LNG position.

Strategic picture is complicated

Strategic considerations will also influence how much LNG China is likely to import from the US over the longer term. China aims to maintain a well-diversified portfolio of gas suppliers and US imports could help ensure that Beijing does not become too dependent on any one state. Beijing is also mindful of the need to maintain varied commodity import routes, in order to minimise its exposure to potential supply disruption (See Figure: China natural gas imports and disruption risk). US supplies could help reduce China’s reliance on gas imports that transit strategic chokepoints, most notably the Strait of Hormuz and the Strait of Malacca.

The internal stability of energy suppliers is another important consideration for Beijing. Verisk Maplecroft’s Government Stability – Projections Index, shows that nine of China’s thirteen largest import partners are categorised as either high or medium risk. Meanwhile, the US is considered low risk and outscores China’s other gas suppliers in the index, suggesting that there is less potential for political instability to impact gas production or supply over the long term.

Nevertheless, geopolitical rivalries between the world’s two largest economies will ultimately act as an impediment to large-scale LNG trade, regardless of other factors. As illustrated in Verisk Maplecroft's Interstate Tension Index, there is a high risk of a diplomatic flare-up between China and the US leading to a militarised dispute. The potential for miscalculation and escalation could see the flow of hydrocarbons from the US to China interrupted in an extreme scenario. For this reason alone, China will never allow itself to become too reliant on gas imports from a strategic rival.

China natural gas imports and disruption risk

US suppliers will have to settle for a small slice of a big cake

Short-term political dynamics increase the likelihood of Trump leaving Beijing with a few MOUs under his belt. However, a combination of economic challenges and strategic misgiving suggest that US LNG suppliers are unlikely to find cracking the China market easy. Yet even a small slice would offer significant commercial opportunities for US suppliers willing to be flexible.

In our view, suppliers that tick all three of the political, commercial and strategic boxes are better placed to benefit from China’s growing gas demand. Most notably, US suppliers face stiff competition from Russia. Despite the existence of latent pressure points, Sino-Russian ties have warmed considerably under Xi Jinping and there is a deal of synergy between Moscow's 'Pivot to Asia' and Beijing's 'Belt and Road Initiative'. Energy cooperation has developed into the central plank of the bilateral relationship.

The latest manifestation of this burgeoning collaboration is the LNG co-operation agreement that CNPC signed with Russia's Novatek on 1 November, just one week before Trump was due to arrive in Beijing. But the bigger threat to US suppliers comes from Russia pipeline gas. In July, Gazprom and CNPC agreed on an accelerated timeline for first gas supplies to China via the Power of Siberia pipeline - now slated to come online on 20 December 2019. The early start to the 38 bcm, USD60 billion project means that China's LNG demand could slow to single-digit growth post-2020. This development does not close the door on future US LNG exports to China, but it is a sign of the fierce competition that American operators will face.

This research was co-authored by Hugo Brennan, Asia Politics Analyst and Kerry-Anne Shanks, Head of APAC Gas & LNG at Wood Mackenzie

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