Due to the low oil price, weaker economic growth and structural change in overall energy intensity in the economy, China’s LNG demand dropped slightly in 2015, the first time since 2006. But we still believe there is huge potential for LNG demand growth in China considering its economic scale and population. Importantly, natural gas only contributes 5.3% of the primary energy supply in the country and gas-fired power generates less than 3% of total power generation, far below the average level in developed countries.
Three major factors are driving LNG market growth in China:
- Growing gas demand, especially in the power sector. The National Energy Administration (“NEA”) has published the power plan for the 13th Five-Year Period (2016-2020). This plan specifies that power demand is expected to grow at 3.6%~4.4.% to reach around 7000 TWh by 2020. Installed capacity for gas power is planned to double to have 100 GW by 2020.
- Third-party access to gas and LNG infrastructure. The Chinese government has pushed for market liberalization in the gas industry and issued several announcements since 2014 to encourage third-party access to existing LNG terminals and participation in gas infrastructure by private companies and local state-owned companies. Following the NEA’s recent requirement to all state-owned oil and gas companies, announced in September 2016, three NOCs (CNPC, Sinopec and CNOOC) have established official websites for gas assets including gas pipeline, LNG terminals, etc. It is anticipated that the Chinese government will continue to push for market liberalization and encourage non-NOC participation, through measures that are likely to include access to LNG terminals and localized and simplified terminal approval process.
- The current international market environment is favorable to LNG buyers. LNG buyers have more bargaining power in the market and current low spot LNG prices provides a good opportunity for new players to develop capabilities before committing to a long-term deal.
Seeing these opportunities, a large number of non-NOCs are actively planning to enter into the LNG business. They can be categorized into the following:
- Power companies (mainly state-owned)
- Gas wholesalers / distributors
- Local city gas companies (mainly state-owned)
- LPG and oil players (mainly traders)
It is important that the gas market is liberalized with more and various companies participating. However, the LNG business requires not only large investment capital but also significant industrial experience to ensure operational success as well as business capability to mitigate market risks. These 2nd tier players are new to the LNG industry and therefore lack LNG industry knowledge and operational experience. Furthermore, the new player face major uncertainties in the market, including:
- Gas demand growth uncertainties, influenced by the economic growth slowdown and structural change towards less energy-intensity sectors.
- Large competition from pipeline gas imports and LNG imported by NOCs, particularly in view of potentially over-committed long-term pipeline gas supply and LNG supply through 2020. Such competing sources include a total of 135 bcm/y in long-term pipeline gas imports from Central Asia / Myanmar / Russia (by CNPC) and over 40 MMt/y long-term LNG contracts imported by the three NOCs.
- Price risks related to the regulated gas price mechanism, which could significantly dampen players’ profitability and flexibility.
It is understood that international suppliers are paying more attention to these second-tier LNG players, who do not have LNG terminals or LNG experience. It is likely that these suppliers would present good offers to attract these new buyers. However, buyers’ due diligence is very critical to suppliers before such a business commitment should be made, with the special focus in the following areas:
- Buyers’ credit rating and asset positions
- Buyers’ downstream business (to assess the reliability of the gas/LNG demand)
- Buyers’ affordability or sensitivity & to gas price (to test their ability to bear/mitigate price risks)
- Buyers’ relationship with local governments and NOCs (to assess the likelihood for third-party access to LNG terminals or construct new-build terminals)
- Buyers’ exposure to international business (to ensure a cultural fit with international business environment)
- Buyers’ decision making process (to ensure a prompt communication)
China has a huge potential for LNG demand growth and many second tier players are planning to enter into the LNG business. It is important for international suppliers to pay more attention to these emerging players as the drivers of incremental demand growth. However, these players could have different strategic focuses and performance patterns reflecting their business models and positions. We suggest suppliers undertake a screening process to shortlist the high potential buyers and then develop tactics and approach tailored to each shortlisted player. A detailed due diligence will be critical to ensure a long-term business success with these new buyers.