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State-run oil and gas major China National Offshore Oil Corp (CNOOC) took the unprecedented step on February 6 of declaring force majeure with at least three of its major liquified natural gas (LNG) suppliers, including Royal Dutch Shell, France’s Total SA and BP, due to the coronavirus crisis.
CNOOC declared force majeure, which allows companies to opt out of contractual obligations due to events beyond their control, for both February and March LNG purchases, a new big blow for an industry already in turmoil due to a historic supply overhang and anemic market prices.
As recently as last week, China said it would provide support to state energy companies seeking to declare force majeure on their international contracts due to the coronavirus epidemic. Total SA, which supplies a large part of China’s contractual LNG supply, unsurprisingly rejected the declaration.
“Of course, we have to be careful, if there is a real quarantine in all unloading ports in China, we have a real case for force majeure,” said Philippe Sauquet, Total SA’s president for gas, renewables and power. “But for the time being, this is not the case. For me it is ordinary negotiation.”
Shell and BP did not immediately comment on the announcement, according to news reports. Other suppliers of CNOOC’s contracts include Australia’s North West Shelf and Queensland Curtis LNG, Malaysia’s Bintulu, and Qatargas, according to press reports.
The coronavirus emergency is sending shockwaves through the Chinese economy, diminishing demand for natural gas used primarily in its faltering industrial sector. That, in turn, is causing chaos in global supply chains, as rising travel restrictions and growing panic disrupt interlinked businesses across the globe.
China has said that it did not have enough personnel to work in many of its LNG import facilities due to the viral outbreak. A report by IHS said that China’s LNG demand growth could fall as much as 38% due to the spreading health emergency.
That’s raising concerns that other major Chinese LNG importers may soon follow suit.
CNOOC’s move will put even more downward pressure on LNG spot prices in the Asia-Pacific region, which accounts for around two-thirds of global demand.
That demand is projected to increase going forward from newer LNG importers, including India, Pakistan, Bangladesh, Thailand and soon Vietnam and the Philippines.
Though LNG demand growth in legacy buyers like Japan, South Korea and Taiwan is expected to remain mostly flat in the near term, new demand from other Asian buyers, as well as China, guarantees that the region will continue to dominate markets for the super cooled fuel.
LNG prices in Asia were already tanking before CNOOC’s force majeure declaration. On February 5, LNG spot prices in the region dipped to US$3 per million British thermal units (MMBtu), the lowest price point on record.
In early January, prices were over $5/MMBtu (See graphic). CNOOC’s move means the stage is now set for subpar $3/MMBtu prices, a price collapse that will negatively hit producers and traders.
“The fundamentals were already really weak [before CNOOC declared force majeure],” said Ira Joseph, head of gas and power analytics at S&P Global Platts, which tracks LNG prices. “The whole market is really oversupplied.”
To put the subpar $3/MMBtu possibility in perspective, LNG spot prices in Asia breached $20/MMBtu in February 2014, amid a then somewhat limited supply of the fuel and increased spot purchases by Japan.
At the time, Japan was still grappling with replacing lost nuclear capacity needed for power generation in the wake of the 2013 Fukushima Daiichi nuclear disaster, which eventually forced all of its 50 plus nuclear facilities out of service due to safety concerns.
The problem for LNG markets, notwithstanding China’s evaporating demand amid the coronavirus outbreak, is a coincident ramping up of US shale gas production and LNG exports, as well as new supply hitting the market from Australia and others.
At least five LNG projects reached final investment decisions (FID) last year, more than any other year on record, with three in the US, and the others in Mozambique and Russia. The projects combined would have capacity of 9 billion cubic feet (bcf) of natural gas per day, energy consultancy Wood Mackenzie said.
Added to the quandary, at least for producers, is Qatar’s recent announcement that it plans to increase its liquefaction capacity to a record-breaking 126 million tons per annum (mtpa), from a current 77 mtpa, boosting the possibility that current oversupply and low prices could well persist until the mid-part of the decade.
For buyers in Asia, like Japan, India and others, falling LNG prices is a boon. Japan has been taking the opportunity to become a major secondary trader of the fuel.
India is leveraging collapsing prices to pressure its main supplier Qatar to renegotiate long-term off-take agreements originally pegged to an expensive Brent crude oil price indexation. Delhi is also procuring record amounts of LNG on the spot market to help cover a domestic gas crunch from both demand growth and a shortage of domestic gas production.
Suffice to say, global LNG has turned from being a seller’s to a buyer’s market in just a number of years. Producers will have to become more creative in selling volumes, financing models, investing in LNG value chains and cost cutting as part of their business models while they wait for semblance of market equilibrium to return.
For producers, the problem of lower prices is paramount. With prices now in the lower $3/MMBtu range and the growing threat that they will soon dip below the psychologically important $3/MMBtu price point, many producers will scramble just to cover costs, while others could forgo deliveries all together to avoid losses.
Weak prices will also force a temporary underutilization of US liquefaction capacity this summer period. Given that it typically costs about $2/MMBtu to liquefy and ship the fuel to Asia, producers now face severe market headwinds.
Warmer than normal temperatures in North Asia have also contributed to the current market overhang, as legacy buyers Japan, South Korea and Taiwan, as well as China, have all reported ample inventories of the super cooled fuel – an unusual situation for this time of year when inventories are often low due to colder weather and increased demand.
Last month, before the coronavirus outbreak hit Chinese demand, some of its firms were already trying to offload unwanted LNG cargoes on an already over-supplied spot market.