The Fuse

China Drives Gas Consumption, U.S. Drives Supply

by Nick Cunningham | June 28, 2018

Global gas demand is set to rise by 1.6 percent annually through 2023, with China accounting for a significant portion of the increased consumption, according to a new report from the International Energy Agency (IEA).

The global gas trade is undergoing several major transformations, the energy agency said, with China driving demand and the U.S. accounting for the lion’s share of new supply. Meanwhile, in terms of use, gas demand will increasingly come from industrials, such as petrochemicals, rather than for electricity. While a wave of new supply is coming online in the next few years to meet this rising demand, the current shortfall of new investments means that the market could tighten significantly next decade.

China takes over demand story

China will dominate demand growth going forward, importing increasing volumes of LNG to replace coal-fired electricity and coal-burning furnaces.

China will dominate demand growth going forward, importing increasing volumes of LNG to replace coal-fired electricity and coal-burning furnaces. The government has made a concerted effort to slash the horrific air pollution that plagues many Chinese cities, to great effect. Gas demand jumped by 15 percent in 2017 and in the first six months of 2018 China’s LNG imports were up 55 percent compared to the same period a year earlier. The campaign has been so successful that China ran into gas shortages this past winter.

Looking forward, the same trends are expected to continue. The IEA expects China’s gas demand will grow at an average annual rate of 8 percent through 2023, which translates into China alone accounting for 37 percent of the global increase in natural gas consumption over that timeframe. As early as next year, China will become the world’s largest natural gas importer, a position long held by Japan.

India, Pakistan, and several other smaller emerging markets in Asia will also see LNG imports rise significantly. “The future imports’ growth of these emerging Asian players will however be determined by the competitiveness of LNG, as most of these markets are more price-sensitive than China or traditional Asian buyers such as Japan or Korea,” the IEA said.

Europe has seen a surprise uptick in LNG imports, even though overall gas demand remains mostly flat. The decline of gas production, led by the phase out of the enormous Dutch Groningen gas field, is increasing import dependence. A coal and nuclear phase out is also adding momentum to imports.

The industrial sector will likely take on a much more influential role in driving gas demand.

Over the past decade, natural gas has carved out market share in the electricity sector, eating into the position of coal, particularly in the U.S., but also in a growing number of other countries. However, “slower global electricity demand growth, the rapid rise of global renewable electricity production and tough competition from coal, particularly in Asia, limit” the growth prospects of gas in the electricity sector.

Instead, the industrial sector will likely take on a much more influential role in driving gas demand. The agency singled out chemicals, fertilizers, and feedstocks for other industrial processes.

New supply needed

On the supply side, the U.S. accounts for the bulk of the increase over the next five years, representing roughly 45 percent of gas production growth and three quarters of additional LNG export capacity. Upstream gas production is soaring in the U.S., the result of rapid growth from the Marcellus shale as well as significantly higher production of associated gas in the Permian basin, a byproduct of the oil drilling frenzy. In fact, the growth of associated gas is taking on a greater role, which will translate into both more gas exports via pipeline to Mexico and also LNG exports from the Gulf Coast.

By 2023, the U.S. will overtake Australia to become the world’s second largest LNG exporter, and it could even surpass Qatar to become the top exporter. For that to occur, however, it would require a handful of additional final investment decisions on new LNG export terminals in the next two years, the IEA says. Together, Australia, Qatar, and the U.S. will account for 60 percent of global LNG capacity by 2023.

Up until only recently, natural gas markets appeared as if they would be well supplied for years to come. However, surging demand, particularly in China, has soaked up a large portion of the expected surplus. The proliferation of floating storage regasification units (FSRUs) has “opened the door to LNG for a range of additional markets recently,” according to the IEA.

Rather than building massive import terminals, which takes years to build and often tens of billions of dollars of investment, countries can use an FSRU at a desired location, meeting short-, medium-, or even long-term import needs. For buyers, low upfront costs allow them to buy LNG cargoes for periods of time when gas is competitive, to meet seasonal demand or to fill a supply gap on short notice. Buyers also can avoid having to make long-term commitments. The use of FSRUs is multiplying, and in recent years has included Lithuania, Egypt, Jordan, Pakistan, Colombia, Turkey, the UAE, China, Malta, and Bangladesh.

In this year’s gas report, the IEA warned that insufficient investment could lead to a supply shortfall after 2023, a remarkable turnaround from years past when the market appeared to be well-supplied well into the 2020s.

“Nearly all the new liquefaction capacity should be operating by 2020. In the short run, this massive capacity addition is likely to result in a surplus,” the IEA wrote. “This loose market could be short-lived owing to the dynamic growth in Asian emerging markets. Without new investment, the average utilisation rate of liquefaction is likely to return to its pre-2017 level by 2023.”

“Without new investment, the average utilisation rate of liquefaction is likely to return to its pre-2017 level by 2023.”

The most likely candidates for new FIDs are projects in North America, the IEA concludes, because they do not require separate investment in upstream gas production, due to abundant supply. The IEA said that the surge of gas production from the Permian basin “provides a supply push, and is likely to incentivise further FIDs in U.S. LNG export projects,” but that it could take more than four years from the initial FID to achieve completion for a brownfield project. There are currently five LNG projects under construction in the U.S.—all on the Gulf Coast—plus four more that have received approvals but have not yet broken ground. Beyond that, there are a dozen more pending applications.

Uncertainties loom

There are still a wide array of uncertainties to these predictions. Demand could disappoint, especially if China suffers an economic slowdown. China’s main stock index, the Shanghai Composite Index, just entered a bear market, down 20 percent since January. The trade spat with the U.S. is putting pressure on the Chinese currency as well, and the turmoil could cut into China’s already decelerating economic growth rate. A slowdown in industrial activity could potentially drag down the growth rate in China’s natural gas consumption.

A slowdown in industrial activity could potentially drag down the growth rate in China’s natural gas consumption.

Also, the evolving nature of the LNG market creates heightened uncertainty for new FIDs. LNG importers are increasingly balking at the long-term fixed-price contracts that have traditionally dominated the LNG trade. New sources of supply have increased liquidity and bolstered the use of the spot market, reducing the need to secure long-term contracts. These changes, which are still in flux, are undercutting LNG exporters. Ultimately, that is deterring developers from greenlighting new export terminals, which could lead to a tight market beyond 2023.

In the short term, the trade war between the U.S. and China could pose some hurdles to an expanded gas trade. Up until now, LNG has not been hit with tariffs, but China has proposed a 25 percent retaliatory tariff on U.S. crude imports. LNG could yet become ensnared in the fight if retaliatory measures continue.

Despite the uncertainties, the long-term trends in the gas market are becoming clear. Natural gas demand continues to rise at a faster rate than crude oil, and will fuel growth in a variety of industrial applications. Asia, and China in particular, will dominate demand growth over the next five years, while the bulk of new supply will come from the United States.

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