Beyond the Terminal

On the development of the inland LNG market in China
By: Mark Lay, Deputy General Manager, Financial Trading, ENN Energy Trading
There is much discussion today about the rapid growth of the LNG market. Most of this discussion is focused on shiploads of product transiting oceans. Even the recent resurgence of FSRUs remains at the shipload scale in a world of huge credit and tight margins where profit depends on charter rates and managing a global portfolio.
There is another market that is rapidly developing around the world. This is the world of LNG beyond the terminal. Energy demand has driven this market into trucking and barges. Virtual pipelines are becoming a force for utility owners to scale their expansions with lower risk or entrepreneurs to capture future market distribution points anticipating pipeline growth in to a market.
Large scale, industrial applications in remote regions, where the cost of diesel makes LNG economic, are equally interesting. Imagine a coast to mine implementation of an LNG fuel supply chain that cuts the fuel operating costs for a facility by 40%.
Arguably, the most vibrant market for small-scale LNG is inland China. In 2016, China consumed 13.3 million tonnes of LNG as liquid delivered by trucks. This market is roughly 1/3 each for transportation, industrial (including electricity) and urban distribution. The terminal operators, mainly SOEs, maintain their own operations, but they remain focused on larger scale opportunities and growing pipeline shipments.
The point to point marketing is dominated by smaller companies. ENN Energy Trading is the largest among a field of competitors.
The exciting part about this market is that it is a true market. There are certain boundary limitations. Our pricing is impacted by the twice-yearly government price changes in pipeline prices and resource supplies. There are regulatory drivers like the increased emphasis on clean air. The most significant drivers are fundamental supply and demand.
The market for inland liquid emerged as the SOEs finished terminals and found the pipeline networks connected to them to not have sufficient offtake needs. The lower capacity utilization is one reason the government allows terminals to collect terminal charges that are a multiple of global norms.
The lower pipeline takeaway capacity naturally lead to marketing LNG as a fuel for transportation and industrial applications. With the emergence of the liquid supply chain, independent merchants entered the market taking the liquid great distances (some delivery routes in China are 1,000 km). The accelerated growth of this offtake has even lead to the development of terminals that only have truck racks for their distribution.
Almost all of the terminals are controlled by one of the SOEs. It is interesting to see how the different companies seem to have unique personalities. Universal among the general managers in charge of the facilities is the desire to meet their annual throughput objectives. This leads to tiered pricing designed to maximize offtake. For the terminals that are in mature markets where there is enough offtake to reduce the logistics circle, pricing reflects a desire to defend a specific market area.
This year marks a major change for the terminals. Much like the LNG production projects that they supported, there are multiple terminals finishing construction this year.  LNG producers may be excited by the prospect of these large off-take contracts starting to move, but they are moving in to markets where the growth predictions of 2013 and 14 are not being met. Each of the major trading regions, Guangdong, Shanghai and Shandong, are preparing for 30% or greater increases in import capacity.
Some of these terminals are the ones mentioned earlier where trucks are the only offtake mechanism. Most importantly, each of these regions will host a non-SOE player with significant spot capacity that will be available to arbitrage the depressed international market against the term agreements signed by the SOEs.
In addition to this capacity, there has been significant growth in the inland production capacity. These plants depend on the price of resources allocated by the central government. Again, this pricing follows seasonal patterns with twice per year price changes. These prices are designed to make sure the producer is able to maintain their production flow and maximize economics.
This year, we saw a coordinated effort by the plants to manage capacity to avoid seasonal oversupply that destroyed prices last spring. The creation of production cooperatives helped support the market for a gentler seasonal repricing and helped the operating producers continue to generate cash flow. The need for such cooperation is testimony to the overbuilt capacity.
The market for LNG is still in its earliest stages. Only this year, ENN introduced fixed priced transactions through a portfolio trading model that I developed for the company. The customer interest has been even greater than we anticipated. Today we are working through the challenges of liquidated damages and credit, not customer interest.  The rapid acceleration of this interest is testimony to the realization among Chinese industrial’s that budgeting is an important part of their business process.
There is also increasing interest from the inland plants to manage cash flow through the typical seasonal cycle and develop models that will reduce their dependence on ad-hoc cooperatives. The plants remain competitive despite their recent cooperative behavior.
The terminals are faced with the reality that they must also adapt to a changing marketplace. The companies that are locked in to contracts with net prices significantly above market will squeeze as much value as possible out of the market. The value transfer from consumer to supplier is slowing rapidly and I expect it will stop altogether as independent terminals, and independent minded SOEs, loosen the market. This is likely to happen on a regional basis first and migrate along the coast as reality creeps through the market.
China’s emphasis on growing natural gas will continue to drive demand for LNG. Over the course of the next three to five years, this market will go through the changes we have seen in other markets. ENN is actively developing the trading capacity to manage fixed priced and more advanced types of contracts. In parallel with these activities, we are introducing credit management to a market that looks a lot like the US natural gas market in 1992. The introduction of the fundamental tools to build a market will position ENN to manage operations when the government deregulates the long-haul pipeline market and electricity markets.
Really, a similar growth path to that experienced in North America and Europe, but, as with all things, uniquely Chinese.
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