The dust has settled after two years of tit-for-tat tariffs and incendiary accusations. At least for now. On 15th January 2020, the USA and China signed a landmark trade deal. Landmark because it extracts some concessions from China to redress the trade imbalance between the world’s two economic superpowers, and also because it halts the escalation of the trade war. Call it a trade truce, but the Phase 1 trade deal – as it has been called – also does not undo the previous two years of tariffs. In fact, it enshrines them at least until a Phase 2 deal is agreed.
But that’s very far away. For now, the headlines are all about the US getting China to buy almost US$200 billion more of US products over 2020 and 2021 across four key industries, in exchange for not raising tariffs on Chinese imports even further, including energy. Those are lofty promises. Verging on the unrealistic. But they make for great headlines, and good rhetoric for the White House. For energy, China has agreed to increase its buying of US energy products – including crude oil, LNG, refined products and coal – by US$18.5 billion in 2020 and US$33.9 billion in 2021, relative to the 2017 levels. That’s the promise. Can it be achieved?
Let’s take the base year. In 2017, the US exported some US$9 billion of energy products to China. On the oil side, this translated into 450,000 b/d of products – half of which was crude, another third was natural gas liquids (ethane and butane) and the remainder refined products. On the natural gas side, the US is estimated to have shipped 103 billion cubic feet of LNG to China in 2017. Across 2018 and 2019, exports of both oil and gas fell – and in the case of 2019, drastically as China slapped import tariffs of 5% on US crude and 25% on US LNG and NGLs. Which is why 2017 was chosen as the base year, representing a normal market before trade barriers kicked in. On a surface level, this would means that China would need to triple its purchases of US oil and gas to meet its Phase 1 trade pledges.
Is that realistic? US crude represented only 3% of Chinese crude imports in 2017, with LNG representing roughly the same portion. For LNG, China enjoys good relations with Australia, Qatar, Malaysia and Indonesia – all of which provide more competitive pricing given their proximity. For crude, it isn’t just volumes but also quality. Most Chinese refineries are designed around Middle Eastern and Russian crude – heavier and sourer than US crude. US crude could supplant existing volumes taken by China from West Africa and North Sea, but the Gulf of Mexico is once again at a distance disadvantage. A supply glut means China is awash with refined oil products, which leaves NGLs – which could be a bright spark as feedstock for Chinese petrochemicals producers. There is definitely room to grow, but expecting a tripling of volumes over two years seems highly unlikely unless strictly enforced.
Crucially, China has provided itself a safety clause. Buried in the text of the trade deal, is that these purchases – while representing minimum purchase requirements – are subject to ‘market conditions’ in China. These ‘market conditions’ are then further defined as being influenced by actual domestic Chinese demand, relative pricing of US goods vs comparable goods from other nations or supply availability, or all of the above. This crucial clause takes the purchase pledges by China from the realm of optimistic promises to fantasy. Emphasised throughout the trade deal document – and repeated again in the energy section – this essentially means that China’s pledge is not mandatory. China will continue to source its commodities based on ‘market conditions’ at the best availability and price; and if those suppliers happen to be American, good. US energy producers won’t be able to depend on a guaranteed deposit of demand from China – and they wouldn’t be able to produce all those required volumes anyway – but must continue to compete with established energy powerhouses like Russia, Saudi Arabia, Qatar, Australia, Iraq, Malaysia and more… just like they do now.
To expect China to be able to meet its pledges to increase US energy purchases by the required amounts is a fool’s game. Increases will happen, but even then, not by as much as expected given that the existing tariffs are still in place. The Phase 1 trade deal seems to be full of hot air. It will make the negotiations for a broader Phase 2 trade deal tougher – given that progress on the targets will be expected – but that’s a question for the future, and possibly a different government. For now, not much has changed. Don’t call it a trade deal, call it what it is, which is a stalemate.
Phase 1 Trade Deal in Summary:
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This winter, natural gas prices have been at their lowest levels in decades. On Monday, February 10, the near-month natural gas futures price at the New York Mercantile Exchange (NYMEX) closed at $1.77 per million British thermal units (MMBtu). This price was the lowest February closing price for the near-month contract since at least 2001, in real terms, and the lowest near-month futures price in any month since March 8, 2016, according to Bloomberg, L.P. and FRED data.
In addition, according to Natural Gas Intelligence data, the daily spot price at the Henry Hub national benchmark was $1.81/MMBtu on February 10, 2020, the lowest price in real terms since March 9, 2016. Henry Hub spot prices have ranged between $1.81/MMBtu and $2.84/MMBtu this winter heating season (since November 1, 2019), generally because relatively warm winter weather has reduced demand for natural gas for heating. Natural gas production growth has outpaced demand growth, reducing the need to withdraw natural gas from underground storage.
Dry natural gas production in January 2020 averaged about 95.0 billion cubic feet per day (Bcf/d), according to IHS Markit data. IHS Markit also estimates that in January 2020 the United States saw the third-highest monthly U.S. natural gas production on record, down slightly from the previous two months.
IHS Markit estimates that U.S. natural gas consumption by residential, commercial, industrial, and electric power sectors averaged 96 Bcf/d for January, which was about 4.4 Bcf/d less than the average for January 2019, largely because of decreases in residential and commercial consumption as a result of warmer temperatures.
However, IHS Markit estimates that overall consumption of natural gas (including feed gas to liquefied natural gas (LNG) export facilities, pipeline fuel losses, and net exports by pipeline to Mexico) averaged about 117.5 Bcf/d in January 2020, an increase of about 0.2 Bcf/d from last year. This overall increase is largely a result of an almost doubling of LNG feed gas to about 8.5 Bcf/d.
Because supply growth has outpaced demand growth, less natural gas has been withdrawn from storage withdrawals this winter. Despite starting the 2019–20 heating season with the third-lowest level of natural gas inventory since 2009, by January 17, 2020, working natural gas inventories reached relatively high levels for mid-winter. The U.S. Energy Information Administration’s (EIA) data on natural gas inventories for the Lower 48 states as of February 7, 2020, reflect a 215 Bcf surplus to the five-year average. In EIA’s latest short-term forecast, more natural gas remains in storage levels than the previous five-year average through the remainder of the winter.
According to the National Oceanic and Atmospheric Administration (NOAA), January 2020 was the fifth-warmest in its 126-year climate record. Heating degree days (HDDs), a temperature-based metric for heating demand, have been relatively low this winter, which is consistent with a warmer winter. During some weeks in late December and early January, the United States saw 25% to 30% fewer HDDs than the 30-year average. This winter, through February 8, residential natural gas customers in the United States have seen 11% fewer HDDs than the 30-year average.
Source: U.S. Energy Information Administration, based on National Oceanic and Atmospheric Administration Climate Prediction Center data
Headline crude prices for the week beginning 10 February 2020 – Brent: US$53/b; WTI: US$49/b
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