China struggles with US trade deal [NGW Magazine]

Six months after US president Donald Trump signed “one of the greatest trade deals ever made”, it seems unlikely that China will live up to the ambitious targets for energy purchases in the phase one agreement that he inked in mid-January.

China is significantly behind on purchases of US energy products, comprising LNG, crude oil, refined products, and coal, as part of the phase one economic and trade agreement that took more than two tense years to negotiate. Unless something extraordinary occurs, China will not meet its targets, which are set in dollars, not tons.

And with US-China tensions already flaring up again over a range of issues – from the outbreak of Covid-19 in Wuhan to Hong Kong’s new national security law passed last month – any failure by Beijing to keep up with purchases could collapse the agreement and accelerate the US-China decoupling.

There have been recent signs that Washington is unimpressed with China’s progress in reducing the $345.6bn trade deficit. White House trade adviser Peter Navarro said the trade deal was “over” in a media interview in June, but then rowed back a few hours later after Trump and senior officials said the deal was still alive.

But trade statistics from both the US and China show that energy imports are falling far short of the desired momentum needed to achieve the targets in the agreement. The deal signed by Trump and Chinese vice-premier Liu He committed China to buy US energy imports worth at least $18.5bn more in 2020, and at least $33.9bn more in 2021, than the 2017 pre-trade-war baseline amount.

There is no consensus on the 2017 baseline, with estimates ranging from $5.4bn to $9.1bn. But the Peterson Institute for International Economics puts it at $6.8bn when calculated using Chinese customs data, or $7.6bn when using official US trade data.

This implies that China will need to import at least $25.3bn worth of energy from the US this year, which is equivalent to a monthly average of $2.11bn. But Chinese imports in the first five months of 2020 reached only a combined $780mn, lagging well behind a year-to-date target of $10.5bn. The objectives for next year look even more challenging as the average monthly target will rise to at least $3.39bn.

Momentum in May

While it would be easy to dismiss China as not trying hard enough or even of ignoring the agreement, there are indications that Beijing has started to respond. Chinese imports of energy products from the US rose sharply in May compared with the first four months of 2020, when demand was severely impacted by Covid-19.

China, the world’s second-biggest LNG buyer, did not import any LNG from the US in the first three months, but then received 210,863 metric tons (mt) in April valued at $38.9mn (about $3.50/mn Btu) and 340,233 mt worth $123mn in May (about $7/mn Btu), according to Chinese customs data. US volumes made up around 4% of China’s total LNG imports in April, rising to 6.5% in May.

There was a similarly sharp pick-up for crude oil and refined products. In May, Chinese refineries received their first crude cargo from the US since November 2019, while liquid petroleum gas (LPG) imports from the US hit a record high of 733,385 mt in May, eclipsing the previous record of 475,092 mt in December 2017.

With the caveat that May represents a single month of data, the sudden uptick can be read as a sign of good faith from Beijing that it is attempting to live up to the trade deal. The Chinese government can also cite as mitigating factors the ongoing recovery in the economy and the collapse in crude prices, which has also affected the cost of other energy products such as LNG and LPG. It has also slowed down pipeline imports from central Asia, and invoked force majeure on LNG from Australia and elsewhere earlier this year, suggesting that it has severe limitations on its demand.

Because the two nations had agreed to a dollar target, the goals become vastly more difficult when energy prices plunge. Effectively, the fall in energy prices in the first half of 2020 means China must now import much larger volumes to meet the targets.

While energy prices have halved since the start of the year, US energy imports are still far lower than they should be under the agreement even on a price-adjusted basis. China imported $549mn of energy products from the US in May, according to NGW analysis of Chinese customs data, which is still only one-quarter of the monthly level required.

The low amounts to date will reinforce suspicions that the purchasing targets in the trade agreement are unachievable for China, and that Beijing is simply going through the motions of doing just enough to keep the deal alive.

Mountain to climb

If China does make an earnest attempt to meet the trade agreement targets, then imports of LNG, crude oil and LPG will need to rise sharply in the remainder of this year. But there are several barriers that stand in the way of China achieving the energy purchasing goals.

The first obstacle is that the precipitous drop in commodity prices and reduced oil and gas production in the US as a result of Covid-19 is likely to cut the annual value of American energy exports from $100bn in 2019 to $75-80bn in 2020 and 2021. This means the US would need to send an overwhelming share of its energy exports to China – around one-third this year and more than half in 2021 – in order to satisfy the phase one deal’s targets. This is clearly unrealistic.

Meeting the purchasing targets will not be easy for other reasons. Chinese refiners are geared to take heavy sour crude from the Middle East with limited capacity to process all-light sweet crude exports from the US.

LNG imports also face limitations, as although China shipped in 60mn mt in 2019, around 90% of the country’s volumes are under long-term contracts and cannot be adjusted downwards significantly. The contract terms do offer some flexibility but not enough to enable a major increase in LNG imports – especially as the arrival of Russian gas through the Power of Siberia pipeline will put further pressure on accommodating additional LNG volumes.

Chinese companies are also locked into LNG imports from Russia, where Beijing has financially backed the 18.5mn mt/yr Yamal LNG project, where the trains have been producing about 10% better than nameplate, again adding to the surplus.

The only way to accommodate greater imports from US suppliers would be to boost gas demand further – a tough call at a time like this.

The slow pace of energy trade between the US and China is a far cry from rosy forecasts from the Chinese side that LNG imports from the US would quadruple from 2018 to $10bn this year. A decoupling between the US and China would generally be negative for oil and gas in the long term, with a breakdown in the relationship likely to focus China even more on energy security to reduce import dependency.

Another difficulty for the deal is China’s emphasis on greater production at home. Its gas output growth in 2020 to date has maintained the strong momentum seen in the past two years, putting the sector firmly on track to meet a production goal announced recently by Beijing.

Chinese gas production reached 78.8bn m³ in the first five months, representing an increase of 10.1% from the same period of 2019 as well as an acceleration from last year’s overall growth of 9.8%.

The encouraging figures put China, the largest gas producer in the Asia-Pacific region, on course to achieve a goal of producing around 181bn m³ this year, which was included in recent guidelines for promoting energy development this year from the National Energy Administration. China produced 173.6bn m³ of gas in 2019, so the new target represents a 4.3% increase.