From the Editor: China in trouble [Gas in Transition]

China’s apparently ever-expanding appetite for LNG imports has been a key foundation of the modern LNG market. Between 2012 and 2016, rising Chinese demand for the fuel accounted for two-thirds of total market growth. In the next five-year period, China took in about 40% of the new LNG exports coming to market.

In the process, in 2021, it briefly overtook Japan as the world’s leading importer of LNG. Domestic gas demand, led by the country’s aggressive coal-to-gas switching programmes, outstripped, by some margin, growth in domestic production and pipeline imports combined.

GDP, COVID and Chinese LNG demand

China’s need for LNG appeared undiminished by its slowing rate of GDP growth. In fact, LNG imports grew quicker as the country’s growth rate slowed, indicating how demand for the fuel was being driven by a combination of policy-led structural change within the Chinese economy as much as overall economic growth. As a result, the structural deficiencies of the Chinese economy were overlooked, or at least downplayed.

As the COVID-19 pandemic took grip in 2020, GDP growth sank, bounced back in 2021, but dropped sharply again in 2022. On an average basis, the pandemic appears to have resulted in a downward shift in Chinese GDP growth – an acceleration of the existing trend. It seems the travails of dealing with an unprecedented health crisis have exposed more clearly the pre-existing weaknesses of the Chinese economy. China, it appears, has some form of long COVID.

This provides a different perspective from which to view China’s LNG demand.

Recent scenario building has naturally been dominated by the dynamic of Russia’s invasion of Ukraine and the curtailment of Russian gas exports to Europe. This saw spot LNG prices leap as European LNG imports rose. Chinese LNG imports fell significantly for the first time since the country began importing the fuel.

Simple cause and effect – higher prices crimp demand. LNG imports this year are expected to return to growth, but to remain below the peak levels of 2021. But when set against the long-term trend, 2023 will, in reality, be a second year of depressed Chinese LNG demand.

Is this just the Ukraine effect?

Economic fallout

Fundamental problems with the Chinese economy appear to be emerging, although the existence of bad debts and an overblown housing market should not be a surprise. China watchers have warned for years, and more loudly in the last five, that China’s economy has structural problems, but it hasn’t been in vogue to listen.

China appears to be on the brink of deflation and, in August, another large property developer China Evergrande filed for bankruptcy.

Underlying the malaise is that the country’s demography has changed massively from its period of huge population growth – a period, along with the infamous one-child policy, apparently hard-wired into older generations’ perspectives of the country.

Today, China has a surfeit of males and an ageing population with more retirees and fewer workers. It does not attract immigrants, but loses people on a net basis each year. It is hard for an economy to grow with fewer workers, and even harder to support a growing population of older people.

Moreover, the Chinese housing market’s need for population growth becomes more evident as the rural-urban population movement slows and more young people find accommodation unaffordable. Youth unemployment is rising fast, hitting a record 21.3% in June, causing the government to announce that it would stop publishing the data.

Economists are now starting to argue that China’s rise as an economic giant has hit a wall.

This might be welcomed by those concerned that the country was becoming too powerful, but as US Treasury Secretary Janet Yellen has pointed out, a slowing Chinese economy is a risk factor for the US economy. Moreover, a China beset by internal tensions may well be a more dangerous beast than one in which its population’s aspirations are being met.

What holds true for the US, in this case, also holds true for Europe, where GDP growth is forecast to be just 1.0% this year. OECD economies broadly have benefited from the strength of the Chinese economy. China was the EU’s second largest trading partner in 2022 behind only the US, accounting for 15.3% of the EU’s total trade.

LNG exporters take note

LNG exporters, as prime beneficiaries of China’s economic rise, are clearly no exception.

An economically-troubled China will undoubtedly be more price sensitive in its LNG purchases. Owing to the internal slow down and deflationary pressures, Chinese gas prices are falling, meaning that it is still expensive, and potentially loss making, to import LNG spot cargoes.

China, moreover, has alternatives. Gas pipeline imports from Central Asia are reviving, they will grow from Russia, along the Power of Siberia pipeline, and China is bringing ever larger volumes of both coal production and renewable energy capacity into operation.

Domestic Chinese gas supply rose by 6% last year, the sixth year in a row in which it has increased by 10bn m3 or more, according to the National Energy Administration’s China Natural Gas Development Report 2023.

A depressed Chinese industrial sector, both as a result of weak internal demand and slow export markets – where it faces growing trade barriers – is bad news for gas and therefore LNG demand. About 42% of China’s gas demand is consumed by industry – 50%, if the chemicals sector is included. About a third is accounted for by the less price-sensitive city-gas sector.

The remaining 17% is used for gas-fired generation, and, although Beijing has plans to increase gas-to-power, these plans may slow as a result of the huge annual increases in renewable energy generation and the existence of that cheaper back-stop, domestic coal. Phasing out coal may be a long-term aspiration, but the sector is also a major employer, as well as a domestic rather than imported source of energy.

LNG demand without Chinese growth

If flatlining Chinese LNG demand is assumed, the LNG market over the next decade does not look as healthy as it did. Asia’s other, more mature, major import markets do not promise much growth, possibly even decline, as they engage in their own energy transitions, and India is not the next China, at least not on the same scale or timeframe which some comparisons might suggest.

The key factor then becomes the speed and manner in which Europe adjusts to the permanent loss of Russian gas imports. Growth in renewable energy will supplant gas-fired generation quicker in a slow growth environment, just as low growth in China will limit its appetite for LNG. In the event that Europe’s LNG demand boom proves to be a bubble, and China retreats into a decade of lost growth, where will new demand for LNG come from?

The old adage that there is nothing like high prices to cure high prices is true and works in reverse. A period of low pricing is what the LNG market needs to reset its demand-side prospects.

This will, of course, be heavily tempered by the energy transition, but, in the background, global coal demand hit a record last year and is expected to inch higher still this year. LNG will still be needed to substitute for the world’s use of coal.

Although it feels odd to conjoin the fates of a fossil fuel, LNG, and the energy transition, the problem is the same for both; weak economies – China and India predominantly – are likely to fall back on a cheap domestic energy resource, coal, in times of economic trouble.