The most recent edition of the Energy Information Agency monthly Drilling Productivity report confirmed what news reports had anecdotally told us. U.S. domestic shale production is on a decline, and one I think, from which it will never recover. Is it going to round trip to 2010 levels? No, I am not predicting that, and will discuss where I think shale production is heading later in this article.

 

EIA

First, a brief recap. I have discussed the problems and fallacies associated with shale in a number of OilPrice articles over the last year. 

Note-I typically go into a lot of technical and geologic detail in these articles. If you missed them, here’s some links you may find illustrative. 

The natural gas market is reeling from the triple whammy of a stubborn supply overhang, particularly in the Asia-Pacific region--which accounts for nearly two-thirds of global demand--a mild winter, and a hobbled global economy. China has emerged as a rare bright spot as energy demand in the country remains relatively high. However, Beijing is taking advantage of the health and economic crisis to do a dramatic overhaul of its natural gas supply chains. 

China has shifted its attention from its traditional Central Asia supply hub further west where another natural gas and LNG powerhouse is emerging.

The United States is emerging as the surprising winner as China, the world’s second-largest importer of liquefied natural gas (LNG), continues to ramp up its LNG imports despite a buildup of tensions between the two nations.

Force Majeure

Over the past decade, Turkmenistan, Uzbekistan, and Kazakhstan have emerged as major natural gas exporters to China. In 2019, Turkmenistan sold over 30 billion cubic meters (bcm) of natural gas to Beijing--good for more than 90% of its total exports--with Uzbekistan and Kazakhstan exporting 10 bcm apiece to the Middle Kingdom.

Things have, however, taken a turn for the worse--especially for Turkmenistan.

In early March, Kazakhstan revealed that Beijing had issued a force majeure declaration to state pipeline company KazTransGas (KTG) regarding its natural gas supplies. Consequently, import data published by Beijing revealed that Turkmen imports had declined some 17.2% during the first two months of the year. Meanwhile, Uzbekistan’s exports to China, of which gas is a major component, fell 35.4%. Kazakhstan was the outlier in this trilogy, with its natural gas exports to China rising 31.6%. 

The same trend continued in March and April, with Turkmen and Uzbek exports to China falling in excess of 20% and 30%, respectively, while Kazakh exports once again climbed more than 20%.

Despite these large declines in natural gas imports from Central Asia, China’s National Development and Reform Commission has claimed that natural gas consumption by the country increased by 1.6% to 78.5 bcm during the first quarter.

China’s LNG Imports Grow

China’s largest LNG importer, China National Petroleum Corporation (CNOOC), and PetroChina also invoked force majeure clauses on various LNG suppliers, though the notice was rejected by Shell, Total, and Qatargas. 

Meanwhile, commodity trading houses such as Trafigura as well as Middle East gas producers did not officially confirm receiving the notices. However, China resumed buying LNG cargoes later in the quarter as spot market prices plunged to multi-year lows.

And now, Natural Gas Intelligence (NGI) has reported that China’s LNG imports have actually been rising on a year-on-year basis, with the U.S. stealing market share from traditional powerhouses Australia and Qatar. 

According to Wood Mackenzie via NGI, China took in 10 LNG cargoes from U.S. suppliers between April and May at the expense of Australia whose market share slipped up in May. 

There are several plausible explanations as to why China is buying U.S. LNG—despite Washington and Beijing feuding over everything from the novel coronavirus to Hong Kong to 5G networks.

First off, China could be using the crisis as a bargaining chip to renegotiate its contracts with long-term suppliers, including Turkmenistan and Uzbekistan. This could, however, prove to be a tough proposition because force majeure cases are rarely straightforward and even reference to specific events like ‘epidemic’, ‘acts of government,’ or ‘quarantine restrictions’ under an SPA (sale and purchase agreement) does not automatically guarantee relief.

Second, Beijing could be trying to increase its sphere of influence in Central Asia, a region that has long been a geopolitical battleground between Beijing and Moscow. 

It is instructive to note that Russia and Turkmenistan have reached a tentative rapprochement that saw a resumption of gas exports from Turkmenistan to Russia sometime in mid-April after ceasing exports in January 2016 over a dispute over price and payments. A decade ago, Turkmenistan was exporting over 40 bcm/yr of gas to Russia, significantly more than its current exports to China. Perhaps it is not a coincidence that China has fallen out with Turkmenistan at a time when the latter has made up with Russia.

Meanwhile, in February, under pressure from Moscow, Uzbekistan became an observer of Russia’s Eurasian Economic Union (EAEU), probably irking China.

Lastly, Beijing might simply be trying to stick to the January trade agreement with Washington to prevent another full-blown trade war. Although the accord did not specify quantities of the products, it committed Beijing to purchase an extra $52.4 billion of U.S. energy supplies over the next two years. 

Under the deal, China’s deal amount increases to $18.5 billion in 2020 and another $33.9 billion in 2021 from a baseline of just $9.1 billion in 2017. China has already instructed state-owned firms to suspend large-scale purchases of U.S. farm produce including soybeans and pork, in retaliation to Trump’s Hong Kong stance but has not said anything about energy products. 

Whatever the case, U.S. LNG suppliers appear to be cozying up to a second major customer after recently doing so with Turkey.