By Michael Lelyveld
Frictions are rising between China and its energy suppliers as the world’s leading importer tries to cancel natural gas deliveries due to slumping demand.
On March 5, multiple news agencies reported that China’s largest national oil company had suspended gas imports, citing force majeure, a legal exclusion from contract commitments in cases of circumstances beyond a party’s control.
The notification to suppliers followed weeks of plunging demand as the coronavirus epidemic brought economic activity and consumption to a near-total halt in February.
This week, in one of the first official economic reports during the crisis period, the National Bureau of Statistics (NBS) said that industrial production fell 13.5 percent in the first two months of 2020 from a year before. Power generation dropped 8.2 percent.
The depth of the decline and the import rejection may challenge the government’s assurances that production has already started to recover as virus-free manufacturers cautiously get back to work.
The suspension of imports applied to both liquefied natural gas (LNG) and pipeline gas. Reports by Reuters and Bloomberg News differed on whether the force majeure notices were made in the name of PetroChina or its parent company, China National Petroleum Corp. (CNPC).
The market had been bracing for a restriction of gas imports since early February when China National Offshore Oil Corp. (CNOOC) sent force majeure notices to suppliers including Royal Dutch Shell and France’s Total in an effort to forestall LNG cargoes supplied under long-term contracts.
On Feb. 6, Total made clear that it would not accept the application of force majeure, without identifying CNOOC as the source of the notice, Reuters reported.
“We have received one force majeure that we have rejected,” said Philippe Sauquet, head of Total’s gas, renewables and power segment.
Reports suggest a degree of skepticism over the force majeure claims against LNG supplied at high prices under long-term contracts at a time when the spot market is awash with available gas at record low rates.
The coronavirus slowdown coincided with the seasonal slackening of demand at the end of the winter heating season.
Separately, CNPC said on March 5 that it had stopped taking gas out of storage for heating at the end of February, according to Bloomberg.
Taking Russia by surprise
But the stoppage of pipeline deliveries appeared to take some suppliers like Russia’s Gazprom by surprise after having opened its 3,000-kilometer (1,864-mile) Power of Siberia gas line to China on Dec. 2, just three months before the shutdown.
The first response from Gazprom was denial.
When asked whether it had received a force majeure notice from PetroChina, the company said it had not, Interfax reported.
“We have received no notifications. Deliveries are proceeding routinely,” said Gazprom. In any case, it said, “Our contract is with CNPC.”
Five days later, Gazprom announced it would close the U.S.$55-billion (384-billion yuan) pipeline for “a routine maintenance checkup” in the second half of March, Interfax and Reuters said.
The company did not say how long the checkup procedure would take, but the announcement implied that the import restriction could last through the end of the month.
While Gazprom has declined to comment, the maintenance shutdown was expected to last about two weeks, S&P Global Platts news service said.
The force majeure (FM) notices appear to represent an escalation of China’s efforts to curtail imports following a series of “pre-FM” letters, or warnings, sent to suppliers in February, according to Energy Intelligence Group reports.
A major LNG supplier quoted by Reuters said that PetroChina was seeking to defer deliveries until the third quarter.
The letters to gas suppliers were aimed at seeking volume reductions or delays in contracted LNG cargoes before formally invoking FM clauses in supply contracts to turn away the deliveries, Energy Intelligence said.
China may have gradually ramped up its efforts to refuse contracted imports, but the goal of invoking force majeure and escaping legal liability for “take-or-pay” provisions is more easily said than done, experts say.
Outside the energy sector, China’s government has promoted the use of force majeure certifications as a solution for manufacturers to avoid penalties for failing to deliver supplies under international contracts during the epidemic as a result of labor shortages and quarantines.
This week, the China Council for the Promotion of International Trade (CCPIT) said that its affiliated departments had issued 5,637 force majeure certificates to enterprises seeking relief from non-performance penalties.
But experts say that similar strategies are unlikely to work for Chinese importers with contractual obligations to international energy suppliers.
Last month, Robert Sims, research director at the international consultancy Wood Mackenzie, said that invoking force majeure to put off LNG deliveries would be “contractually complex,” Kallanish Energy news service reported.
“Contract wording will need to specifically include epidemics as force majeure events,” Sims said. “Demand reduction on its own or a notice by a relevant Chinese government authority will likely be insufficient,” he said.
An expert cited by CNBC said that Chinese buyers who seek to apply force majeure protections will be in for “a rude awakening if they think they will allow them to get out of contracts with international parties.”
Brian Perrott, a partner at the law firm Homan Fenwick Willan said that most of China’s international contracts are governed by English law that requires lengthy and detailed definitions.
“Most of these FM claims will not succeed,” Perrott said.
In a commentary on the attempts to invoke force majeure, the China Energy Program at the Oxford Institute for Energy Studies (OIES) said that “Chinese buyers are unlikely to blatantly breach contracts in a way that would put supply security at risk.”
Importers will be wary of cancelling contracts or damaging relations with suppliers in anticipation of shortages when demand recovers and the market eventually turns around.
“Even though Chinese buyers may be willing to test sellers, they are unlikely to jeopardize their supplies,” the analysis said.
Instead, the force majeure declarations may be part of a negotiating strategy.
“Invoking force majeure may have been an attempt to test sellers’ willingness to review contractual terms prompted by logistical challenges,” OIES said.
Mikkal Herberg, energy security research director for the Seattle-based National Bureau of Asian Research, agreed with the assessment.
“My view is that the force majeure announcements are both a response to the coronavirus gas demand drop and logistical unloading problems, but also an effort to open up the contracts to more flexible terms,” Herberg said.
More serious implications
The shutdown of pipeline imports may have separate and more serious implications, however, particularly since Russia has invested so heavily in the Power of Siberia infrastructure and field development for a single customer.
Gazprom deliveries to China were scheduled reach a relatively modest 5 billion cubic meters (176 billion cubic feet) this year, rising to full capacity of 38 billion cubic meters (bcm) in 2022-23.
If volumes are curtailed for a prolonged period, the increases and the payback period for the project could slip, straining Gazprom finances and potentially Russian relations with China.
Gazprom’s maintenance shutdown, so soon after opening, is likely to be a cover for frictions over China’s declarations of force majeure.
“I don’t think they are aimed at Russia in particular but the timing of cutting Power of Siberia gas just three months after starting the flows must be especially galling to Gazprom and the Russians,” Herberg said.
By contrast, the initial reaction to the declaration from Turkmenistan, China’s main pipeline supplier, was relatively mild.
“If this is the case, we hope this measure will be short-term and will not affect long-term, strategic and mutually beneficial Turkmen-Chinese partnership in the gas sector,” an unidentified Turkmenistan government official told Reuters.
The country has been highly dependent China for field and pipeline development, as well as demand for gas exports.
Kazakhstan’s transport monopoly KazTransGas (KTG) said it had received a force majeure notice from PetroChina on March 5 and was now holding consultations on further gas supplies to China, Interfax reported.
Kazakhstan exported 7.5 bcm to China last year and was scheduled to deliver 8 bcm in 2020, the news agency said. The country had earlier planned to supply 10 bcm this year.
On March 10, Uzbekistan said it had not stopped pumping gas to China, according to Uzbekistan Newsline.
“Uzbekistan continues to export gas to China, there have been no interruptions,” the country’s Ministry of Energy said without disclosing the volumes.
The China-Central Asia Gas Pipeline delivered over 47.9 bcm to China from the three Central Asian countries last year, China’s official Xinhua news agency said.
A prolonged downturn in China’s gas demand “could send shock waves through the economies of Kazakhstan, Uzbekistan and Turkmenistan,” said an analysis by the Eurasia Program at the Foreign Policy Research Institute.
“How Beijing treats its Central Asian gas suppliers during the next few weeks and months may prove revealing about its long-term strategy in the region,” the analysis said.