By Brian Spegele 

BEIJING--The energy industry overestimated just how much natural gas China needs, and global oil-and-gas companies risk paying a heavy price.

When China's economy hummed along a few years ago, energy companies from Australia to Canada bet its demand for natural gas would grow fast. They spent billions of dollars on promising fields, with plans to freeze the gas into liquid, called LNG, and load it on tankers to sell to energy-starved Asian buyers at a premium.

China was "always seen as the kind of wonder market that was going to grow and need so much LNG," said Howard Rogers of the Oxford Institute for Energy Studies and a former gas executive at BP PLC. "People got somewhat carried away."

Recent data paints a grimmer picture. Chinese LNG imports are down 3.5% this year, compared with a 10% rise in 2014. Total gas consumption grew about 2% in the first half, a turnabout from double-digit growth in recent years.

Natural gas is an extreme example of how China's slowing economy has contributed to a global commodities crash. Producers of raw materials from aluminum to iron ore made heady bets on Chinese demand. So far, many are being proven wrong.

The downturn is sparking an industrywide recalibration. Energy consultancy Wood Mackenzie slashed its China gas-demand forecast by about 15% to 360 billion cubic meters by 2020.

Globally, the market faces 25 million tons of LNG oversupply by 2018, says Citi Research--more than China imported all of last year. If all the projects being constructed, planned and proposed today came to fruition, the market would face around one-third more capacity than it needs by 2025, Citi estimates.

"We're already seeing China cannot absorb all the gas that is thrown at it--that it's choking on gas somewhat at the moment," said Gavin Thompson, an analyst at Wood Mackenzie.

Northeast Asia spot LNG prices have fallen to less than $8 per million metric British thermal units from over $14 last fall, according to pricing agency Platts. U.S. Henry Hub prices are under $3 per mmBtu versus around $4 a year ago.

Slowing demand could affect how North America develops as an energy-export hub. U.S. gas exporters may have less of a market than hoped for, though their cheap gas should remain competitive. Some exports may head eastward to Europe instead.

Depressed LNG demand follows the collapse in crude-oil prices that has shaken the energy industry to its core and added to global deflation fears. Natural gas, used in industry, power generation and transport, has been touted as the fuel of the future; gas is cleaner than oil and abundant in supply. The road bumps today show that transition will be far from smooth as key emerging markets intended to accelerate demand show weakness instead.

Several reasons explain China's lackluster LNG demand. Government-regulated gas prices are proving too expensive, sparking conflict between government and industry in some areas. Meanwhile bloated sectors are cutting capacity, which lowers energy needs. China is also importing more gas via Central Asia pipelines and has plans for big Russian shipments.

Australia's Arrow Energy Pty Ltd., a joint venture between Royal Dutch Shell PLC and state-controlled PetroChina Co., typifies LNG projects whose economics soured. The pair bought Arrow--which produces gas from underground coal seams--in 2010 for 3.5 billion Australian dollars ($2.49 billion), planning to liquefy the gas for export.

But the Arrow venture lost about A$1.5 billion last year, including an impairment charge of A$700 million, amid what it called a poor "economic environment." Shell announced this year it was shelving the planned export terminal.

Write-downs have stung others. The U.K.'s BG Group took a $4.1 billion pretax charge on its huge LNG export facility in Australia due to lower oil-and-gas prices.

"The issue is: What kind of returns are we going be making on these projects now?" said OIES's Mr. Rogers. "Yes, these things have a 25-year-plus operating life, but you kind of want some nice cash flows during the first five to six years."

Signs that China may buy less LNG emerged last year. In May 2014, China and Russia signed a massive gas-delivery deal which will eventually supply China some 38 billion cubic meters of gas annually--about 20% of total Chinese demand last year. The countries are negotiating a second pipeline to bring even more Russian gas to China.

China wants to expand energy ties with its neighbors--including Turkmenistan and Kazakhstan--to curtail reliance on far-flung imports. Moscow and Beijing see mutual benefit in cooperation as Russia cuts dependence on shipments to Europe and China secures a large, new supply source.

Still, slack gas demand poses problems for Chinese companies. Sinopec Corp., the state-controlled refining giant, is contracted to take some 7.6 million tons of LNG annually from a project coming online later this year in Australia, called Australia Pacific, where it is invested with ConocoPhillips Co. and Sydney-based Origin Energy Ltd. But with the Chinese market well supplied, Sinopec will likely be forced to sell some of that gas on the spot market, potentially for a loss, industry analysts say.

Sinopec said it would decide how to use Australia Pacific gas based on market conditions and the company's needs. ConocoPhillips Chief Executive Officer Ryan Lance said the company was discussing with Sinopec how much gas it could take in the next two years.

No doubt, Chinese oil-and-gas demand will grow over time. The problem with stumbling demand now is that it hits energy companies' profits just as they also struggle with low crude prices.

Lower Chinese gas demands are partly the result of government-regulated pricing that is discouraging its use. Despite falling prices globally, authorities have been slow to lower domestic gas tariffs.

When crude prices fell over the past year, petroleum-based products that compete with natural gas as fuels for industry got cheaper. Coal is also a cheaper option in China.

The reluctance of companies to pay more for LNG can be seen in Jinjiang, a city on China's east coast that has made ceramics for centuries. Today, producers are locked in a dispute with authorities.

A government program designed to cut pollution ordered ceramics-makers to switch from coal to using natural gas. An LNG terminal nearby would supply the fuel.

But some companies reported production costs with gas were triple those of coal.

Business leaders have taken to the streets to protest. Wu Shengtuan, the 48-year-old chairman of a local building-tile maker, said his sales would slide roughly half this year, after suspending two production lines. He says he fears high gas prices could bankrupt Jinjiang ceramics-makers.

Lowering prices in the coming months--as many expect economic planners to do--would help. But lower demand also reflects a slowing Chinese economy.

"You always wanted to be able to count on China as a backstop because Chinese growth was always there," said Mr. Thompson, of Wood Mackenzie. "Companies are having to re-evaluate what the Chinese market ultimately offers."

Kersten Zhang and Yang Jie contributed to this article.

Write to Brian Spegele at brian.spegele@wsj.com

 

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(END) Dow Jones Newswires

October 05, 2015 15:14 ET (19:14 GMT)

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