Who Will Feed the Chinese Dragon?

Will China walk away from Canadian energy or double down on its $50 billion investment?

January 11, 2017

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While Beijing warily eyes U.S. President-elect Donald Trump, wondering if he’s serious about a trade war, China is also reassessing its exposure to Canada. The voracious energy consumer faces a raft of Canadian investment choices: including whether to; sign off on a long-term LNG deal or walk away; invest in an Albertan methanol export industry; buy wholesale Canadian liquefied propane or propane-derived plastics?

LNG
The Chinese dragon is a natural gas guzzler. The world’s third-largest importer of LNG demands more and more year after year. Imports in the first half of 2016 rose 21 percent to 11.56 million tons from the same period in 2015. That curve could grow steeper as China introduces national carbon pricing in 2017 and tries to wean itself off of coal.

“China will need more LNG,” says Edmonton-based gas consultant Darwish Shala. “It’s building so many terminals, building huge installations. China is coming—they consume lots of energy. I think they will buy from Canada.”

But before Canadian gas producers can start pouring the cement on new LNG facilities, they need an end-user willing to lock into 25-year purchasing agreements at a price that makes export plants viable. Asian LNG prices are linked to crude prices via the Japanese Crude Cocktail index, an average of crudes imported to Japan. Those prices are currently low and Beijing is wary of signing up for contracts that are above today’s market price. Bill Gwozd, senior VP at Calgary-based Natural Gas Consulting, says: “Canada’s name pops up on China’s medium- to long-term LNG picture.”

“We are continuing to see a lot of Chinese interest in investing in propane-derived plastics.”
– Garret Matteotti, Alberta Industrial Heartland Association

At first glance, Woodfibre LNG greenlighting its B.C. export project last November signaled confidence that finally the long-awaited LNG export boom was underway in Canada. But Woodfibre could be all alone for some time. As the runt of the 20-plus proposed projects, weighing in at only 2.1 million tons per year and $1.6 billion in investment, the Singapore-based RGE group is able to fund the project debt-free off its balance sheet.

The other larger projects have been put on ice. In July, Shell announced the indefinite postponement of its LNG Canada project. Petronas, the Malaysian state-owned company behind Pacific Northwest LNG, has continually put back its final investment decision (FID) despite getting an official thumbs up from the Canadian government in 2016. The two projects would each have exported about 10 times more than the Woodfibre plant, and brought in tens of billions in investment dollars. Further behind on the permitting list is Beijing’s preferred child. Stewart Energy is proposing a floating 3-million-ton-per-year LNG plant, which aims to start operations by 2020 and could add a 30-million-ton-per-year land-based plant by 2025.

LPG and Methanol
In 2016, China smashed its own liquefied propane gas (LPG) import record, hitting a monthly high of 1.5 million tons—doubling 2015’s best month. The shopping spree was fueled by tanking North American gas prices and a buildout of domestic propane dehydrogenation plants.

Albertan LPG producers are now pushing to export to Asia. ATCO Energy Solutions and Petrogas Energy already ship Albertan LPG from North America’s only Pacific coast LPG export terminal, the 30,000 b/d export terminal in Ferndale, Washington. AltaGas, a Petrogas shareholder, plans to build a similar terminal in B.C., while Pembina Pipeline says it too is seeking a coastal terminal for propane from its 155,000 b/d NGL fractionator at Redwater, Alberta. By the end of 2017, the Redwater output is expected to increase to 210,000 b/d.

Another alternative the Chinese are eyeing is investment in finished propane products. Garret Matteotti, a business development manager at the Alberta Industrial Heartland Association, says: “We are continuing to see a lot of Chinese interest in investing in propane-derived plastics.” It’s cheaper to import plastics than propane, due to their ease of transport.

Matteotti says China, the largest global consumer and producer of methanol, is also interested in building methanol plants. It would follow Methanex, the world’s biggest methanol manufacturer based in Vancouver, which has reopened its 560,000-ton-a-year methanol plant in Medicine Hat, Alberta, and is looking at other potential plant sites in North America.

China had previously planned to build three huge refineries in the U.S. to export methanol back home, but the biggest, a $3.4 billion plant in Tacoma, Washington, has been cancelled due to environmental protests.

China’s petrochemical industry, vehicle fleets and home cooking and heating markets use a methanol derivative that is blended into LPG. Supplying North America’s over-produced natural gas to methanol refineries in China would be win-win for both markets.

Oil Sands and Refineries
Alberta bitumen refinery units built in China using Chinese loans—that was the plan for the proposed Kitimat refinery on the B.C coast. Its backers bank on it being one of the world’s lowest carbon-emitting refineries in existence. They aim to dodge pipeline protests and regulatory delays by bringing the bitumen by rail from Alberta as semi-solid slabs. They hope that because many refined products float and evaporate if spilled at sea, they can avoid the tanker controversy too.

The $18 billion, 400,000 bpd Kitimat project would be one of the world’s ten largest refineries—with its capacity being one-third larger than Canada’s largest refinery, in Saint John, New Brunswick.

David Black, the project proponent and Canadian media mogul, was in talks with the Industrial and Commercial Bank of China (ICBC) to finance the project. But the talks have ended and Black says he is diversifying his investor base.

Beijing is now banking on the Trans Mountain pipeline. But its B.C. terminal isn’t in a deepwater port, meaning the extra cost to ship on smaller tankers will likely make the deal less competitive. When Beijing invested in the oil sands, it likely didn’t expect to face pipeline delays, carbon tax hikes and the oil sands carbon cap.
China’s Canadian oil investments have been poor performers. For example, Sinopec is a major investor in the Northern Gateway pipeline project, which has just had its life support turned off.

Beijing hasn’t done much better upstream. PetroChina’s Brion Energy is expected to produce its first oil from the oil sands in 2017, eventually ramping up to 35,000 b/d, far short of its original plans to quickly become a major operator.

CNOOC bought Nexen for $15 billion in 2012, but idled its oil sands upgrader in July, resulting in a US$1.2-billion write down. Some analysts say it might have to take a $5 billion-plus impairment hit. With these problems, and before Trans Mountain pipeline was approved, CNOOC said it was completely rethinking its oil sands business. Meanwhile, China’s been getting bitumen from Venezuela in lieu of debt payments.

Another sign of Beijing’s thinking comes from across our southern border. China Investment, the sovereign wealth fund, has closed its Toronto office and opened a new one in New York after losing money on resource investments in Canada. But this was before Donald Trump was elected president.

“Divestment [from Canada] is possible,” says Gordon Houlden, a China expert at the University of Alberta. But he thinks increased investment is more likely. Last year, China invested $930 million in Canadian oil and in the first 10 months of this year invested $2.35 billion, including buying out Bankers Petroleum and Husky’s midstream assets. “Beijing’s thinking is long-term,” he says. “They don’t worry about quarterly results.” In addition to low prices making Canadian assets more attractive, there is also the possibility that Ottawa will remove the fence that the previous government put around the oil sands to keep out foreign state-owned firms. “It sent a chill,” Houlden says. “But Trudeau may be rethinking it.”

More posts by Nick Wilson

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