China's LNG and natural gas markets are unique. Unlike in other North Asian countries, only one-fifth of China's natural gas consumption is for power generation. Its collective industrial consumption (including fertilizers) accounts for 50% of total gas consumption^*.

China's trucked LNG is a much-followed part of this unique market. There are a few reasons for this: LNG that leaves import terminals by truck – totalling around 22 million mt in 2021 – accounts for around 30% of China's LNG import volume, which was the largest in the world in 2021. It is also a very prompt market and not price-regulated. Therefore, it can give an indication of the immediate prevailing fundamentals in the region of China the trade takes place.

In this sense, China's trucked LNG market is similar to the port stocks trade that takes place for other major bulk commodities, such as iron ore or coal. Like these commodities, the trade takes place off the back of imported cargoes, and it happens in many locations around China – each with different local market dynamics – making it hard to have a unifying "trucked LNG price". For instance, in south China, there's less connectivity to pipeline gas from than the north and east China, so it is relatively more reliant on LNG and therefore the demand for trucked LNG comes from power generation, industrial and city gas. In northern China, trucked LNG demand comes mainly from the industrial sector. The regional imbalances can be so big that they can attract, occasionally, trucked LNG from one part of the country to another, as what happened in April 2022, when there were sales of trucked LNG from north to south China.

Cargo benchmarks solve this issue by reflecting a whole seaboard or multiple locations, meaning that the fundamentals of the whole are reflected, rather than the minutiae of the local.

Unlike these other commodities, in some ways trucked LNG trade is taking place due to a lack of infrastructure: pipelines. Nearly always it would be more cost-effective in the long run to regasify and transport the gas by pipeline to demand sources, rather than ship in individual trucks. Indeed, market participants noted that trucked LNG trade has declined in the last couple of years, especially in areas where alternative infrastructure has been installed. As a difficult-to-store fuel, LNG – unlike many other commodities – is also rarely stockpiled in the expectation (or hope) of upward market movements.

Chinese importers slow spot LNG procurement activity in winter

Trucked LNG prices have recently diverged from LNG import prices, causing difficulties for importing companies, which are faced with a higher LNG spot import price than their sales price in trucks. This situation is historically unusual: in 16 of the last 24 months, LNG spot prices (represented by the JKM) were below trucked LNG prices, allowing for profitable import and on-selling.

There are several reasons for the decoupling that took place in winter 2021. Industrial users of gas in China started to consume less because of high prices caused by fierce competition for the marginal spot LNG cargo between the Pacific and Atlantic basins. This reduction in demand caused an imbalance at terminals in China because cargo imports are agreed several months before trucked LNG sales take place, due to the mismatch in lead times.

It therefore took some time for LNG import volumes to react to the sudden sharp reduction in demand from more elastic end-users, leaving an ongoing imbalance in fundamentals.

Moreover, China's LNG importers pulled back from spot purchases as these were more expensive than long-term contract formulas linked to Brent crude oil. This temporarily weakened the pricing link between spot LNG prices and China trucked LNG. Given spot purchases typically accounted for 30%-40% of the country's LNG imports in the past few years, this also meant that China's overall LNG imports started to significantly drop year-on-year in Q1, falling over 15% to around 16.5 million mt.

Indeed, such was the lack of demand that importers began to sell cargoes in the spot market from both long-term supply and strip tenders. Unipec, CNOOC, ENN and Guanghui all sold cargoes during the winter period.

China's LNG importers were the biggest participants in signing long-term contracts in 2021, in light of the higher spot prices at the time, but only around 6 million-7 million mt of the 35+ million mt of term contracts signed are commencing in 2022.

If China's importers maintain the current strategy, at least one of the following will likely happen: LNG imports will be curbed in 2022 – because term demand only covers circa 15 million mt less than the total import demand from 2021, LNG spot prices will come down and allow for elastic Chinese industrial demand to return, or local prices will rise to meet the international market.

Judging from the recent price progression, it looks like south China trucked LNG prices are coming up to meet (and exceed) LNG import prices. This could lead to the situation seen in previous years where spot LNG prices allowed for profitable trucked LNG sales. In fact, the average ex-terminal trucked LNG price in south China has risen to $25/MMBtu, according to domestic market participants.

However, the price and timing risks are still there for importers, who are generally buying on an index-linked basis for the future delivery of cargoes and selling in the trucked LNG market on a fixed price basis for very short-term delivery.

Chinese spot LNG importers enjoyed an average positive margin of Yuan 1,500-2,000/mt over 2020 from ex-terminal trucked LNG sales, as the JKM fell to a record low of $2/MMBtu in the year as gas demand dwindled significantly due to lockdowns across major cities in North Asia. However, fast forward to winter 2021, and China's importers faced an almost continuously negative margin for on-selling spot-procured LNG, and hence pulled back from the market.

How can importers manage this time and price risk?

Greater linkage between upstream and downstream markets required

They could be resolved by linking downstream markets like trucked LNG to the international spot cargo price, the main feed-in cost, and the market price China contends with to import LNG. Even though a lot of LNG is invoiced to other benchmarks, LNG spot prices remain the opportunity cost for China's importers, and are being used in downstream price negotiations or contracts in countries as diverse as Brazil and Japan.

In fact, the model of using international LNG prices in Chinese gas contracts already exists. China's Sinopec introduced spot LNG pricing in its downstream trucked LNG sales by referencing the JKM in its ex-terminal trucked LNG offers from April to October 2021, after procuring spot LNG cargoes through a strip tender on a JKM-linked basis earlier in 2021. BP China signed multiple regasified LNG supply contracts with buyers like ENN for pipeline gas from the Guangdong Dapeng terminal linked to the JKM. This pricing model allows sellers like BP China to import LNG at international spot prices and on-sell gas to the downstream markets via a back-to-back method, ensuring that a positive margin is locked in.

Furthermore, state-owned PetroChina also announced its plans to pass through its cost of spot LNG to downstream buyers of its spot natural gas volumes. China's Shandong province had also allowed city gas distributors to sell their spot LNG cargoes at market prices to non-residential users in October 2021.

Because LNG is the glue that links together regional gas markets, LNG price benchmarks are also being used in contracts between upstream suppliers and LNG liquefiers. Multiple 15-year term US feedgas agreements have been signed by Cheniere with American gas producers Tourmaline, EOG and Apache, all referencing the JKM.

As China's gas consumption is forecast to reach 430 Bcm-450 Bcm by 2025 from 395 Bcm in 2022, spot LNG imports will continue to play an important role in the country's efforts to decarbonize and transition to cleaner fuels. The ability to pass down import costs to downstream markets like trucked LNG would hold the key to ensure sufficient, stable gas supplies to non-residential users at times of peak residential demand, as LNG importers in China would be incentivized to make additional spot LNG cargo purchases, hence reducing margin pressure for them. This would also allow China's power sector to move toward more market-oriented balancing mechanisms.

*According to CNPC's Economics and Technology Research Institute