BMI View: Sinopec's long-term supply contract with US' Phillips 66 for liquefied petroleum gas (LPG) is set to further alter the composition of countries making up China's LPG imports as the US rises in prominence as a LPG exporter. This is on the back of the US' oil and gas renaissance led by its unconventional production boom. The Middle East, -the traditional suppliers of LPG to China- is set to see higher competition in the long-term Chinese LPG market should further contract deals with the US are signed.
A long-term supply and purchase agreement (SPA) was signed between China's Unipec and US downstream major Phillips 66 that will see the latter deliver supplies of liquefied petroleum gas (LPG) to the Chinese firm. While neither the length nor size of this contract is stated in their official press releases, it will nonetheless see the US establish a stronger foothold in China's growing LPG market.
Unipec is the subsidiary of state-owned China Petroleum and Chemical Corporation (Sinopec), which is also China's largest downstream player. The subsidiary mainly deals with the trading and logistics of oil, oil products and liquefied natural gas (LNG). The LPG supplies - specifically noted to be propane in Sinopec's press release - procured from Phillips 66 will likely be sold to its parent company. Senior vice president of Sinopec Dai Houliang stated that the contract will 'further diversif[y]' the firm's feedstock supply channels and 'will be critical to adjust our chemical feedstock structure', hinting that the propane will most likely be used in petrochemical production.
The US' LPG Boom
The US' LPG production has risen steeply alongside the oil and gas renaissance the country is currently experiencing from a boom in shale gas and liquids production. Between 2004 and 2013, total LPG production rose from about 2.2mn barrels per day (b/d) to 2.8mn b/d.
| A Gas Bonanza |
|US LPG Production By Type ('000b/d)|
Much of this growth has taken place not from oil refining, but from gas fractionation, as the US' gas production rises from tapping its shale formations and from the associated gas produced from liquids-rich plays. Our US LPG forecasts suggest that US LPG production will continue on this upward trajectory as both oil and gas production grows. Also, as long as the US' crude export ban remains in place, producers will seek to refine their crude product wherever possible in order to overcome the limits of the ban to achieve higher profit margins. Rising regulatory pressure to capture associated gas that would be otherwise flared from liquids projects would push this further up.
| Gas Boom Fuels LPG Growth |
|US LPG Production By Source ('000b/d)|
This has contributed to an increase in US LPG exports in recent years. 2013 saw a particularly steep climb as LPG exports rose 69.4% year-on-year (y-o-y) to hit 332,000b/d.
| Renaissance Pushes Exports Up |
|US LPG Exports ('000b/d)|
Rising crude oil production, and more importantly, our forecast for higher gas and NGLs output will translate into higher LPG volumes produced in the US. Although domestic consumption of LPG is expected to increase, there will still be ample supplies available for the export market, to the benefit of LPG consumers in other countries.
| Crude Oil & Gas Production Growth Backs LPG Exports |
|US - Net LPG Exports ('000b/d), 2011-2018|
Also interesting to note is the increasing number of countries that are now obtaining LPG supplies from the US. In 2004, majority of the US' LPG exports were directed towards North America Free Trade Area (NAFTA), with Mexico and Canada alone making up 72% of total exports. By 2013, NAFTA's share of US LPG exports has fallen to 22%. Of particular note is the sharp rise in exports to the Netherlands and Japan, which together made up 23.8% of US' total LPG exports in 2013 from zero in 2004.
| New Seekers For US LPG |
|Share Of US' LPG Exports, 2004 and 2013|
China: Taking A Slice Of The US Action
In comparison to Japan and the Netherlands, China's share of US' LPG exports in 2013, at only 7,000b/d, is small. However, Sinopec's deal with Phillips66 is set to see this share increase in the near future. In addition, we note that other deals could follow, or Chinese companies could seek to obtain more supplies from the US.
Indeed, propane consumption from China is set to grow on the back of gas-based chemical plant investments made by the country. Sinopec, for one, proposed a US$3.1bn ethylene plant in Qingdao, Shandong province in June 2013 - a proposal that is significant for it would be Sinopec's first chemical plant to use gas as feedstock. China is also expecting at least 11 new propane dehydrogenation plants to come online by 2015, with another 5 likely to follow by 2017; a Platts' source estimates that this could lead to at least 11.17mn tonnes per annum (or about 354,992b/d)of new propane demand.
| Price Advantage To The US |
|Propane Spot Prices - Bloomberg Arab Gulf & Mont Belvieu (US$/bbl)|
US LPG supplies have a considerable price advantage over their Middle Eastern counterparts. Growing supplies from the US has led to the widening of the spread between spot prices of propane from the Middle East (represented by Bloomberg's Arab Gulf index) and the US (represented by prices at the Mont Belvieu exchange in Texas) especially from 2012. Contract and monthly posted prices of propane from the two regions broadly correspond with trends in spot prices, as Middle Eastern propane shows few signs of narrowing its premium with Mont Belvieu in the short term.
The opening of the Panama Canal in 2016 (most likely following the construction delays) will enable very large gas carriers (VLGCs), which have capacity of up to 85,000 cubic meters/55,000 DWT, to transport LPG to North Asia from the GoM via the Panama Canal thus cutting the distance travelled by 40%.
Indicative of the heavier trade anticipated for LPG in the coming years, there are nearly 135 orders for new LPG vessels at time of writing, the second largest after crude oil tankers.
| US Price Advantage Few Signs Of Fading |
|Propane - Bloomberg Arab Gulf Monthly Posted Price & Mont Belvieu Contract Monthly Average (US$/bbl)|
In the medium term, an expansion in the US' petrochemical industry - which investment had been made on the assumption that there will be abundant gas supplies domestically - will see an increase in US demand. However, we note that as long as US natural gas prices are pressured by the country's restrictive policy against natural gas exports, the US petrochemical industry would prefer and turn to natural gas to LPG for feedstock. This would allow for sufficient LPG volumes to be exported at competitive prices.
Iran: At Risk Of Long-Term Chinese Market Loss
We note that our forecast for an 18% expansion in domestic refining capacity between 2013 and 2018 should see domestic propane production rise and help meet some of the expected increase in demand. However, with LPG consumption growth set to outstrip production growth, China's LPG import requirement is set to rise over the same period.
| Petrochemical Expansion To Fuel LPG Import Rise |
|China - LPG Production, Consumption & Net Imports ('000b/d)|
While this should provide room for US LPG exports to China to grow, this will also pose competition to Middle Eastern countries who have traditionally been suppliers of LPG to China. Although sanctions on Iran has seen the country's market share of the Chinese propane export market shrink from 32% in 2009 to merely 2% in 2013, other Middle Eastern countries have not been able to fully capture the remaining 30%.
| Middle East: Seizing Little Advantage Of Iranian Fall |
|Changes In Country Share Of Chinese Propane Export Market, 2009 and 2013|
Other long-term supply deals established between Chinese firms and US sellers will narrow the opportunities available in the Chinese market to the Middle East further. We note the biggest loser could be Iran, which is looking to recapture its previous market share in the global oil industry if and when sanctions against it are fully lifted. While political rapprochement between Iran and the West are making progress, it has thus far only helped to prevent an escalation of sanctions rather than to remove them. Therefore, the more supply agreements sealed between China and US companies in the short-term, the smaller the remaining share of the long-term Chinese propane export market left for Iran when it fully returns to the global market - a development our Country Risk team does not foresee until late 2014 at the earliest.
Picky Americans Provide Middle Eastern Upside
Nonetheless, we highlight that Middle Eastern suppliers will not be completely squeezed out of the Chinese market and have moderate expectations for the extent of an increase in the US' share of the Chinese LPG market. According to sources quoted by Platts, the perceived lack of credit-worthiness of smaller Chinese LPG buyers - many of whom are smaller players in China's petrochemical sector - restrict their ability to obtain long-term supply contracts. Until the terms of supply agreements are loosened, the need to procure US LPG supplies through larger trading firms such as Unipec could narrow the price differential of US and Middle Eastern LPG supplies for these firms.
Also, prices may not always remain in the US' favour, particularly if the following takes place:
Fall in crude oil prices: Given that much of the Middle East's LPG supplies are associated output from crude oil production, a fall in crude oil prices will put downward pressure on prices. Although we have already priced-in this expectation in our current oil price forecast, a steeper-than-expected fall will also see a corresponding fall in LPG prices.
| Steeper Fall Could Boost Middle East LPG Position |
|OPEC Oil Basket Price Forecast (US$/bbl)|
Increase in LPG supplies: Like the US, some of the Middle Eastern countries could see a rise in LPG production. Kuwait, in particular, is expected to add a fifth gas processing train to the country's Mina Al-Ahmadi gas plant by 2017. According to our forecasts, this could boost its exports by about 17.3% in 2017 from 2013 levels. At present, our projections for Saudi Arabia to cut back on its crude oil output in the next five years will hit associated LPG production, thereby limiting the total increase in exports from the region. Nonetheless, a decision by Saudi against reducing crude oil output is an upside risk that could boost Middle Eastern LPG production, and thus downward pressure on the region's LPG prices.
| Production Upside Could Increase Price Competitiveness |
|Middle East - LPG Net Exports Of Selected Countries ('000b/d)|