In 1H17, cumulative natural gas supplied was 117bcm, up 10.7% y-o-y, as importsrose 16% y-o-y to 43bcm and domestic production increased 8% y-o-y to a recordhigh of 74bcm. We believe industrial users are increasingly dealing direct, via bothLNG direct contracts and spot, creating an uptick in LNG imports in 2017 YTD. Theexpansion of LNG imports balanced the contraction of cumulative PNG imports.
Through 1Q17, cumulative natural gas supply amounted to 59bcm, up 4% y-o-y, asimports rose 4% y-o-y to 21bcm and domestic production increased 3% y-o-y to arecord high of 39bcm. In March, natural gas supply rose 6% y-o-y as domesticproduction increased 11%. In addition, imports contracted 3% due to a sharp declinein PNG imports in March and 1Q17, as China-Asia pipeline supplies were in shortsupply. However, monthly liquefied natural gas (LNG) imports rose 17% y-o-y asPetroChina (Hold, CP HKD5.10, TP:HKD5.15) adjusted LNG imports based onshipping periods, demand, and market prices.
Crude oil supply rose 10% y-o-y in March. Net crude import growth accelerated to18%, or a record 37.7mt, to offset declines in domestic production, which fell 5%, thoughthe rate of decline looks to have bottomed. Refinery runs rose only c.6%, less thancrude supply increased, suggesting SPR and teapot inventory builds, while reportedcommercial crude inventories fell. Through 3M17, crude supply rose 8%, consistentwith trends since 2016: (net imports +14%, domestic production -7%). Another importchannel, the China-Myanmar crude oil pipeline (capacity of 22mtpa), was commissionedin April 2017. In May 2017, the PRC Ministry of Commerce (MOC) disclosed strategicpetroleum reserves (SPR) of 33.25mt/244mb, or c.40 days of import volume, which issteadily moving higher toward the IEA guidance of 90 days. This level of SPR implies abuild of 50kbd during 1H16, more modest than we had projected.
2Q17 gas demand surged 20%, including a 30% y-o-y jump in imports and a 13%increase in domestic production. Although demand is seasonally weak in June,natural gas supplied rose 30% (domestic 15% and imports 20%). Some of this likelywent to storage to increase gas availability during seasonal peak demand.
Monthly data suggests that domestic gas output reached a new record high. Importsmaintain a critical role in supply, with import dependence at more than 60% during thewinter. Chinese LNG importers may benefit if North American LNG exports increase theoversupply of LNG globally and put further pressure on LNG spot prices, particularly inthe summer.
Underlying oil product demand rose 4.5% in the month and 3.2% through 3M17:kerosene grew, gasoline was stable and diesel remains weak, but volume was flat y-o-y.
A series of documents were released, sending a strong signal to stimulate gasbusiness: In 2Q17, the NDRC issued gas marketization reform schemes including 1)a requirement for gas producers and independent operators to fully publicize detailedgas transportation costs, aiming to normalize gas transportation prices byinstitutionalizing the 7% ROI cap. The government also gave guidance on oil and gastransportation pipeline construction via a medium-term pipeline plan to 2025.
Lower value added tax (VAT) to stimulate demand: From 1 July 2017, VAT on gas willbe cut to 11% from 13%, resulting in lower gas prices for end users. PetroChina plans tolower its non-residential gas price in the summer, after raising it temporarily in the winterof 2016. In addition, stricter environmental protection standards require provincialgovernments to establish measures to improve demand for natural gas. For example,Shanghai cut its base non-residential gas price by RMB0.4/cm from April, in line with thecountry’s gas pricing reforms, i.e. moving to a market-based pricing mechanism.
Kerosene inventories remain elevated, as an expected price hike stimulated restocking.
Lower prices improve gas competitiveness: In 1H17, industrial gas prices fellRMB3.31/cm or 0.10/cm y-o-y , but still lack an advantage compared to power coal,diesel and LPG in industrial activities. End-user gas prices may slip further as theShanghai Gas Trading Centre is creating a benchmark industrial LNG price, whichmay help stimulate industrial gas demand. Residential gas prices rose in 1H17, butthe impact on volumes should be minor as urban population trends are intact.
2017 outlook – macroeconomic factors are the biggest risk to demand: In 2016, thegas demand/GDP multiplier was 1.25x, which was above our expectation. In 1Q17, onthe back of slower growth, the multiplier fell to 0.52x, as natural gas lost itscompetitiveness vs. fuel oil. We believe the multiplier will rebound to 1.4x GDP and,referencing HSBC’s 2017e GDP growth forecast of 6.7%, should drive volume growth ofc.9% y-o-y. In our view, for Chinese natural gas demand to meet the government’s targetgrowth rate of 10-15%, there needs to be incremental government policy. For natural gasconsumption to rise from c210bcm to 300-320bcm, as targeted by the 13th FYP, theincremental annual volume growth required to meet the policy target is about c.20-25bcmper year. We will be watching the data carefully to see if demand growth in the secondhalf of the 13th FYP accelerates accordingly.
Net oil product exports rose 52% in March, to 2mt/477kbd, with diesel net exportsat a record 1.82mt. Gasoline and kerosene net exports rose 25% and 22%, respectively.
2017 outlook and demand prospects: China’s 2Q17 GDP growth beat marketexpectations at 6.9% y-o-y, and the gas demand/GDP multiplier picked up to 2.8x in2Q and 1.35x YTD. Government policies remain constructive. Stricter environmentalprotection policies incentivize local governments to accelerate the shift in industryuse of coal to gas. Demand is normally higher in the second half of the year, whichmeans the full-year demand is likely to be above 235bcm, implying 10%+ y-o-ygrowth in 2017. Breakthroughs on shale gas production and the diversification ofimport sources are both contributing to long-term gas supply security. We believeKunLun Energy (135 HK, Buy, CMP HKD7.41, TP HKD8.10, Buy) is the cleanestway to play gas in our upstream/mid-stream coverage.
Expansion of oil exports remains likely given domestic oversupply and ample quotas,with the 1Q17 export quota of 12mt almost fully satisfied, in line with our expectation.
Oil product export quota was lowered q-o-q in 2Q17, which should slow 2Q17exports. The MOC lowered the 2Q17 quota by 73% q-o-q, to 3.3mt; and teapots gota zero quota, as in 1Q17, likely due to less supply given 2Q refinery maintenance.
News reports (e.g. Sina Finance, 17 April 2017) suggest a possible levy on mixedaromatic hydrocarbon imports, which could increase refining costs and limit 2Q runs(vs 77% in 1Q17 and 59% teapots). The NDRC halted applications for crude oil importlicences from 5 May 2017 on; cumulative teapot crude imports surpassed 100mt.
2017 Outlook: We expect oil demand growth of 2-3% based on a 0.3x-0.4x GDPmultiplier. While the multiplier was lower in 2016, and just 0.15x in 1Q17, lower oilprices may continue to stimulate demand in 2Q17. Crude supply fed by imports shouldcontinue to rise as SPR and other inventories build. Domestic crude oil productionshould bottom out, but are likely to remain relatively low.