Will Chinese Tariffs Hurt U.S. LNG?

On May 13, China announced that it would increase tariffs on many U.S. products, including liquefied natural gas (LNG). This the second time that China has targeted U.S. LNG: it set a 10 percent tariff in September 2018, which reduced flows to almost zero. The new tariff, at 25 percent starting June 1, will likely end the LNG trade between the two countries (for now). This escalation is widely interpreted as a major blow to U.S. LNG exports. It is certainly a blow, but even that statement should be followed by several asterisks.

Since 2010, when the United States emerged as a prospective LNG supplier, U.S. exporters have tried to secure long-term sales contracts with Chinese customers—but to little avail. There were various attempts over the years, although mostly with second-tier players, rather than the big three Chinese national oil companies (CNPC, Sinopec, and CNOOC). But the deals were never consummated. The sense was that the Chinese companies, which were perfectly willing to sign long-contracts with everyone else, simply did not trust the United States. No amount of lobbying and reassurance from the U.S. side changed that fact.

So U.S. projects went ahead without Chinese customers directly. The first long-term contract between a U.S. project and a Chinese buyer came in February 2018, two years after the United States started exports from the Lower 48 and almost six years after the first long-term contracts were signed in late 2011. Of course, the Chinese market still mattered. A lot of U.S. LNG has been purchased by portfolio players—companies with multiple sources of supply and multiple customers—who have, themselves, contracts with Chinese customers. And the appeal of U.S. LNG has always been its flexibility: if a customer does not want to bring their contracted LNG to their home market, they can always re-sell it on the spot market, including to China.

Even without direct contracts, therefore, some U.S. LNG flowed to China through these channels—the relationship has been intermediated by third parties. The volumes were small for China: in 2017 and 2018, China relied on U.S. LNG for about 4 percent of its LNG imports. For the United States, China accounted for a higher share: just over 10 percent of U.S. LNG exports ended in China in 2017 and 2018. This trade has been disrupted after September 2018, and we can expect it to dwindle to zero if the higher tariffs are enacted. In practice, this means that China will have to source its LNG from other countries, and U.S. exporters will have to place their volumes elsewhere. In a highly optimized market, this adjustment would be costly. But LNG is not a highly optimized market—LNG flows have to contend with numerous constraints, and this is a wrinkle that the market can work around.

Less certain is the impact on new projects. Projects under development that cannot sell LNG to China are at a competitive disadvantage—there is no doubt about that. But even that simple statement requires qualifications. For one, Chinese buyers have never been major customers for U.S. LNG—the tariffs merely solidify an unfavorable reality, and there were few takers even before the tariffs were in place. Nor are Chinese buyers that critical for new LNG projects in general—Chinese companies usually offtake only a share of a project’s total output, and success still depends on finding a diverse customer base. In short, the notion that if it were not for tariffs, there would be lots of Chinese companies signing long-term contracts, which would help underpin the next wave of U.S. LNG projects, is not really consistent with the data, which paint a far more nuanced picture.

The point is not that the Chinese tariffs do not matter—everything else being equal, they do. But the impact of the tariffs should be understood in a hierarchy. They affect the ability of the two sides to transact directly, a risk that has existed for a while, and which companies have learned to manage. Even with this headwind, another wave of U.S. LNG projects is coming. It signals the extent to which energy relations and trade are becoming politicized—which is a bigger concern for long-term projects and for energy security, undermining confidence in an open market for energy and LNG. More importantly, they are a proxy for how well the United States and China are getting along—and, given the impact their relationship has on the global economy, a protracted trade war will have cascading effects on energy markets. Those second order effects are likely to be far more important than whether U.S. LNG can flow to China.

Nikos Tsafos is a senior fellow with the Energy and National Security Program at the Center for Strategic and International Studies in Washington, D.C.

Commentary is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

© 2019 by the Center for Strategic and International Studies. All rights reserved.

Nikos Tsafos