CNOOC took the drastic step encouraged by the Chinese government, which said it would hand out ‘force majeure’ certificates to domestic companies if they cannot fulfill their offtake obligations as the coronavirus crisis accelerates. Beijing apparently tries to mitigate potential losses of state-owned gas companies.
PetroChina and Sinopec are also understood to be considering invoking ‘force majeure’ on some contracts, given that they cannot get enough workers to run their regasification and import terminal at full capacity.
“Those of a more cynical disposition would say this may be an attempt to unwind long-term LNG sales and purchase contracts using force majeure as an excuse, on the basis the LNG spot market prices are significantly lower and there is excess supply in the market right now, with potentially new suppliers whispering in the ear of the buyers that they can achieve same volumes at much lower prices,” commented Myles Mantle, partner at law firm Haynes and Boone.
Force majeure is usually aimed at dealing with events such as unforeseen operational outages, rather than changes in broader economic circumstances in which case the risk lies with the buyer. Most long-term LNG purchase contracts include take-or-pay obligations, which require a buyer to pay for a certain quantity of LNG even if it doesn’t take, on the understanding that the buyer can receive some of the volume at a reduced price in the future.
Short-sighted cancellations damage relations
Cancelling contracts outright could be “short-sighted,” analysts noted, as spot market does are not significantly developed to be able to cover the volumes required by Chinese buyers, at normal times.
Should more Chinese importers invoke ‘force majeure’, this would “severely damage relationships and willingness of suppliers to enter into long-term contracts in the future,” Mantle noted. Particularly, where U.S. suppliers have used those long-term contracts as a basis of FID and financing for their liquefaction and export facilities.
Analysts agree it might take time for to justify this virus outbreak as force majeure. “While it might affect a buyer’s ability to fulfill its contractual obligations, most of the long-term contracts have an annual volume commitment that can be postponed to later in the year,” S&P Global Platts said, suggesting “it might be early for Chinese companies to justify and obtain reliefs from performance.”
However, China’s gas demand growth started to tumble even prior to the outbreak due to the slowing economy. Given that 60 percent of Chinese gas demand comes from power and industry, the coronavirus infections impact the gas market at a time of underlying weakness.
Assuming a relatively quick containment of the virus, Wood Mackenzie expects slower Q1 economic growth in China at 5.8 percent year-on-year, before a notable rebound to 6 percent in Q2. In contrast, the China Academy of Social Sciences warned that economic growth could fall below 5 percent in the short run, which would be much more damaging to the global economy.