Husky and Primeline legal threats against CNOOC put spotlight on mainland China gas pricing dilemma

Threats of legal action by Husky Energy and Primeline Energy against partner and customer China National Offshore Oil highlight a dilemma created by the big price differential between mainland China’s state-guided onshore gas pricing and free-market offshore gas pricing in times of extreme energy price volatility. Analysts say the only way to resolve the problem is further market reform. On the one hand, China National Offshore – parent of listed oil and gas giant CNOOC – needs to meet its contractual obligations to buy gas at the high prices fixed a few years ago when international oil and gas prices were high. The slump in gas price and oversupply have caused friction between offshore gas buyers and sellers Neil Beveridge, Sanford Bernstein On the other hand, it faces demands from downstream customers of the cleaner-burning fuel to lower prices after Beijing cut regulated benchmark prices for onshore gas. “The slump in gas price and oversupply have caused friction between offshore gas buyers and sellers, since offshore gas prices are unregulated while onshore gas prices are linked to [state-guided] city-gate prices,” said Sanford Bernstein senior analyst Neil Beveridge. “With the change in market conditions, offshore [long-term contract] prices look expensive relative to onshore gas prices, highlighting some of the problems China faces as a gas market.” He said the price disputes and uncertainty over their outcome sent a negative signal to potential investors in Chinese offshore gas exploration projects, and a greater push by Beijing for transparent market-based pricing via exchange-traded spot and futures contracts was needed to mitigate the risk of such disputes. After international gas prices dived more than 60 per cent from mid-2014, Beijing made its first substantial cut to regulated domestic wholesale gas prices in November last year, following a modest reduction in April. The belated response was partly due to opposition to timely price cuts from the mainland’s dominant gas producer and importer, state-backed PetroChina, which signed long-term contracts for huge volumes of imported liquefied natural gas (LNG) at high prices to help fight air pollution. It has been losing tens of billions of yuan a year as a result. China National Offshore, the mainland’s biggest importer of importer of LNG, has also been losing money on long-term imports, even with delayed domestic price cuts. Renegotiation of long-term gas import contracts is rare internationally, as buyers and sellers have their credibility as long-term players to worry about if they demand changes to contract terms. Long-term gas importers in Japan, the world’s largest LNG importer, and in South Korea, the second-largest, had always honoured their contracts, Beveridge said, and mainland China, the third-largest importer, had also met its import obligations so far. China seen holding off LNG deliveries amid glut and high-cost domestic output But that might not be the case for domestically produced gas, at least in one instance. Gas producer Primeline Energy, listed in Canada and controlled by Hong Kong businessman Victor Hwang Yiou-hwa, alleged on April 15 that Hangzhou-based gas distributor Zhejiang Natural Gas Development (Zhejiang Gas), had failed last year to take delivery of the minimum quantity of gas stipulated in a contract. Zhejiang Gas is majority owned by provincial government-owned Zhejiang Energy Group and partly owned by China National Offshore. Primeline produces gas at an East China Sea field that sells its output to Zhejiang, in a joint venture with CNOOC. Primeline said that in February last year – just over three months after the two firms signed a gas sales and purchase contract – Zhejiang Gas began requesting a price cut from April 1 last year. It also alleged that a further price cut was later demanded to match the wholesale onshore piped gas guidance price announced by Beijing with effect from November last year. Chinese shipping firms, Greece’s Dynagas in talks to build Arctic LNG vessels The contract carried a so-called “take or pay” provision under which the buyer was generally obliged to pay for an agreed minimum volume at the agreed price, even if it took delivery of a smaller volume, Primeline said. “While the gas sales contract provides that the parties should at some point agree [on] a price adjustment mechanism, Primeline’s position is that any such [mechanism] must be negotiated and [subject to mutual agreement] ... Zhejiang Gas is not entitled to unilaterally reduce the gas price,” it said. Since June last year, it alleged, Zhejiang Gas had only paid for the gas at the reduced price it proposed, resulting in a shortfall of 374 million yuan (HK$448 million) owed to CNOOC and Primeline. CNOOC, which is also affected by the dispute since it has a 51 per cent interest in the gas field, had not asked for arbitration proceedings, said loss-making Primeline, which faces the risk of defaulting on a project finance loan owed to three mainland banks. US discourages Chinese investment in LNG export industry Primeline said it had started arbitration proceedings against Zheijiang Gas at the China International Economic and Trade Arbitration Commission, adding it reserved the right to recover from CNOOC money it is owed by Zhejiang Gas, since CNOOC, as operator of the gas field, had not taken action against Zhejiang. Asked about the dispute’s impact on CNOOC, the company’s chief financial officer, Zhong Hua, said on Thursday that CNOOC was not involved in the price mechanism talks between Primeline and Zhejiang Gas, but it had been communicating with Primeline. Last year’s dramatic slowdown in gas demand growth and rising supply had resulted in a “tremendous challenge” maintaining domestic production, but CNOOC remained confident about China’s long-term gas demand growth, he added. Primeline’s case was quickly followed by another gas price dispute, in Guangdong, between Canada’s Husky Energy, majority controlled by Hong Kong tycoon Li Ka-shing, and its Chinese partner. Husky said in its first-quarter results filing last week that its Liwan 3-1 natural gas field in the South China Sea – in joint venture with CNOOC – had its selling price fixed in a contract for the first five years, after which it would be linked to mainland China’s benchmark pricing, subject to a floor and a ceiling. The contract was signed in 2011 with buyer CNOOC Gas & Power Group, a unit of China National Offshore. Husky said China National Offshore officials had indicated changes in the Guangdong gas market meant prices needed to be cut. Husky said it had an enforceable contract on the fixed selling price and was in talks with China National Offshore to find a solution, adding it would take legal action if a “satisfactory outcome is not obtained”, ensuring that any changes in the contract terms were “value neutral” to Husky. Liwan 3-1, China’s first deepwater offshore gas project, is Husky’s largest project.

Husky and Primeline legal threats against CNOOC put spotlight on mainland China gas pricing dilemma

.css-1c6uqr6{color:inherit;font-weight:inherit;font-size:inherit;font-family:inherit;line-height:inherit;overflow-wrap:break-word;}Analysts say the only way to resolve the problem is further market reform

Analysts say the only way to resolve the problem is further market reform