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3 things to know in energy: China fuel tax, crypto mining, LNG outlook

INSIGHT ARTICLE  | 

Biweekly, we highlight three things going on in the energy industry that we think you should know about. This week, we take a look at a new tax on blending fuels in China, how natural gas production plays into cryptocurrency mining, and the shifting outlook for liquefied natural gas production. Here’s the latest.

1. A new fuel tax in China and its expected impact on demand

Last week China announced a new consumption tax, to begin on June 12, on imports of light cycle oil (LCO), mixed aromatics and bitumen mix, increasing costs for these blending fuels by up to 40-50%. The tax is aimed to “ease the domestic fuel glut and reduce pollution,” according to this Oilprice.com article.

The tax will have a variety of effects on supply and demand of crude oil and on the markets supplying the blending fuels. These products to be taxed are basically blending fuels, which refiners use to produce sub-quality grade gasoline and other fuels. Specifically, LCO is used to blend gasoil, mixed aromatics are used as a component of gasoline and bitumen blend is used by independent refineries as feedstock. The taxes will increase the cost of importing the fuels—typically from South Korea and Japan (LCO) and Malaysia (bitumen).

In the short term, imports of these products are expected to dramatically decline upon imposition of the new tax, drastically affecting the supplier markets—namely South Korea, Malaysia and Venezuela (bitumen from Malaysia is said to be comprised mostly of heavy crude blend from Venezuela). At the end of the day, the tax treatment of these products is based on how they are classified at customs, so some expect that traders may eventually find ways to rename the products to avoid the new taxes.

“A small number of companies have imported record amounts of these fuels and processed them into sub-quality fuels which were then funneled into illicit distribution channels, threatening fair market play and also causing pollution,” the Chinese Ministry of Finance said in a statement reported by Reuters. China is expected to increase crude imports and raise refinery run rates to source barrels of suitable crude as replacements, according to Bloomberg. As a result of the expected increase in demand in China, “spot differentials for Middle Eastern and Russian crude have risen to a multi-month high, while timespreads for Dubai crude strengthened on expectations China will continue its purchasing spree,” also according to Bloomberg.

China is likely to look to Saudi Arabia and Russia to fulfil the domestic demand growth, leaving fewer Saudi/Russia exports available for other countries. In this scenario, the United States could be positioned to fill the supply void other countries are expected to see as a result of the diversion of Saudi/Russia crude to China.

2. Using natural gas for cryptocurrency mining?

Cryptocurrency has had a tumultuous couple of weeks, and as a result, discussions about the crypto mining process—which is extremely power-intensive in terms of both computer processing power and the electricity necessary to power the computers—is once again at the fore. Historically, the vast majority (65% as of 2019) of cryptocurrency mining has happened in China, where most electricity is generated from burning coal, which is extremely carbon intensive. The carbon footprint of cryptocurrency has been the subject of much debate, and has contributed to recent swings in valuations.

However, as Reuters reported this week, mobile mining rigs with a lower carbon footprint are on the rise: Supercomputers on a trailer with a natural gas-fueled generator are increasingly being hauled out to production facilities to capture produced associated gas that would otherwise be flared, converting the natural gas into electricity to fuel the computer which then mines (solves extremely complex mathematical equations) cryptocurrency, which is classified as a commodity.

Historically, the vast majority of cryptocurrency mining has happened in China, where most electricity is generated from burning coal, which is extremely carbon intensive.

Natural gas is a much cheaper and greener solution than coal, and in certain producing basins, it is occasionally even given away for free. The energy transition has made significant strides during the pandemic, and mobile cryptomining rigs are yet another solution to a problem that has long plagued oil and natural gas producers looking for a viable economic solution to managing natural gas that has nowhere to go.

Sustainability and scalability of mobile mining and cryptocurrency remain to be seen, but this is a rather innovative way to capture harmful emissions from oil and natural gas producers and, at the same time, reduce the overall carbon footprint of cryptocurrency by reducing the need for coal-powered electricity.

3. The future of LNG is looking murkier

Once viewed as a significant source of growth for natural gas producers, North American liquefied natural gas (LNG) is beginning to have a less certain future. A May 18 announcement from Australia-based Woodside Petroleum Ltd. that it was exiting the Kitimat LNG development and looking to sell its 50% non-operated interest in the project underscored that shift.

Woodside cited higher value opportunities elsewhere among its reasons for abandoning the proposed LNG terminal on British Columbia’s coast. Given the search for a buyer willing to invest billions of dollars to construct the terminal and pipelines, the project is likely to be shelved indefinitely. The First Nations Limited Partnership, which represents the 16 First Nations with traditional territories along the proposed pipeline, released a statement on May 20 expressing that it was “incredibly disappointed by this setback.”

Chevron Canada, the operator and owner of the other 50% stake in the project, announced its intention to sell its interest in December 2019. When the company was unable to find a buyer, it made the decision to cease continued funding of the project on March 17 this year.

Growth expectations for LNG hinged on the premise that super-cooling natural gas down to liquid form for overseas transport would supply energy-consuming markets such as China with a cleaner alternative to displace coal, while simultaneously solving natural gas oversupply issues in Canada and the United States where landlocked production has increased significantly over the past decade.

But LNG purchasers have become hesitant to commit to signing long-term contracts with North American LNG projects. Among the reasons why: a large LNG project in Qatar has exacerbated concerns about oversupply, especially given the rising adoption of renewables; and recent guidance from the International Energy Agency that encourages investors to divert financing from new oil, gas and coal supply projects to renewables instead. So far, 2021 has seen more LNG projects put on hold and facing potential cancelation.

LNG purchasers have become hesitant to commit to signing long-term contracts with North American LNG projects.

In 2014, there were more than 20 proposals for LNG projects in British Columbia, but LNG Canada, led by Royal Dutch Shell, is the only project underway in the country, with construction expected to be completed in 2025. On April 22, Pembina Pipeline Corp. decided to put its Jordan Cove LNG export plant in Oregon on hold, and on March 22, Annova LNG similarly announced that it was stopping development of its LNG export plant in Texas. There are 14 North American LNG projects awaiting a final investment decision (FID) this year, with only one or two expected to move forward.

With fewer LNG projects expected to come online with positive FIDs over the foreseeable future, North American natural gas producers can alternatively look to blue hydrogen production and a rising petrochemicals industry for long-term growth.

RSM CONTRIBUTORS

Anne Slattery,  Director, RSM US LLP


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