Cancel All Australia's LNG Off takes to China

A modest proposal

Europe is facing the possibility of its gas being turned off by Russia. Analysis by Brugel and others is showing a very large deficit that will be hard to cover. While a great deal can be done to switch from gas to coal for power generation and convincing people to turn down the thermostat next winter there are fairly hard limits to what can be done in the short term. Replacing a lot of gas very quickly requires capital investments that substitute gas demand: heat pumps for housing, district heating from geothermal sources for industry and offices, renewable energy deployment and the like. All these things can be accelerated but they do take time. In an ideal world Europe would have massive reserves of domestic coal, underutilized coal plants and extensive local gas supply and production along with coal to chemicals plants that can replace gas used for plastics. That does not describe Europe, but it precisely describes China.

The current “hole” in European gas markets in the event of a full shutdown of Russian gas supply is a minimum of 400TWh and arguably 800TWh. Australia exports approximately 2.5MT or ~32TWh per month to China. So on that basis alone Australia could fill half the maximum gap (~384TWh on an annual) and fill it quickly. Europe can do a good deal of coal-gas switching and could keep its nuclear plants on longer but it likely is not enough without serious impacts to consumers and growth. At this point the question is, how would this impact China and particularly China-Australia relations?

I will answer the second question first: the relations are already bad, and China has sanctioned barley, coal, wine and numerous other products. Australia has managed to walk this off with limited impacts and now has no illusions about there being any separation between politics and economics with China. China has not set a particularly good precedent here - one might argue they’ve taken enough rope to hang themselves with. However, the impacts on China would be fairly modest to if LNG contracts were cancelled.

Firstly, China produces substantial amounts of natural gas domestically - you can see this in the EIA Sankey diagram linked here and monthly domestic production now is around 200 TWh. LNG imports are 95 TWh monthly of which Australia is a third as indicated above. In addition, China imports significant quantities of gas by pipeline as shown below which account for another 43 TWh. Australia’s output might be a big deal for Europe but for China it is less than 10% of total supply. And from this report, they are trying to push us out anyway.

Most gas in China is not used for heating - it goes into industry and particularly petrochemical production, something for which China has invested heavily in substitutes especially coal to chemicals. China is suspending these plants over their energy use but that’s a luxury that can be afforded outside of war time which is what we face now.

China’s power sector uses very little gas and can fuel switch quickly. China has been slow to get off coal and continues to build new plants and that has been well reported. A corollary of this is that China has extensive capacity in its grid and a lot of underutilized plants that can load follow and are very efficient. If they do not use them now, then when?

There are multiple barriers to this plan. Firstly, the contractual off takes for gas: while I suspect these are firm, I also suspect government intervention and indemnification can go a long way here. The other constraint is transport - costs per GJ are likely to be $2 higher to Europe but in the current context of $30+ per GJ and outright demand destruction that seems almost quaint. Europe has LNG landing capacity that is under utilized according to the Brugel piece, so that is not a problem but internal gas distribution might be. Thirdly is the Australian government which remains deeply incompetent and beholden to fossil fuel interests and probably quite antipathetic on a personal level with European leaders especially Emmanuel Macron or at least so for Scott Morrison. Nonetheless they do appear to be running a “khaki” election campaign and scare mongering on China, so, do they care about logistics more than the Russian army and can they walk the talk? Time will tell. Much is made of Australia’s formative experiences in war, in this one all we have to do is redirect some gas carriers to play a critical role.

Might this stop the war? Who knows. Putin knows he has Europe by the throat in the short term thanks to gas. Taking that leverage away may end this faster, and to that end if China is true to its word it might see some merit in this for themselves if they genuinely do want this conflict to end and for it to end quickly. If China were to initiate this it could even look like the good guy.