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China will shut small coal boilers to cut pollution but LNG oversupply will remain

China aims to shut almost half a million small-scale coal boilers in its industrial sector by 2018, in what should have been a positive move for the liquefied natural gas (LNG) market.

However, LNG prices will continue to struggle as massive new supplies come online in an already oversupplied market, ANZ analysts wrote in a recent report.

The world's second-largest economy aims to cut its use of thermal coal as an energy source, in order to clean up its notoriously polluted air.

China's annual LNG import growth is expected to increase as the country retires 400,000 small-scale coal boilers in the industrial sector by 2018, some of which will be replaced by gas boilers, ANZ said. A $3-per-mmBtu - mmBtu stands for one million British Thermal Units - reduction in China's regulated gas prices and lower domestic gas prices will also help encourage coal-to-gas switching as the East Asian giant aims to control air pollution, the house added.

But China's LNG imports will still fall behind those of Japan and South Korea, which together account for almost half of global imports, ANZ calculated. And the forecast rise in Chinese imports will likely be offset by a bigger jump in supply.

Natural gas prices hit their lowest level in almost two decades earlier this year, in turn hitting LNG, the super-cooled version of natural gas that's made for easier storage and shipping. Depressed oil prices - which hit prices across the commodities complex - did not help LNG prices either.

Natural gas prices have since rebounded but the longer-term price outlook isn't positive, with global LNG supplies expected to rise 50 percent by 2020, wrote ANZ Research's strategists Daniel Hynes and Natalie Rampono

Tomohiro Ohsumi | Bloomberg | Getty Images

Much of this supply will come from up to 130 million metric tons per annum of approved new LNG capacity, predominantly from Australia and the U.S., they added.

Australia's current committed LNG projects will make it the world's largest LNG producer by 2020, when 82 million tons will be produced Down Under every year.

The U.S., meanwhile, started exporting LNG in 2016 and was projected to produce 36 million tons a year by 2020, making it the world's third-largest producer after Australia and Qatar, noted the analysts.

To add more gloom to LNG's outlook, Japan, once a source of demand optimism for the LNG market, is looking subdued.

Despite the shutdown of all nuclear power plants in the aftermath of the Fukushima nuclear disaster of 2011, Japan's demand outlook in the near-term remained weak, with imports down 6 percent in the first seven months of 2016 versus the same period a year ago. This was, in part, because coal use had increased as power generators expanded coal-fired capacity in order to reduce average fuel costs. The country has also restarted five nuclear power reactors, noted ANZ.

While South Korea's demand currently remains positive, with imports up 3 percent in the first eight months of 2016, the start of new coal-fired power plants and a nuclear reactor restart would keep demand flat-to-weaker going forward, the analysts added.

ANZ forecast a further decline in Japanese LNG contract prices this year, with the average price likely down to to $6.9 per mmBtu, from $16 per mmBtu in 2015. Medium-term prices will settle closer to $10 per mmBtu, the house forecast.

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