China Turns to Natural Gas to Fuel their Economic Growth

A New Role of Natural Gas in China’s Energy Mix

The Chinese economy has grown by an average of 10 percent a year over the past two decades, crossing the milestone to become the second-largest economy and energy user in 2010 after the U.S., as well as the world's largest emitter of greenhouse gases.  Stable energy supplies being at the core of China’s rise, they remain pivotal to its continued economic growth, especially coal, oil and gas.  While coal still constitutes around 68 percent of China’s energy use, Chinese policymakers and energy executives lean more and more towards cleaner fuel sources, particularly natural gas.  According to International Energy Agency’s June 2012 report, the share of natural gas is set to rise in China’s energy mix, which is expected to have strong implications on the country’s energy usage in the years to come. Given the increased importance of gas, what is China’s natural gas policy?  Who are the main players in the Chinese gas market? What kind of problems does Beijing face as the share of natural gas grows in the country’s energy market? 

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Energy supply security based on reliance on primarily domestic production and energy diversification coupled with control of greenhouse gas emission and environmental protection constitute the core of China’s energy policy and appear frequently in statements of Chinese policymakers and leaders of energy companies.  As part of its 12th Five-Year Plan (2011-2015), China has put a particular emphasis on cutting carbon emissions by reducing its use of coal and oil.  Natural gas is the preferred energy source to achieve this goal. The Chinese government has set an ambitious goal of increasing the share of natural gas in the energy mix from its current 4 percent to 10 percent by 2020 and cutting carbon emissions by 17 percent between 2011 and 2015 through closure of energy-intensive enterprises.  

Although the industrial sector is the major consumer of natural gas (45 percent in 2007), residential and utilities sectors have also upped their gas consumption and imports in recent years. As illustrated in Figure 1, gas consumption in China went up from 25 billion cubic meters (bcm) in 2000 to over 100 bcm in 2010, overtaking domestic production since 2007.  The volume of gas imports has also steadily increased since 2006, going up sharply in 2010, as shown in Figure 2.  To meet an expected increase in gas demand, China hopes to nearly double domestic gas production from its 102 bcm in 2011 to 180 bcm a year by 2020. The country is also expected to increase natural gas imports from 28.1 bcm in 2011 to estimated 77 bcm a year by 2020.  

China's Natural Gas Production and Consumption            Fig. 1 

Source: EIA International Energy Statistics

China’s Natural Gas Imports                            Fig. 2

Source: EIA International Energy Statistics

The central government is boosting investment in developing unconventional energy resources, such as coal-bed methane (CBM) and shale gas, and expects that unconventional natural gas will improve the country’s energy supply security in the years to come by providing affordable and ample gas.  Aiming to increase the production of shale gas from 6.5 billion cubic meters (bcm) by 2015 to more than 60 bcm by 2020, Beijing envisions that shale gas will account for 8-12 percent of total natural gas by 2020,  while CBM is to be 14 percent of China’s total domestic gas supply by then.  

But conditions that existed in the U.S. to revolutionize the shale gas industry may not exist in China until it overcomes key hurdles for shale gas to become a commercially reliable and a competitive energy source.  China faces a more complex geology, high capital and operational costs, inadequate or lack of access to equipment, water, manpower, and infrastructure as well as complex land ownership compared to the U.S.  The key difference between the two is the U.S. shale gas sector flourished thanks to small independent firms, while the Chinese energy sector is heavily dominated by large state-run companies.  At the moment, incentives to invest in developing China’s shale gas remain weak because of low domestic natural gas prices.  Given these factors, it appears that setting a timeframe for commercial-scale success of shale gas in China is still highly uncertain.

The Players

The Chinese central government maintains power over the course of domestic natural gas production and the volume and price of gas imports, thereby affecting the operations of domestic energy companies and the country’s economy as a whole.  Wielding a significant influence on the energy industry, the Chinese Communist Party continues to appoint senior party leaders to corporate positions and the Chinese government still holds controlling shares in all major oil and gas companies.  The Party’s right to directly appoint or dismiss executives of state-run companies indicates its ability to control their actions.  Although Beijing still lacks a strong coordinating body to oversee the industry, several government agencies, such as National Development and Reform Commission, Ministry of Commerce, Ministry of Land and Resources, and the State Asset Supervisory and Administration Commission, have influence across all energy sectors.  

Because the state can more effectively control monopolies, energy giants, such as China National Petroleum Corporation (CNPC), China National Offshore Oil Corporation (CNOOC), and Sinopec, dominate the domestic energy sector. As a result, investment in the natural gas sector, particularly the relatively new shale gas industry, is hamstrung by artificial prices set by the government.  Burgeoning private investors in the natural gas sector ten years ago were eventually forced to sell to the state.    Paradoxically, unlike a real monopoly, the state-run energy companies in China do not always charge prices above their marginal costs or cut supplies to increase profit.  Since energy prices are determined by government fiat, Chinese gas importers and distributors habitually incur losses because they are forced to sell gas to domestic consumers at lower than imported prices, which will be discussed in detail later.  On the other hand, although domestic oil and gas companies are owned by the government and remain largely centralized, Kevin Tu of Carnegie Endowment for International Peace stresses that they are not operated by the government.  According to Tu, state-controlled energy companies can have the latitude to make their own decisions, but it would be difficult to develop the natural gas sector without opening it to the private sector.  

Almost all of China’s powerful oil and gas majors – CNPC, CNOOC, Sinopec – have championed the development of natural gas as part of a low-carbon economy.  As CNPC’s dominates the domestic natural gas production and sales, Vice President of this natural gas monopolist, Zhou Jiping, sees a special role for his company in advancing the use of natural gas in China.  Jiping anticipates that the position of natural gas as a clean and highly-efficient energy is bound to rise in the hierarchy of energy sources in his country.   His words echo a 2011 report of the Chinese Congress on social and economic development plan, which underlined the central government’s prioritization of clean energy, specifically, natural gas.   But faced with losses from artificially set domestic gas rates, state companies have been pushing for reform of natural gas prices, which is key to making the sector commercially viable. 

The Price Issue

Expansion of natural gas in China’s energy market did not come without a cost.  While China has ramped up domestic production of hydrocarbons, its rising natural gas consumption made it a net importer of gas since 2007.  Because current energy prices in China do not necessarily reflect demand and supply relationship, the discrepancy between the higher-priced imported gas and artificially low domestic rates set by the central government have been a problem.  Fixed prices resulted in inefficiencies, distortions and monetary losses for Chinese energy majors.

Imports of natural gas from Turkmenistan via the 40 bcm a year-capacity Central Asian Pipeline have increased from 2.9 bcm in 2009  to 17 bcm in 2011.   According to chairman of Petrochina, Jiang Jemin, whose company is in charge of importing Central Asian gas, gas imports from this region would amount to 25 bcm in 2012.   Anticipating more gas imports, Chinese officials and energy executives have been lobbying to carry out a pricing reform because local gas importers and distributors have been incurring massive financial losses from distorted pricing.  Government imposed domestic price caps resulted in China importing Turkmen gas at a higher price than sold at home.  Unable to pass the costs to consumers, Chinese companies have been forced to cover them, while trying to lobby the government to reform the gas prices. However, the central government continually delayed the reform fearing inflation.

According to CNPC’s 2011 data, the company lost more than 5 billion yuan ($785 million) from its domestic sales of Central Asian gas imports in 2010.   Petrochina, a publicly-traded subsidiary of CNPC, posted a loss of 10 billion yuan ($1.6 billion) in its natural gas business just in the first quarter of 2012.   Similarly, losses from imported liquefied natural gas (LNG) have been mounting because of the price gap.  PetroChina posted a loss of 60 million yuan ($9.5 million) from LNG imports at the end of December 2010.   Faced with losses from higher-priced gas imports, Chinese importers and distributors have been eager to slow down gas imports to signal urgency to reform prices. 

Although the Chinese government hiked domestic natural gas rates from 925 yuan ($145) per thousand cubic meter (tcm) to 1,155 yuan ($182) per tcm on June 1, 2010,  which most energy analysts saw as a small, but necessary step towards reform, it also froze prices in some parts of China in December 2010 to stop climbing consumer prices and inflation.  But in December 2011, the government mandated pilot tests in southern Guangdong and Guangxi provinces to ease control over domestic gas prices and linking them to oil prices with a prospect of extending pricing reform across the country in the next few years.  The government chose these provinces because of already relatively high prices there.  Given that gas consumption in China is expected to more than double in the next five years, it looks like there is point of no return from the reform.

Conclusion

Mounting demand combined with the official endorsement of clean energy sources is bound to solidify the position of natural gas in China’s energy mix in the years to come.  A recent effort of the Chinese government to draft new rules to encourage private investment to the energy industry, especially applicable to tightly state-controlled oil, natural gas and electricity sectors, is potentially a positive step forward. But liberalization of prices will be key to private investment in the energy sector in order to successfully develop domestic energy sources. The pilot gas pricing program, launched in Guangdong and Guangxi provinces last December, is already pointing at a possible incentive for U.S. gas imports. Because U.S. offers lower gas prices compared to world rates and the pilot test in these two Chinese provinces raised the price to an average of $12 per million British thermal units, which is five times higher than the U.S. benchmark futures in New York Stock Exchange, the North American gas would find an appealing market in China.  In the end, the price reform is likely to open the Chinese energy market to much needed know-how to tap domestic conventional and unconventional natural gas. 

By. Saltanat Berdikeeva for Oilprice.com