Our country is actively exploring a pricing model linked to gas prices

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Our country is actively exploring a pricing model linked to gas prices. Author/Source: Sinochem News Network. Date: August 8, 2019. Clicks: 2. Linking gas prices to oil prices is an international practice. But in reality, natural gas is not the only alternative to oil; its greater rival is coal. Replacing coal with clean and efficient natural gas is a major trend in the cleaner transformation of China’s energy sector. In practical applications, the increase in China’s natural gas demand also stems largely from the shift from coal to gas. In 2018, China became the world’s largest importer of natural gas and the second-largest importer of LNG (liquefied natural gas). As the world’s largest buyer of natural gas, could China’s natural gas import prices be linked to coal prices? The industry is actively exploring more scientific pricing models for natural gas that suit China’s national conditions, and such efforts and breakthroughs are likely to trigger a \"storm\" in global natural gas pricing. Long-term LNG pricing agreements are becoming increasingly diverse. Can the LNG pricing mechanism be decoupled from oil prices? In response to this question, Shell’s Global Vice President Steve Hill said frankly, “It’s a simple question, but the answer is very complex.” ” The tradition of linking gas prices to oil prices originates in Europe. In the international market, it is almost standard for LNG long-term contract prices to be linked to international oil prices; however, pricing methods are becoming increasingly flexible to meet the varying needs of buyers. In April this year, Royal Dutch Shell and Tokyo Gas of Japan signed an LNG supply agreement linked to coal prices, breaking with market conventions and creating a new pricing model. “Oil prices are not the best benchmark for pricing natural gas; they are simply the most commonly used price at the moment. ”In Steve Hill’s view, LNG has its uniqueness compared to most commodities, and its pricing mechanism differs from that of most other commodities. Historically, most LNG contracts have been linked to oil prices, but when buyers and sellers conclude an LNG sales contract, there are various formulas based on market conditions that can be used to determine the price. In recent years, a global surplus of LNG has led to changes in the balance of market power, with buyer’s market characteristics becoming increasingly evident. Buyers now hold more leverage, new changes have emerged in the pricing mechanism for long-term LNG contracts, and further innovative pricing models are likely to appear. In the view of industry experts, the 10-year LNG purchase contract signed in April this year between Tokyo Gas in Japan and Shell, with its price linked to coal prices, allows their LNG prices to move in tandem with coal prices, thereby helping to better mitigate the cost risks associated with natural gas-based power generation. That same month, another international energy giant, TotalEnergies, signed an agreement with Tellurian based on pricing tied to the East Asia LNG index. Experts say that the LNG pricing method linked to coal prices has a certain degree of rationality and feasibility. If this approach is widely recognized and accepted, it will help reduce Asia’s LNG import costs. Natural gas prices are higher than coal prices, but lower than crude oil prices; when gas prices are high, coal-based power generation increases, and when gas prices are low, gas-based power generation increases. Although natural gas is cleaner than coal, coal has better market liquidity than natural gas, and it remains an **essential primary energy source in the Asian regional market, especially in the power generation sector. Obviously, in recent years, as the rules regarding destinations have become more flexible, LNG has flowed more widely between different regions, which has contributed to the formation of a global market; meanwhile, LNG trade contracts and pricing methods have become increasingly diverse and flexible. **Zhang Yuqing, former deputy director of the Energy Administration, believes that currently, the share of spot trade in global LNG trade volume has risen from 18.7% in 2012 to 26.5%, and when short-term trade is taken into account, this figure exceeds 32%. The **volume of imports and exports** involved in natural gas trade is gradually increasing. Currently, there are 42 countries involved in LNG imports and 20 countries involved in exports, and this number is set to increase in the future. Affected by the above factors, there will be a shift from pursuing \"short-term\" LNG contracts to a balance among short-, medium-, and long-term contracts, in order to achieve a balance between flexibility and supply security. As a result, the pricing methods for long-term LNG agreements will also become more diversified. Linking gas prices to coal prices is in line with China’s national conditions. For our country, exploring a natural gas pricing mechanism linked to coal prices holds practical and strategic significance. Looking at the trend in energy substitution, driven by policies such as the \"Blue Sky Defense Campaign,\" the development of natural gas power generation and clean heating methods is accelerating across China. A significant portion of growth in the natural gas market is attributed to the shift from coal to natural gas. Therefore, linking natural gas pricing to coal prices is in line with China’s national conditions. The \"China Energy Development Report 2018\" compiled by the Electric Power Planning and Design Institute shows that in 2018, natural gas accounted for 7.8% of China’s total energy consumption, an increase of 0.8 percentage points compared to the previous year; coal consumption accounted for 59.0%, a decrease of 1.4 percentage points on a year-on-year basis. From a strategic perspective, linking gas prices to oil prices is extremely disadvantageous for China, which faces shortages of both oil and gas. Affected by a combination of factors such as geopolitics and market speculation, international oil prices have a strong financial character and experience significant fluctuations; import natural gas prices, which are linked to them, are greatly impacted and therefore also fluctuate sharply. In 2018, China’s dependence on imported crude oil reached 71%, while its dependence on imported natural gas reached 43%. As China’s dependence on imports of crude oil and natural gas continues to rise, and with the domestic pricing mechanism closely linked to international prices, sharp fluctuations in international oil and gas prices have an increasingly direct impact on China’s real economy, exerting a greater and greater influence. The situation is different in the coal sector. China is the world’s largest producer and consumer of coal, and as a key player in the global coal market, it holds considerable influence and a say in international coal affairs. Establishing a scientific and reasonable natural gas pricing system linked to coal prices is of strategic significance for ensuring China’s energy security. The replacement of coal by natural gas is not only occurring in China; another notable example can be found in the United States across the ocean. In the United States, cheap and abundant natural gas has drastically reduced coal’s market share, dropping it from over 50% in 2008 to less than 25% last year. BP’s latest World Energy Statistics Yearbook (2019) shows that in 2018, U.S. natural gas consumption increased by 78 billion cubic meters, which is almost equal to the total increase over the previous six years. Behind this extraordinary growth, an important factor is that the United States phased out around 15 gigawatts of coal-fired power capacity at that time, which led to an increase in the use of natural gas for power generation. In 2018, the United States (an increase of 78 billion cubic meters), China (an increase of 43 billion cubic meters), Russia (an increase of 23 billion cubic meters), and Iran (an increase of 16 billion cubic meters) – these four countries accounted for 80% of the global increase in natural gas demand. From an international perspective, replacing coal with cleaner and more stable natural gas has become an inevitable trend and choice. BP’s latest statistical yearbook shows that on a global scale, coal remained the dominant fuel for power generation in 2018, accounting for 38% of that use; however, natural gas became the second most important fuel for power generation, with a share of 23.2%. In North America, natural gas has surpassed coal as the main fuel for power generation, accounting for over 30%; however, in Asia, coal-based power generation still accounts for more than 50%. Jiangsu Province leads the gas power generation market in China, with gas power generation accounting for over 10% of the total capacity. According to the local development plan, by 2020 the installed capacity for natural gas power generation across the province is set to reach 20 million kilowatts, while total coal consumption is expected to decrease by 32 million tons compared to 2016. Actively explore a Chinese-style \"gas price\" approach. \"What is learned from books is insufficient; to truly understand something, one must put it into practice.\" ”Chen Gang, assistant general manager of the Shanghai Petroleum and Natural Gas Trading Center, an expert with over a decade of experience in the LNG industry, is leading the center’s R&D team in exploring new natural gas pricing models that suit China’s national conditions. Following his research approach, by adding the costs associated with reducing carbon dioxide and PM2.5 emissions to the benchmark coal price, the clean energy value of natural gas is taken into account. This new pricing model for natural gas will provide a market-relevant reference for the market-based pricing of natural gas in China as well as for its import from abroad. Obviously, exploring a new natural gas pricing mechanism linked to coal prices must address two core issues. First, how should the benchmark coal price be determined? At the beginning of June this year, Chen Gang and his team went to Shanxi for investigations and visits. This is China’s “coal sea,” as well as an important hub for coal trading and pricing in the country. The China (Taiyuan) Coal Trading Center is the largest national spot coal trading market in China. Since its opening in 2012, the total volume of spot trades has exceeded 8.2 billion tons, with transaction values reaching over 4 trillion yuan; it plays an extremely important role in China’s spot coal pricing market. Additionally, in a tranquil forest park on Binhe East Road in Jiancaoping District, Taiyuan City, lies Fenwei Energy, one of China’s earliest coal consulting companies. Founded in 1998, this private enterprise established and operates China Coal Resources Network. Its database of basic information on Chinese coal mines and their production capacities includes data on 6,092 coal mines located in 25 coal-producing provinces (municipalities, regions) across the country, with a total production capacity of 5.521 billion tons. Liu Jing, deputy general manager of Fenwei Energy, said that the CCI index published by the company’s information platform, China Coal Resources Network, can guide the main stages of coal circulation – from domestic trade to imports, from thermal coal to coking coal, from inland areas to ports, and from production to consumption. It accurately reflects the actual transaction prices of Chinese coal in the market, and has become an effective complement to the domestic coal long-term contract system. We hope to strengthen information sharing and experience exchange with the trading center, and work together to explore new pricing mechanisms for natural gas linked to coal. Second, how should the clean value of natural gas be measured and evaluated? On June 25, Lin Hui, chairman of the Shanghai Environment and Energy Exchange, said that he hopes to explore the relationship between natural gas and carbon emission reductions, with a view to jointly developing influential green energy indices. Currently, the total volume of spot transactions in Shanghai’s carbon market is 120 million tons, with a total transaction value of 1.246 billion yuan. Of this amount, the total volume of quota transactions is over 35 million tons. The total volume of voluntary greenhouse gas emission reductions in China is over 80 million tons, keeping it in first place nationwide. Of course, designing a scientific and reasonable pricing mechanism for imported natural gas for the world’s largest buyer of such gas, and getting all market participants both domestically and internationally to accept it, is by no means an easy task, nor can it be achieved in a short time. SteveHill reasoned that if a so-called Asian price index is to be developed over time, two conditions need to be met. First, there needs to be a credible indicator to replace oil prices, one that the market can rely on; second, market participants need to be willing to use such a price.