China’s 12th Five-Year Plan: An opportunity for the natural gas industry

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Many regions are considering raising natural gas prices; its share in the energy mix is set to rise from 4% to 8% during the 12th Five-Year Plan period, with total consumption reaching 260 billion cubic meters by 2015... As natural gas assumes an increasingly important role in the energy structure, there has been a surge in efforts to develop it, leading to both increases in volume and prices, and various types of capital are competing to enter the gas industry. “The 12th Five-Year Plan set new goals for optimizing the energy structure, aiming to increase the proportion of natural gas usage from 4% to 8%. As a result, the natural gas market became highly profitable, prompting various companies to enter the downstream sectors related to natural gas. Major gas companies accelerated their expansion in first- and second-tier cities across the country, and began to extend their operations to third-tier cities as well; private capital also started to invest actively in these third-tier cities. In the coming period, China’s gas market is expected to feature fierce competition. As the regional monopolies characterized by franchise rights endow pipeline gas with good investment value, various capital sources are vying for the rights to operate pipeline gas in different cities. However, some private enterprises with limited financial resources and technical capabilities, after obtaining concessions for pipeline gas services, focus too much on investment returns, market demand for gas, and factors such as inadequate supporting infrastructure in their subsequent development efforts, which results in urban pipeline gas systems facing challenges such as insufficient gas supply, limited investment, and slow development. Franchised utilities, as well as regulated access to pipeline networks and gas distribution rights, have become prerequisites for channel monopolies. High profit margins and a large rent-seeking market also pose potential risks for such developments. Currently, there are cases of reselling franchise rights in certain areas, where people use their connections to obtain the rights to operate urban gas services and then sell them back to gas companies at high prices. The secrets behind pipeline networks: In line with China’s commitments upon joining the WTO, the country will continue to increase openness in the oil and gas sector in the future, and gradually allow foreign investment in six key areas, including natural gas exploration and development, urban natural gas distribution, natural gas power generation, oil and gas infrastructure construction, and the petrochemical industry. Among them, all segments of the natural gas industry – upstream, midstream, and downstream – are open to foreign investment; there are no restrictions on the proportion of investment required for the construction of urban pipeline networks, and foreigners can operate such projects on a wholly-owned basis. After the access restrictions were lifted, various capital sources sought to get involved in the gas industry. According to Zhou Xiuje, an energy industry researcher at CIC Consulting, driven by the construction of the West-to-East Gas Pipeline and the high demand for city gas, the gas market exhibits distinct regional characteristics as well as fierce competitive dynamics. State-owned enterprises such as CNPC are located at the upstream end of the industry, controlling the supply of natural gas; they leverage their financial and policy advantages to aggressively enter the urban gas market ； Local state-owned gas companies continue to strengthen their capabilities by leveraging their regional advantages and good relationships with local authorities ； Private enterprises such as SNOW Gas and New Hope are developing rapidly ； Hong Kong-funded enterprises such as Hongkong China Gas began cooperating with the Chinese mainland at an early stage and possess strong competitiveness ； Foreign-funded companies such as Mobil have substantial financial resources and extensive operational experience. In the coming period, China’s gas market will feature intense competition. According to the 12th Five-Year Plan, China’s natural gas consumption target for 2015 was initially set at 260 billion cubic meters, with its share in the energy mix rising to around 8.3%. The supply structure is 170 billion cubic meters from domestic sources and 90 billion cubic meters from imports; the 170 billion cubic meters of domestic supply also includes 20 billion cubic meters from coalbed methane and 30 billion cubic meters from coal-to-natural gas production. The establishment of this planning goal means that our country will enter an energy phase characterized by vigorous development of the natural gas industry, and the consumption of natural gas will **increase**. Competition among various parties has intensified, and it is gradually spreading to third-tier cities as well as smaller counties. Our country stipulates that industries such as urban water supply, gas supply, and heating operate under a franchise system. The Ministry of Construction’s \"Opinions on Accelerating the Marketization of Municipal Public Services\" clearly states that the construction of municipal public facilities should be subject to open bidding to select investors; former municipal state-owned enterprises, foreign investors, and private investors compete on the same platform. The authorities grant enterprises a franchise to operate certain municipal public products or services for a specified period of time. The urban gas business is considered a public utility; gas pipeline construction companies cannot make decisions on their own and must obtain **legal approval as well as a franchise to carry out such activities. Since the construction of urban distribution networks requires substantial investment, duplicate construction would lead to waste of resources, and the interconnection of underground pipelines poses serious safety risks. Therefore, the construction and management of urban natural gas network systems do not permit duplicate construction, as they fall under the category of natural monopolies. Therefore, after obtaining the franchise and pipeline construction rights, an exclusive monopoly is granted to a certain extent, forcing later entrants to cede a large portion of their profits to those who were there first. Competitive Division of Profits: In this struggle, the three major oil companies are at odds with each other, among whom CNPC is the most prominent player. CNPC, which is currently the leader in the gas market, adopts a strategy of first obtaining the franchise rights for an entire region, and then developing it piece by piece. This top-down approach enables CNPC to adopt a forceful military-style strategy, allowing it to quickly take control of an entire region – a capability that other capital players do not possess. “We communicate directly with various regional administrative units, and obtain the franchise rights through project presentation meetings. ”An insider at CNPC told our reporter. This pattern is similar to investors in the real estate market who acquire entire buildings in residential complexes; they are not only wealthy but also decisive in their actions. All the oil fields under CNPC have gas operations, but they are spread out and unable to work together as a cohesive force. In August 2008, CNPC consolidated all its fragmented resources under Kunlun Gas Company to create a platform for integrating urban gas services ； In September of the same year, Kunlun Natural Gas Utilization Company was officially established to integrate natural gas resources and pursue a two-pronged strategy in the gas market ； It also established the offshore Kunlun Energy Company, aiming to attract foreign capital to expand both domestic and international markets. Kunlun Gas has successively taken over the gas assets in various cities under CNPC. In May 2009, Kunlun Gas offered around 1.093 billion yuan to acquire the gas business assets in eight provinces and cities that were on the market for sale by its parent company, PetroChina Group. These assets included the equity interests in various companies under PetroChina Pipeline Gas Investment Co., Ltd. and PetroChina Huayou Gas Company. The Sichuan gas assets, worth 1 billion yuan, were also acquired by Kunlun Gas through the Beijing Property Rights Exchange. In addition, there were several gas companies affiliated with PetroChina Group’s oil fields. Kunlun Natural Gas Utilization Co., Ltd. is primarily engaged in CNG business, and is responsible for the construction and operation management of the Shenzhen liquefied natural gas project (hereinafter referred to as LNG). Its market has now expanded across the whole country, with particularly rapid growth in the CNG business. Kunlun Energy is headquartered abroad and is listed on the stock market; in addition to developing its gas business in China, it is also expanding its market presence in other places. Leveraging these three companies, CNPC controls almost all of the domestic natural gas pipeline resources, and develops its business along CNPC’s pipelines to seize competitive markets. At present, a backbone oil and gas pipeline network that spans east to west, runs north to south, covers the entire country, and connects to foreign territories has been initially established. According to statistical data, in the Chinese mainland, except for Qinghai and Tibet, Kunlun Gas is now operating in all provinces on the mainland. In addition to CNPC’s outstanding performance, Sinopec and CNOOC are also making great efforts to expand their gas business, gaining an advantage in certain regions. For example, Shandong is a strong stronghold for Sinopec, while in Fujian and Guangdong, CNOOC holds a dominant position. All three companies are striving to capture a larger market share. Private capital steps in: The imbalance between profits and market share in the gas industry, along with shortages of limited resources, leads many companies to prefer to incur losses in order to gain control over the market first. Furthermore, the efforts by companies such as CNPC and Sinopec to develop their gas business and seize market share have raised concerns among other small and medium-sized enterprises. With these large companies taking such aggressive actions to gain market control, other firms are forced to keep up, leading to increased competition among gas companies for the rights to operate urban gas services. But in the areas covered by CNPC’s pipelines, private and foreign companies are powerless and must turn to third-tier cities; this forces small and medium-sized enterprises such as XinAo and New Hope to intensify their competition for market share, even purchasing operating rights and gas resources from other companies. Although the operation of CNG facilities is almost entirely market-driven – one can build such facilities as long as there is land, funding, and a gas supply – this is possible only with planning approval, and such approvals are exclusive in nature. CNG and the gas business both fall under the downstream natural gas market sector; gas operations require a franchise license, and the two have similar characteristics. The behaviors observed in these two markets reflect the new characteristics in the development of China’s natural gas market. Without a gas supply, it is impossible for a company to operate in the urban gas business. Naturally, the purpose of developing its gas business is not for profit. Some companies have seized the opportunity presented by large enterprises such as CNPC to develop downstream natural gas services, thus gaining a head start in obtaining the rights to operate gas businesses. In various energy industry events attended by journalists, the rights to operate gas services in local small and medium-sized cities has also become one of the areas attracting significant interest from private investors. When competing for downstream markets, everyone faces the problem of a shortage of gas supply. A staff member from a Guizhou natural gas company under CNPC told reporters, “The gas supply is a major issue; industrial users downstream are all anxious.” Although the cost of the gas obtained is only 2.4 yuan per cubic meter, the cost rises to 4 yuan once it is transported to Guizhou, including transportation expenses. The local market price is generally around 3 yuan, and we can only sell at a maximum of 3.5 yuan, so our annual net loss amounts to over 50 million yuan. ” Even the companies under CNPC are short of gas, let alone other companies that don’t have access to gas supplies. A journalist once interviewed a salesperson from a liquefied natural gas production company in Dazhou, Sichuan. The salesperson told the journalist that outside of winter, supply and demand are generally in balance; however, during the peak demand period in winter, the amount of liquefied gas produced by the company is far from sufficient to meet the demand. If there are losses, why go through with it? This is a completely normal logic for every enterprise. But the reason why large companies do the opposite is to seize market share and establish distribution channels; by obtaining the rights to operate in that market, they gain the possibility of locking in profits as energy prices rise in the future. Faced with huge profits, many companies lacking the necessary capabilities have begun to get involved in the gas business, and even reselling activities have emerged; such behavior poses various risks to the development of the gas market. Concerns regarding interests: Obtaining the right to operate gas supply services means gaining the ability to seek rent-seeking opportunities in this market. Both pipeline companies and gas supply companies are required to generate profits for such enterprises, even if they do not engage in any actual operational activities. Under such circumstances, many companies that are not involved in the gas industry have also begun to get involved in downstream natural gas activities, in order to secure a share of this lucrative market. These companies exhibit characteristics of short-term speculation. Recently, our newspaper’s reporters learned from an industry insider that in recent times, more than a dozen CNG (compressed natural gas)-related business indicators have appeared in the energy market and are being sold there quietly. In addition, an insider from the energy industry told reporters that not long ago he attended business negotiations between a company owner and a certain official from his hometown’s county, with the aim of securing the rights to operate gas services in that area. “It is true that some companies find themselves lacking the capacity to operate after obtaining the rights to do so and therefore transfer those rights, but there are indeed many cases of franchising rights being sold on in various places; such people usually have some connection to the local authorities or are influential individuals. ”An experienced official from the gas company told reporters, \"The practice of reselling franchise rights has quietly intensified; some people set up shell companies to obtain city gas operation rights by leveraging their connections with local officials, and then sell them at high prices to other gas companies.\" ” Many companies acquire the rights to operate urban gas pipelines and then resell them to make additional profits. The price of these pipeline operation rights after being resold is higher, and these costs are ultimately reflected in the price of gas, borne by the public. However, as markets across different regions are divided up among various gas speculators, gas companies must purchase gas from these speculators in order to gain access to the market, which inevitably leads to higher prices. This practice of merely reselling without operating has had many impacts on China’s gas market. Zhou Xiujie, a researcher at CIC Consulting, believes that the resale of operational rights for gas pipelines takes some time, which delays the construction of such pipelines; it may even cause continuous delays in their construction, resulting in the city’s gas pipeline infrastructure missing its optimal period for development. The qualifications of the buyer after the transfer cannot be guaranteed. Gas pipelines are one of the urban infrastructure components; their investment and operation require substantial funds, operational experience, and a reliable supply of gas. It is difficult to ensure that the company taking over possesses these requirements. The practice of some companies acquiring the rights to operate urban gas pipelines and then reselling them undermines market order and industrial development. According to reporters, some cities have already noticed this phenomenon. Some people concerned about the healthy development of the gas market are calling for restrictions on companies that do not have a gas supply source, preventing them from obtaining the rights to operate urban gas services. For those companies that have already been granted such rights, their licenses should be revoked if they fail to carry out actual operations due to a lack of gas supply.