Future development direction of China’s natural gas market

Thread Content

The Future Development Direction of China’s Natural Gas Market Author/Source: Date: 2016-03-15 Clicks: 41 Currently, with the global economy slowing down and China’s economy entering a \"new normal,\" the low prices of oil and gas pose significant challenges to China’s natural gas market, which is still in its infancy. Meanwhile, following the Paris Climate Conference, low-carbon development has become a global consensus. China is in a critical period of transforming its economic development model and energy consumption structure, and efficient and clean natural gas holds great potential for development in the future. 1 Current Status and Challenges in the Development of China’s Natural Gas Market
1.1 Significant slowdown in the growth rate of natural gas demand
From 2000 to 2013, China experienced a golden era in the development of its natural gas market. The country’s total natural gas consumption rose from 24.5 billion cubic meters to 170.5 billion cubic meters, with an average annual growth rate of 16.1%. The demand growth at that time was mainly driven by supply and prices. Since 2014, due to factors such as economic slowdown, rising gas prices, milder winters, and the rapid development of alternative energy sources, China’s demand for natural gas has declined sharply; in 2014 this decline was significant, with a growth rate of 8.6%, and the apparent consumption volume amounted to 184.5 billion cubic meters ； It further dropped below 4% in 2015, with the apparent consumption estimated to be less than 192 billion cubic meters (see Figure 1). 1.2 Oversupply of resources: In line with expectations of double-digit demand growth a few years ago, China prepared an excessive amount of natural gas supply. **The \"12th Five-Year Plan for Natural Gas Development\" issued by the National Development and Reform Commission in 2012 predicted that China’s natural gas demand would be 230 billion cubic meters by 2015 ； **The \"Work Plan for Strengthening Air Pollution Prevention and Control in the Energy Sector\" issued by three ministries and commissions including the National Development and Reform Commission calls for China’s natural gas supply capacity to reach 250 billion cubic meters by 2015. Due to a slowdown in demand growth, signs of an oversupply are emerging in China’s natural gas market. In 2015, all three major Chinese oil companies experienced varying degrees of production cuts in the upstream sector as well as a reduction in long-term trade imports; they even began to resell at low prices the long-term trade resources they purchased on the international market. China National Petroleum has always been the main supplier of domestic natural gas as well as imported gas. In 2015, several major upstream gas fields such as Changqing and Tarim reduced their production to varying degrees, while LNG receiving stations formulated plans based on minimum delivery volumes to strictly control spot imports. Sinopec shut down more than 20 gas wells at the Puguang gas field during the summer, resulting in a daily export volume of 10 million cubic meters, which is only half of the level at the beginning of the year. In terms of imported supplies, Sinopec resold long-term LNG trading rights from Papua New Guinea (PNG) in the international market in 2014 ； Regarding the long-term LNG trading resources of Australia Pacific (AP), consent has been obtained from the partners to continue reselling them at low prices. At the beginning of 2015, CNOOC decided to put on hold its shale gas project in Anhui, and between October and December it resold LNG spot shipments from 3 vessels of the Curtis (QC) LNG project in Queensland, Australia. 1.3 Import of long-term traded natural gas faces the pressure of take-or-pay arrangements. In 2015, China’s LNG imports declined significantly; from January to October, the volume was only 15.92 million tons, 5.7 million tons less than the total amount stipulated in the annual contracts. Given the commissioning of the China-Myanmar pipeline and the Central Asia Line C, with supply capacities of 12 billion cubic meters per year and 25 billion cubic meters per year respectively, along with the long-term LNG import contracts worth a total of 30 billion cubic meters per year (24 million tons per year) that the three major oil companies are now in the process of implementing, as well as the progress of domestic upstream projects, China’s natural gas market will have sufficient supply over the next 5 years. During the 13th Five-Year Plan period, at least an additional 15 billion cubic meters per year will be needed to ensure that any excess resources can be utilized. 1.4 Significantly insufficient price competitiveness: From July 2013 to October 2015, as the three-phase reform of natural gas prices in China was implemented, the average price at urban distribution stations for natural gas increased by 36%. During the same period, the spot price of Brent crude oil dropped from $108 per barrel to $48 per barrel, a decline of over 55% ； The closing price of thermal coking coal (Q5500) at Qinhuangdao Port dropped from 575 yuan per ton to 383 yuan per ton, a decrease of 33%. Calculated on an energy value basis, the price of natural gas in China at the beginning of November 2015 was roughly on par with that of fuel oil and LPG, and more than three times the price of coal. The electricity costs of coal-fired units continue to decline, while the costs of gas-fired units are rising, which dampens enthusiasm for natural gas power generation. 1.5 The new prices will spur rapid growth in demand, but may give rise to new problems. Starting November 20, 2015, the maximum gate price for natural gas used by non-residential customers in China was reduced by 0.7 yuan per cubic meter, a decrease of nearly 25%, bringing it back to the price level observed in 2011. This will help enhance the price competitiveness of natural gas, promote a recovery in China’s natural gas demand, and alleviate the increasingly severe problem of oversupply. However, a reduction in gas prices could give rise to three new problems: first, it may suppress the production of unconventional gas. The average production and supply costs of shale gas, coalbed methane, and coal-derived gas are relatively high. Although they are not subject to **price caps at the gate station, in a context of oversupply, it is difficult for them to compete with conventional gas even with **subsidies. Following this price adjustment, unconventional gases will face even greater pressures to survive; planned capacity expansion projects will be significantly delayed or even canceled, and the research, development, and production of related technologies, materials, and equipment will also be affected, thereby hindering the long-term development of this industry. Second is to dampen the enthusiasm for importing natural gas. The reduction in domestic gas prices has once again led to an inversion between import prices and domestic terminal prices. Based on Shanghai’s maximum gate price for non-residential gas use of 2.18 yuan per cubic meter, and taking into account factors such as value-added tax and pipeline transportation costs, the break-even point for the price of imported LNG will drop below 7.5 dollars per million British thermal units. Third, end-users find it difficult to directly benefit from the price cuts. Although the prices at the gate stations have been reduced, the terminal sales prices in the provincial gas pipelines and urban gas networks may not be adjusted in a timely manner, which could lead to profit retention at the intermediate distribution stage and undermine the intended effects of the price reform. 1.6 The inverted pricing structure for residential and industrial/commercial gas use goes against market principles; residential gas consumption is on a small scale and experiences significant fluctuations throughout different times of day and seasons, which results in the highest supply costs among all types of users ； Industrial gas has a large scale and stable demand, resulting in significantly lower costs per unit of gas supplied. Therefore, in developed countries, the price of natural gas for residential use is generally twice as much as, or even higher than, that for industrial/power generation use. China is the exact opposite. Taking Beijing as an example, the current retail price of gas for residential use is 2.28 yuan per cubic meter, which is lower than the price of 2.78 yuan per cubic meter for gas at stations serving non-residential users. The price of gas for industrial use is as high as 3.78 yuan per cubic meter, while the price for power generation purposes is 3.22 yuan per cubic meter. Cross-subsidization of energy prices not only disrupts the normal market order, imposing a heavy burden on industrial and commercial natural gas users that should not fall on them, but it also tends to give rise to issues such as favoritism and bribery. 1.7 Lagging development of storage and transportation facilities. As of the end of 2014, the length of gas transmission pipelines in China was approximately 65,000 kilometers, while the length of distribution pipelines reached 400,000 kilometers. The United States, which has a roughly similar land area, has gas transmission pipelines totaling nearly 500,000 kilometers in length, and gas distribution pipelines exceeding 2 million kilometers in length – figures that are 7.7 times and 5.4 times those of China respectively; China’s infrastructure is on par with that of the 1950s. By the end of 2014, China had built 11 underground gas storage facilities, with a peak-shaving capacity of 4.29 billion cubic meters. This figure accounted for only 2.4% of China’s total natural gas consumption in 2014, far below the global average of over 10%. The lagged development of storage and transportation facilities has severely restricted the safety of gas supply in winter in China, affecting the healthy development of the natural gas market. 2 Opportunities and Prospects for the Development of China’s Natural Gas Market
2.1 The potential of China’s natural gas market is enormous
In 2014, China’s per capita natural gas consumption amounted to 13.5 billion cubic meters. Natural gas accounted for approximately 6.0% of the total primary energy consumption in the country ； The global averages are 467 cubic meters per person and 23.7% respectively. Compared to the development patterns of developed natural gas markets, China’s natural gas market is still in its early stages, and it holds significant potential for further growth in the future. Based on the current global average per capita natural gas consumption, China’s population of 1.4 billion could create a market volume of over 650 billion cubic meters. In the long term, economic factors are the fundamental determinants of whether natural gas demand can grow ； In the short term, a decrease in gas prices may enhance the willingness and purchasing power of potential demand users to consume gas. Despite numerous challenges, the Chinese natural gas market still holds significant growth potential in the future. Under the baseline scenario, China’s natural gas demand is expected to approach 300 billion cubic meters in 2020, and exceed 450 billion cubic meters by 2030, with a growth rate of 9% during this period ； With appropriate policies, natural gas demand is expected to reach 330 billion cubic meters by 2020, and over 500 billion cubic meters by 2030, with the growth rate returning to double digits at 11%–12%. 2.2 Prevention and control of air pollution and addressing climate change present historical opportunities. As the world’s largest consumer of energy and coal, as well as a major emitter of carbon dioxide, China has repeatedly made solemn commitments to the international community regarding carbon emission reductions. On November 19, 2015, the **National Development and Reform Commission released the 2015 Annual Report on China’s Policies and Actions on Climate Change** ； On November 30, **the leader** went to Paris, France, to attend the opening ceremonies of the 21st United Nations Climate Change Conference and deliver a speech, conveying to the international community China’s determination and commitment to participating in international climate governance and pursuing low-carbon development. China has committed to reducing CO2 emissions per unit of GDP by 60%–65% by 2030 compared to 2005 levels. This will not only promote the development of non-fossil energy in China; given appropriate policies, it will also significantly boost natural gas consumption. 2.3 The development potential of natural gas lies in replacing coal. As a relatively new type of fossil fuel, natural gas has had a short history of development in China and lacks its own market. Throughout its development, it has always relied on substituting for other types of energy sources. These substitute energy sources include gasoline, methanol, fuel oil, coal, liquefied petroleum gas, electricity, and diesel. Given the current situation, it has the greatest potential and is the most feasible alternative to coal. Based on international experience, the substitution of coal with gas starts in the fields of industrial fuel and chemical conversion, before being extended to power generation. Therefore, at present, the **remaining** coal consumption in developed countries is primarily focused on power generation; coal used for power generation accounts for 90% in the United States, 80% in Germany, 60% in South Korea (with another 28% used for coking), and 53% in Japan (with another 32% used for coking). The same should apply to China’s path of replacing coal with gas. Currently, coal consumption for power generation in China accounts for only 46%; the remaining approximately 50% is used for heating, chemical conversion, industrial fuel, and other purposes. If approximately 50% of the coal currently used for heating, industrial fuel, etc., could be equally replaced by new energy sources and natural gas, then the share of coal in total primary energy consumption would drop from the current 66% to around 33%. Meanwhile, the share of natural gas would increase by about 15%, exceeding 20%, thereby aligning with the international average level. There is huge potential in China for using natural gas to replace coal in the future; it is estimated that the demand for natural gas as a substitute for coal during the 13th Five-Year Plan period will be 112.6 billion cubic meters. Among them, industrial substitution demand is the largest, accounting for 47% ； The demand for power generation substitution accounts for 37% ； The demand for heating substitution accounts for 16%. In terms of geographical distribution, the market for replacing coal with gas is primarily concentrated in the eastern coastal areas such as Beijing-Tianjin-Hebei and Shandong, the Yangtze River Delta, and the Pearl River Delta. These regions are not only areas with high coal consumption but also face significant environmental pressures; at the same time, they have relatively strong economic capabilities, making them key areas for reducing coal use. In particular, areas with a high concentration of coal-fired power plants face significant pressure to reduce emissions; the emission intensity per unit area in these areas is about 5 times the national average, which creates ample opportunities for the development of the natural gas market. 3 Relevant Policy Recommendations
3.1 Deepening market reforms
Over the past two years, to advance the market-oriented reform of natural gas, China has introduced a series of supporting policies, including opening up natural gas infrastructure, establishing and operating the Shanghai Petroleum and Natural Gas Exchange, implementing natural gas price reforms, and inviting social capital to bid for development rights to conventional oil and gas fields in Xinjiang. However, compared with advanced foreign markets, China’s natural gas market still has a long way to go in terms of price management mechanisms, market openness, and competition in the natural gas sector. Therefore, it is recommended to first improve the natural gas pricing mechanism, address issues such as inverted prices for residential and industrial use of gas as well as cross-subsidization, shorten the price adjustment cycle, and enhance the development of oil and natural gas trading centers ； Secondly, accelerate the reform of the electricity market, establish a transmission mechanism linking electricity and heat prices with natural gas prices, and improve the pricing mechanism for peak-load power generation ； In addition, it is necessary to optimize the pipeline network system, strengthen market supervision, reduce intermediate links, allow large users to purchase directly, and promote calorific value-based metering and pricing. 3.2 Strengthening environmental protection: Efficient and clean natural gas is an inevitable choice for China to optimize its energy structure and achieve an energy revolution. Currently, the domestic and international natural gas markets enjoy ample supply, and cooperation on natural gas with resource-rich countries in Central Asia is progressing smoothly. All these factors provide favorable opportunities and resource guarantees for China to vigorously promote the substitution of coal with natural gas. Therefore, **stricter environmental protection policies should be formulated and implemented to guide the transformation of the energy consumption structure through policy measures ； Actively promote the development path of replacing coal with natural gas; accelerate the replacement of coal-fired facilities with natural gas; extend this practice from coastal areas to inland cities; and establish “coal-free zones” in large and medium-sized cities” ； Study the imposition of a carbon tax or environmental tax to reflect the ecological compensation costs of different energy sources. 3.3 Promoting industrial development The rapid development of the natural gas industry requires **support from relevant policies, particularly in terms of technological and management innovation within the industry.** It is recommended to **encourage natural gas and electric power enterprises to strengthen cooperation and pursue vertical integration** ； Strengthen research and development in gas turbine technology to strive to reduce equipment acquisition and maintenance costs ； Provide policy support such as investment and financing assistance as well as tax and fee reductions for the construction of natural gas storage and transportation facilities ； Effectively facilitate the upgrading of the coal industry and provide special support policies for resource-based cities.