China's growing use of gas: substitution for coal or additional energy consumption?

In the USA today, the growing production of shale gas has generated two policy debates. The first concerns the negative impact environmental impacts of the production of shale gas on local ground water. The second debate has much wider implications and raises the issue of whether the sudden availability of cheap supplies of natural gas in the USA will encourage growing energy consumption or the substitution of coal by natural gas. Which route is taken will have a great impact on the USA’s carbon emissions.

The same debates could, in principle, be held in China today. The major differences from the US case are that an increasing proportion of China’s gas supply is imported and very little of the gas in China is cheap to produce or import.

The five-year plan

As China’s five-year plan (2011-2015) for energy gets closer to publication, the scale and nature of the plans for natural gas are becoming clearer, though it must be emphasised that all statistics and information presented in this column are from public sources and may not reflect the final plans. Total domestic production of gas from all sources is to rise from 95 billion cubic metres (bcm) in 2010 to at least 180 bcm in 2015. This includes production from conventional natural gas fields, from a variety of unconventional sources of natural gas as well as from coal gasification.

Three types of unconventional gas are being targeted. Production of tight gas is already significant in China and is expected to rise to 50 bcm by 2015. The next major source of production growth is intended to be in coal-bed methane, a technical challenge that Chinese and foreign companies have been working on for nearly twenty years. Production of coal—bed methane reached 8.6 bcm in 2010, against a target of 10 bcm. But only 3.5 bcm was actually used, most probably because of a lack of pipelines to transport the gas to where it could be used. The production target for coal-bed methane for the year 2015 seems to have risen from 21 bcm in the middle of 2011 to as high as 30 bcm over recent months. New policies will remove the import tariffs and value added tax from all equipment involved in the production of coal-bed methane. The potential for shale gas is still in the early stage of assessment, but targets of 5-8 bcm for the year 2015 are being quoted.

The scale of gas imports will also be boosted. Recent announcements indicate that the annual capacity of the gas import pipeline from Turkmenistan will be enhanced to 55 bcm by the year 2015. This pipeline is already providing about 50% of China’s current annual imports of about 30 bcm. The recent decision to accelerate the capacity additions on this pipeline may have been triggered by the continuing failure of China and Russia to agree a price for gas imports from Russia. This capacity addition is being accompanied by the construction of a third West-to-East pipeline for bringing this gas and other gas from north-west China to eastern China. Indeed, CNPC has plans to build a further 30,000 km of domestic gas pipeline between now and 2015, on top of the current 40,000 km. Further gas imports will enter China along the coast as the number of LNG terminals grows from four to sixteen. Together with the new pipeline from Myanmar which will add more than 10 bcm each year, total annual imports of gas are set to rise to 100 bcm by 2015.


These plans raise three questions: (1) will the production and import capacity be constructed on schedule, (2) will sufficient buyers of the gas be connected to the supplies and be willing and able to pay for all this gas, and (3) if the answer to the first two questions is ‘yes’, will this surge of gas supply result in a substitution of coal by gas or in yet greater energy use. In other words, is the gas strategy part of a climate change policy or an energy supply enhancement policy?

Concerning the first question, the track record of China’s energy industry shows that it has the capacity to undertake large infrastructure projects rapidly, but there are often time lags in connecting the different sections of the supply chain. This can be seen in the failure to use much of the coal-bed methane produced in 2010 and in the significant proportion of the wind power capacity that was not connected to the grid in the same year.

Whilst some of these coordination failures may be caused by the difficulty of planning large integrated networks during a period of rapid growth, part of the problem also lies with the second question raised. One of the reasons why ‘new’ forms of energy, such as natural gas and wind power, have not always been delivered promptly in China is because they are more expensive than the other dominant source of energy, which is coal. The development of China’s natural gas industry in the late 1990s and early 2000s was frequently delayed by the unwillingness of large customers, often city gas companies, to pay for the expensive gas and to put in place infrastructure to use the gas.

The gas prices along China’s supply chain are set by government, either central or local, except for the price of imported gas. But, almost without exception, domestically-produced gas and imported gas are more expensive than its main competitor, domestic coal. The high cost of both domestic and imported gas causes a range of problems for different actors in the industry. CNPC loses money on gas it imports from Turkmenistan. City gas companies facing financial losses seek to get local government approval to raise end-user prices, a move resisted by local industries which see their profits being squeezed. But the current challenge facing the government concerns their efforts to promote the use of gas in power generation, in the face of high gas prices and low electricity prices for end-users.

More than 80% of China’s electricity supply comes from thermal power plans, and about 90% of this is coal-fired. The government is keen to promote gas-fired power generation and has reportedly set the goal of doubling gas-fired capacity from 28 GW to 60GW by the year 2015, of which 10 GW would take the form of 1,000 distributed, small-scale plants. But power generating companies are claiming that they have been losing money with their coal-fired plant on account of the high level of coal prices. So the financial incentives to build gas-fired plants and generate electricity are even less attractive, despite a modest subsidy that is paid to these plants by the government.

This leads us to the third question, of whether the increased availability of natural gas will lead to substitution of coal by gas or to additional energy consumption. Answering this question, even after the event, is not easy because energy demand continues to grow so rapidly in China that it is difficult to decide what total energy demand would have been in the absence of natural gas. What can be said is that if China’s government wants to promote the substitution of coal by gas, given the large price differential in favour of coal, it will have to impose tough administrative measures to constrain the construction of coal-fired power stations and will need to provide strong financial incentives to support the use of gas in power generation. The idea of imposing a carbon tax is being discussed, but its potential effectiveness is likely to be undermined if the current systems for controlling end-user energy prices are maintained.

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