China: Policy for natural gas imports back on track?

The recent announcements of deals to increase the level of LNG imports from Australia and to build a pipeline from Turkmenistan show that China’s strategy to import substantial quantities of natural gas may be back on track after two years of uncertainty.


Until the mid-1990s natural gas was the ‘poor relation’ of other forms of energy in China such as coal, oil and hydro-electricity. The main symptom of this was the very low price paid to producers of gas, providing no incentive to explore and develop new reserves; and lack of infrastructure. Only after the discovery of a large new gas field in Shaanxi Province did the government realise that natural gas could play an important role in the country’s energy supply. Not only does natural gas provide an additional source of domestic energy supply, but it is also cleaner than China’s traditional fuel, coal, and more thermally efficient in use.


By the end of the 1990s the government had allowed prices to rise dramatically for both gas producers and gas consumers, and the first pipeline from Shaanxi to Beijing was in operation. The offshore Yacheng gas field was also providing gas to Hainan and Guangdong. The first years of the twenty-first century saw a wide range of initiatives designed to boost China’s domestic supply of gas and bring it to market under the joint drivers of energy security and environment concern, for example: the development of fields in Xinjiang and Qinghai Provinces and of new discoveries in Shaanxi and Inner Mongolia; the construction of pipelines, most notable the West-to-East Pipeline; exploration and development of reserves in the East China Sea; and further exploration in the South China Sea and in Sichuan Province. Together these efforts have allowed China to raise its domestic production of natural gas from 19 billion cubic metres in 1997 to 55 billion cubic metres in 2006, faster than expected in the late 1990s. Over the same period the proportion of gas in China’s primary commercial energy consumption has risen from 2% to just over 3%, not as much as had been hoped because China’s overall energy demand has soared in recent years.


The second strand of China’s natural gas strategy is the inevitable reliance on gas import through pipelines or on ships as liquefied natural gas (LNG) due to the relatively low level of domestic production. LNG is more cost-effective over very long distances and, as regional LNG markets develop, LNG can be more flexible because a buyer of gas can have a number of suppliers. Despite more than ten years of rhetoric, the first imports of gas arrived in Guangdong only in 2006, as LNG, accounting for less than 2% of China’s total gas consumption that year. No import pipeline for gas has yet been constructed.


Price was also a concern for LNG imports. By chance, China’s first LNG plant in Guangdong was able to secure a very low price for a supply of gas from Australia in 2002. Demand for LNG at that time was relatively flat and a number of gas fields were available as potential suppliers. Encouraged by this low price China’s oil companies announced a number of LNG terminals all down the east coast of the country. PetroChina and Sinopec were keen to follow CNOOC’s lead into this new and apparently profitable market. However the low price achieved by the Guangdong project could not be repeated. Demand for natural gas was growing both in the Pacific and in the Atlantic in response to economic growth and environmental concerns. LNG prices rose back to not just to earlier levels but to be twice as high as in the late 1990s. In response the Chinese government slowed down the approval of LNG projects and seemed reluctant to agree to the current high prices in their negotiations with suppliers. The agreement for gas supply from Indonesia for China’s second LNG terminal, in Fujian, had to be renegotiated to reflect the higher prices.


In early September 2007 both  PetroChina and CNOOC separately agreed provisional terms for importing substantial quantities of LNG from Australia for the coming decades, in deals which, if finalised, would be worth tens of billions of dollars. These supplies would be directed at LNG terminals to be built in Guangxi, Jiangsu, Hebei, Liaoning and Zhejiang. Current plans would add three more LNG terminals to the currently operational plant in Guangdong and the near-completed plant in Fujian, bringing a total of five plants onstream by 2010, and a further doubling of import capacity to 60 million tonnes per year by 2020. Though the exact formula agreed for the price of gas in these new agreements remain confidential, it must at least be close to that in the rest of the world market.


Pipelines are seen as being more secure than LNG because the flow of gas is not open to interruption on the high seas. However, a range of complex geopolitical issues create a degree of uncertainty over the construction of much-needed pipelines and over the building of production capacity. Central Asia and Russia both contain substantial proven and potential reserves of gas which could be imported through pipelines and make a major contribution to China’s gas supply. Turkmenistan has vast untapped reserves and it was in 1993 that China embarked on discussions to construct a pipeline to import this gas. At the same time it was realised that the new Kovytke gas field in East Siberia also could provide a source of gas. Other sources of gas in Russia included the  long-standing fields of West Siberia as well as the more recent discoveries in Sakhalin, in the Russian Far East.


The Turkmenistan project did not progress because of the huge costs involved in building a 6,000 kilometre pipeline. Discussions with the Russians became stuck on account of domestic concerns within Russia over which gas resources should be used to supply China as well as over Gazprom’s insistence that it be involved in all export projects. On the Chinese side the principal concern for both Turkmenistan and Russian gas was the price to be paid for this gas and whether the users in China could afford that price.


In the last few years China has also opened discussions with Kazakhstan and Uzbekistan on possible gas imports, but in these countries there remains considerable uncertainty about when these gas fields could be developed and be ready for export.


Also in September the government announced that agreement had been reached with Turkmenistan over CNPC’s right to explore and develop gas reserves in that country and over the price for gas exported to China.


These recent developments appear to show that China’s government is re-asserting its determination to continue raising the proportion of natural gas in the country’s energy supply, even if it means accepting high and rising international prices. The high priority placed on security of supply and environmental protection gives the government little choice. At the same time new gas fields are being discovered within China and new pipelines are being built, including a second West-to-East pipeline.


Despite this renewed vigour being applied to the country’s natural gas sector, it still appears that there is no coherent policy for natural gas consumption and use. Prices for both producers and consumers remain under the control of the NDRC and no predictable and transparent system exists for setting these prices. Thus investors in China’s gas industry face considerable short-term and long-term uncertainty over their financial returns. It is not surprising, therefore that the domestic gas sector remains dominated by Chinese companies who are better equipped to manage such uncertainty. From the perspective of government strategy, a more pressing concern is the continuing discontinuities, first, between the pricing of cheap, dirty coal and of expensive clean gas, and, second, between the pricing of gas and of electricity generated from this gas. These policy deficiencies are constraining China’s  potential to be a major gas consumer.

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