China takes steps towards market-based gas pricing

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China’s recent decision to raise natural gas prices for non-residential consumers – the first time it has done so since 2010 – is an encouraging sign in a nation determined to increase natural gas consumption as a way of reducing pollution. While at first sight a price increase might be seen as having a dampening effect on demand growth – especially given the recent economic slow-down in the country – over the long term the development of China’s gas industry will depend on appropriate pricing that brings forward new supply, whether in the form of imports, or further upstream development of China’s own resources, be they conventional, shale gas or coal-bed methane.

China’s National Development and Reform Commission (NDRC) announced at the end of June that it would increase the average wholesale price of gas for non-residential consumers with effect from last month and, significantly, expand the use of a market-based pricing mechanism. From 10th July gas prices for non-residential users rose by 15% to 12.95 yuan/cubic metre.

Structural change: A rise in price is all very well per se, but the most significant aspect of the decision was the emphasis on the roll-out of a market-based gas-pricing mechanism, which represents an important structural change.

Natural gas still supplies only a small part of total energy demand in China, despite rapid growth over the past decade. It currently meets about 5% of primary energy demand and the government has set a target to increase that to 8% by 2015. Even that level would be far below the global average of 24%.

The price rise will be welcomed by China’s big energy companies, such as PetroChina, who have seen mounting losses on gas sales because of the difference in the price they pay for gas and the amount they are allowed to charge for it.

Despite the rapid growth of gas consumption in China over the past decade or so – from just 25 Bcm in 2000 to 147 Bcm in 2012 – the nation’s gas industry is still in the early stages of development.

Import dependence: It is heavily dependent on imports, by pipeline and LNG, and storage is almost non-existent, though the government has a substantial investment programme in place to remedy that. Gas procurement costs are likely to rise over time as low-priced contracts with Indonesia, Australia and Malaysia expire.

China has been talking to Russia for years about pipeline imports but with Gazprom insisting on prices comparable to those it receives in Europe there has so far been little progress. Ongoing price reform could eventually lead to a breakthrough in these talks.

There are also hopes that China will eventually develop shale gas and coal-bed methane on a large scale, but this will take time, given the nation’s geology and its relatively undeveloped pipeline infrastructure.

Meanwhile, demand is expected to continue to grow rapidly, though forecasts of how quickly differ widely. There are some who believe that China’s gas consumption could grow to 500 Bcm/year by the end of this decade, while others, such as Cedigaz, believe that reaching that level is more likely by 2030.

Either way, how natural gas is priced will be a key determinant of how China’s market develops. Getting the balance right will be crucial, so that prices are high enough to encourage new supply but not so high that gas is uncompetitive with other fuels, such as coal, nuclear and renewables.

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