CEQ on FT.com: Paying up for gas

By Dawn Lee
Published: October 20 2008 03:35

A key element in China’s twin efforts to diversify its energy sources and reduce greenhouse gas emissions is to increase use of natural gas. Until recently, China’s natural gas program was hampered by the high cost of infrastructure – gas pipelines and terminals for liquefied natural gas (LNG) – and by the unwillingness of national oil companies to pay market prices for imported gas. But the past year has seen a dramatic turnaround. Pipelines and terminals are now in place. And with the international price of gas at less than half than that of its main petroleum-based alternative, fuel oil, Chinese firms are now happily paying market prices. The result should be a rapid upsurge in Chinese gas imports.
The planned increases in natural gas to heat homes, fire power plants, and provide chemical feedstocks are part of a broader move to reduce China’s reliance on dirty coal and expensive oil, and to increase consumption of clean-burning natural gas and renewables, in order to diversify supplies and reduce greenhouse gas emissions. The present target is to increase the natural gas share of China’s primary energy consumption from 2.3 per cent in 2005 to 5.3 per cent in 2010.
Some of this increase would come from domestic gas production, which is targeted to jump by a third over the next three years, from 69bn m3 in 2007 to 92bn m3 in 2010. The major domestic production areas are Xinjiang in the northwest and Sichuan in the southwest; these two regions account for 38 per cent and 25 per cent of the nation’s total natural gas output, respectively. But an even bigger chunk of the increase will have to come from imports, which were less than 4bn m3 in 2007 but are targeted to rise to 48bn m3 by 2010, by which time they will account for 34 per cent of China’s total annual consumption of 140bn m3. So far, China has no pipeline gas imports; LNG imports began flowing into newly-built terminals in southern China in 2006.
NDRC’s gas pricing policy is quite complex and represents a compromise between two conflicting aims: to ensure a degree of price stability while at the same time pushing Chinese prices closer to international norms. NDRC divides the country’s total gas output into two categories (depending on which fields the gas comes from). Category 1 is priced at an NDRC-set benchmark rate; Category 2 is priced at a benchmark linked to a basket representing international crude oil, liquefied petroleum gas and coal prices. The basket benchmark is re-set annually by NDRC, by no more than 8 per cent.
When the pricing policy was established in 2006, about 85 per cent of gas was sold at cheaper Category 1 rates. Since then, however, more and more gas has been priced at the higher Category 2 rates; and NDRC plans to abolish the subsidized Category 1 pricing by 2011.
With the regulated domestic price now rising by 8 per cent a year in renminbi terms (and at 14-15 per cent in US dollar terms once currency appreciation is factored in) Chinese energy companies are now far more willing to pay international market prices for imported gas. They have also figured out that natural gas is far cheaper than its principal substitute, fuel oil. In May 2008 a gallon of fuel oil cost US$3.70, while an equivalent amount of natural gas cost US$1.67. As a result of these price dynamics, the pace of China’s cross-border gas deals has accelerated dramatically.
China’s first major international gas purchase contract came in 2002, when China National Offshore Oil Corp. (CNOOC) paid US$3 per million British thermal units (BTU) for long-term LNG supplies from Australia for its planned Dapeng terminal in Shenzhen. During the next several years Chinese firms signed no new LNG deals, in part because with sharply-rising international crude oil prices, there was no LNG to be had at prices as low as the Dapeng deal. Negotiations over a 25-year supply agreement between BP’s Tangguh field in Indonesia and CNOOC’s planned Fujian terminal, begun in 2002, stalled because of rising prices and came to fruition only in 2006 when CNOOC accepted a ceiling price of US$3.50 per million BTU, a quarter higher than the originally agreed price of US$2.70.
Since then Chinese tolerance for higher LNG prices has risen sharply. In 2006 CNOOC agreed to a price of US$5.6-5.8 per million BTU for Malaysian gas and in September 2007 PetroChina signed two provisional deals to import up to 4m tons a year from the Browse and Gorgon projects in Australia at around US$10 per million BTU.
Finally, the government of electricity-starved Guangdong province authorized CNOOC’s Dapeng terminal to import spot shipments of LNG, without prior government approval, up to a limit of US$15 per million BTU. Dapeng, which began operations in 2006, began importing spot cargoes to cater to demand from local power plants. In 2007, spot cargoes were 435,000 tons, or about 15 per cent of all LNG shipped to Dapeng.
Somewhat better prices may be obtainable through cross-border pipeline deals. PetroChina parent CNPC in 2007 signed a 30-year production sharing and gas import agreement with Turkmenistan, under which CNPC will pay US$5.40 per million BTU at the well-head at the Amu Darya field. Transport to the border in northwest China will add about a third to the price, bringing the total landed cost to around US$7.20. Ultimately, this gas will reach Shanghai and Guangdong via a second West-East pipeline now under construction by CNPC, scheduled for completion in 2011.
Copyright The Financial Times Limited 2008