China’s Natural Gas Paradigm Shift

China’s Natural Gas Paradigm ShiftBy Tim Daiss and Michael J. Economides

China practically dominates the energy news of the day. The long-term effects will be far wider than the stories now fixating the American public.

Last month the big news coming out of China’s Oil Patch was Beijing’s startling, if not long overdue, corruption allegations against one of its state-owned oil majors, CNPC, with corresponding executive resignations, and potential fall-out for more of the same.

Now, however, attention has shifted to natural gas amid Beijing’s goal of diversifying the country’s energy mix further away from coal-fired power plants to gas fired plants, in hopes of reducing record levels of air pollution, health problems and mounting public discontent. State media are covering this energy paradigm shift and the exploration for, and supply and demand of gas and the companies that will harness it, bringing the commodity to China’s polluted-by-coal masses.

On October 23 Novatek, Russia’s second largest natural gas producer, signed an accord that will allow it to supply liquefied natural gas (LNG) to CNPC for a 15-year period. Novatek will sell at least 3 million mt of LNG a year to CNPC on delivered ex-ship terms, with the price indexed to the Japanese Crude Cocktail.

While this marks the continued thawing of energy relations between the two countries that existed for decades, it just as importantly confirms Beijing’s commitment to increase natural gas-fired capacity for power generation, increasing from 26.4 gigawatts (GW) in 2010 to a goal of 56 GW by the end of 2015.

Along with this uptick in all things gas in China, there are some explicit winners. Some that will benefit will not only be those suffering the ill-effects from air pollution attributed to coal-fired power plants (especially in Beijing), but the country’s economy as well.

On October 23 China’s Global Times reported on a white paper released two days earlier in China by General Electric (GE) that stated the country will lead global gas demand, while gas usage will save the nation around 5 trillion yuan ($820 billion) in environmental costs by 2025.

On the corporate side a company that is posed to come out on top is Hong-Kong listed China Gas Holdings, China’s leading piped natural gas operator and distributor. Last week China Gas said that the government’s policy to cut coal use will benefit them as more cities take up the task of cleaning up their air.

Eric Leung, China Gas deputy managing director and chief financial officer, said his company expects to start earning revenue from the policy change from 2016 and for sales to jump as much as five-fold from wider gas usage to replace coal.

Leung also said during a media interview on October 17 that gas deliveries might reach 40 billion cubic meters by 2020 from an estimated 8 billion cubic meters this year. Growing sales will gradually push dividend payouts toward 30% from 23% for the year ended March 31, he said.

However, Leung added that China Gas is not making a profit on half of its 195 city networks because the projects were either new and had not yet reached their break-even point or because they had yet to begin operations. He said he expects the number of profitable city projects to rise to 150 by 2015.

The company executive also said that China Gas plans to extend its mainland network of compact natural gas (CNG) and LNG refueling stations to 600 by 2015, an increase from 165 currently located across 38 cities. He said that these stations have the widest profit margin, approximately 35%, of all of China Gas’s products.

China Gas will also start LNG bunkering next year, according to an October 21 report by Sino Ship News. Liang Yongchang, China Gas vice president, said the company is currently updating facilities at some port terminals and will provide LNG bunkering service on the Yangtze River from next year.

“There are lots of vessels which will be converted to LNG power, so there is a big potential in the LNG bunkering market,” Liang said. He added that China Gas will first sign cooperation deals with shipping companies and set up bunkering terminals according to these shipping routes.

In tandem with its development, China Gas announced in September that it had been included for the first time on the Forbes “Asia’s Fab 50 Companies” list for 2013, which ranks the best large-scale companies in the region.

China Gas has a $5.1 billion market-cap and five-year average sales growth of 53%, operating income growth of 56%, and earnings per share (EPS) growth of 24%.

To date, China Gas owns a total of 205 natural gas projects, including exclusive piped gas development rights in 195 cities and regions, nine natural gas pipeline transmission projects, one natural gas exploration project, as well as the license to import and export LNG and other fuel products in China as well as 44 liquefied petroleum gas (LPG) distribution projects.

However, China still has numerous hurdles to overcome as it develops its natural gas sector, including high costs of developing gas-fired power plants, according to Zhang Guobao, former chairman of the country’s National Development and Reform Commission (NDRC). The Global Times said that Zhang made his remarks at the forum announcing the release of GE’s white paper.

“On the one hand, the power generation enterprises found it difficult to make profits due to high natural gas cost and lower prices fixed by the NDRC; on the other hand, the government is hesitant to raise power prices in consideration of the pressures of inflation,” he said.

Another problem is what Reuters called on Wednesday “disappointing [gas] production growth coupled with insufficient pipeline and storage capacity.”

Likewise, Zhou Dadi, a NDRC Energy Institute senior research fellow said at the forum that a lack of comprehensive nationwide gas pipe network and financing mechanism are the other challenges for the development of natural gas in China.

In the near term, China will likely have a natural gas shortage as winter kicks in. On Friday the NDRC said the gap between supply and demand throughout the winter and into next spring could be significant, and the situation could get worse in case of continued bad weather.

Michael Economides is Editor-in-Chief of the Energy Tribune