With the annual winter heating season in northern China beginning Nov. 15, concerns over the country’s natural gas supplies are rising again following severe shortages last winter. An official with PetroChina, the country’s largest oil and gas producer, said Nov. 15 on state-owned CCTV that natural gas supplies could fall short by 9 million cubic meters (mcm) per day in northern China during peak winter demand, compared to last year’s seasonal shortage of 8 mcm per day. With an unusually cold winter expected this year, insufficient natural gas supplies could become a serious problem when combined with a continuing diesel shortage across the country. According to the PetroChina estimate, daily supplies in northern China will average 63 mcm this winter while daily peak demand may hit 89 mcm. Meanwhile, the National Development and Reform Commission (NDRC), China’s top economic planning agency, admits that natural gas supplies will remain tight this year because of rapid growth in demand despite a 20 percent increase in supplies from last year. While a nationwide gas shortage like the one in 2009 is not expected (China will likely import more to meet the growing demand), regional shortages could occur, particularly in central and southern China, because of distribution and storage constraints. And this is a problem that will not be solved for another two or three years, when pipeline and other infrastructure projects planned or now under construction will start coming on line. To understand China’s natural gas supply problem, one must look back on the situation in 2009. An unexpected cold winter and severe snow storms in southern regions beginning in November revealed kinks in the natural gas supply chain and resulted in severe gas shortages in many southern cities. In some cities, only 60 percent of demand could be met. Meanwhile, the wholesale price of natural gas rose 20 percent in less than two weeks. Natural gas demand also reached historical highs in northern China last winter, adding even more pressure to the nationwide shortage.

Supply and Demand

Natural gas has never been a major energy source in China, where it accounted for only 3.9 percent of the total energy mix in 2009, far below the world average of 24 percent. China relies much more heavily on coal, which supplies more than 70 percent of the country’s energy consumption. But the share of natural gas has been increasing rapidly in recent years, from 2.4 percent in 2000 to 3.9 percent in 2009, and Beijing anticipates boosting that share to 8.3 percent by 2015 to reduce the country’s heavy dependence on coal and crude oil and increase the use of clean energy. This means the country’s demand for natural gas could more than double in the next five years, with some estimates saying consumption could rise from 88.7 billion cubic meters (bcm) in 2009 to 240 bcm in 2015. Nor has China ever been a large natural gas producer. According to the BP Statistical Review of World Energy 2010, the country’s proven natural gas reserves stood at 2.46 trillion cubic meters at the end of 2009, accounting for only 1.3 percent of the world total. From 2000 to 2009, China’s annual natural gas output increased from 27.2 bcm to 85.2 bcm, but it has been outpaced by consumption since 2007. And because the country will be consuming more and more natural gas over the next few years, current domestic production capability will hardly be able to meet the growing demand. It is estimated that the discrepancy between supply and demand may reach 100 bcm by 2020. (click here to enlarge image) Accordingly, China is actively seeking natural gas imports. China has become a net importer of natural gas since 2006 and is now focusing on importing liquefied natural gas (LNG) from overseas and constructing domestic pipelines linked to natural gas suppliers in Central Asia. China has signed long-term LNG contracts with Australia, Malaysia, Indonesia and Qatar and has imported some LNG on the spot market from Russia, Nigeria and Oman, among other countries. Total natural gas imports in 2009 were 7.63 bcm, a 72 percent increase from 2008. Much depends, of course, on infrastructure. The first phase of the 1,833- kilometer Central Asia Pipeline, which passes through Turkmenistan, Uzbekistan and Kazakhstan and connects with the western section of China’s West-East Gas Transmission Project II, started pumping natural gas in December 2009. The second phase was completed in October. According to PetroChina, by the end of 2010, the Central Asia Pipeline’s annual capacity is expected to reach 15 bcm. In June, construction began on the 1,100-kilometer China-Myanmar oil and gas pipeline, which will run from the port of Kyaukpyu on Myanmar’s west coast through the Chinese gateway border city of Ruili in Yunnan province and on to Kunming, the capital of Yunnan. It will separate into two pipelines at Anshun in Guizhou province, one 2,380-kilometer line for oil that will end in Chongqing municipality and one 2,806-kilometer line for gas that will end in Guangxi province. When completed in 2013, the latter pipeline will transport 12 bcm of natural gas annually from Myanmar to China’s southern provinces. China is also talking to Russia about a proposed natural gas pipeline from western Siberia to northwestern China that would link to China’s West-East Gas Transmission pipeline. Negotiations are ongoing but have stalled over price, an issue that both sides claim they can resolve by mid-2011.

Unconventional Gas

While importing LNG and natural gas may help China meet its growing energy demand, it also raises the specter of increasing natural gas dependence, which may make the country even more vulnerable to energy insecurity. As a hedge against this, Beijing is looking to develop the country’s “unconventional” gas — including shale gas and coal-bed methane — as an alternative energy resource. China is thought to have abundant unconventional gas reserves, estimated to be five times larger than its natural gas reserves. The country is aiming to raise the annual production of coal-bed methane to 10 bcm by 2015 and 50 bcm by 2030. Shale gas output is targeted to reach 15 bcm by the year 2015 and 50 bcm by 2030. Due to high technological and economic obstacles, Beijing is encouraging its state-owned energy giants, including China National Petroleum Corp (CNPC) and China National Offshore Oil Corp. (CNOOC), to cooperate with foreign energy companies to jointly explore for and develop unconventional gas as a resource, since such development requires foreign technology and expertise. Much of this cooperation involves partnering with American firms that were the first to experiment with and master unconventional production techniques. So far, CNOOC has completed a deal with U.S.-based Chesapeake Energy Corp. on its Eagle Ford shale project in South Texas, in which CNOOC now holds a 33.3 percent stake. Shell is also talking with PetroChina about developing a shale gas project in Sichuan. In October, Beijing offered six shale gas exploration blocks in Guizhou, Chongqing and Shanxi provinces and along the border of Zhejiang and Anhui provinces each with an area of 6,000 to 7,000 square kilometers, and encouraged foreign participation in the bid. Beijing also has offered subsidies of 0.2 yuan per cubic meter for the exploration of coal-bed methane and plans to raise the subsidy to 0.23-0.3 yuan per cubic meter as well as reduce the tariffs on key exploration equipment. While the development of unconventional gas offers some promise in addressing the country’s long-term natural gas shortage, technical obstacles could impede the initiative in the short term. It requires constant political effort to reassure foreigners that sharing their knowledge and technology will be beneficial for all participants. Moreover, China’s low natural gas prices and lack of storage capacity as well as the monopolies enjoyed by state-owned oil companies will limit infrastructure development and contribute to ongoing shortages over the next two or three years.

Storage and Distribution

Although China is building an extensive gas pipeline network across the country, it lacks sufficient gas storage capacity to balance out fluctuations in the natural gas supply and meet demand for gas in a flexible manner. By 2008, the total length of gas pipelines in China was 35,000 kilometers, furnishing a total annual gas supply of 80 bcm. However, China’s natural gas storage capacity in 2010 accounts for only 3 percent of total consumption, far below the 15 percent world average. Currently, China has only two gas storage complexes, one in Tianjin and one in Beijing, and these facilities help supply only northern China. There are no storage facilities in the 10 provinces, from Xinjiang to Shanghai, through which the country’s major gas pipeline, West-East Gas Transmission Project I, has been transmitting natural gas since 2004. This problem is expected to be alleviated somewhat when 11 planned gas-storage facilities are built along the pipeline through the southern provinces, but these facilities are not scheduled to start coming on line until 2012 or 2013. Moreover, most of the existing pipelines in the country run west to east and lack north-south connections while supplies are concentrated in the northern provinces, where demand for natural gas is greater because the weather is colder. When southern provinces experience a gas shortage, there is no way to effectively deal with the emergency. This problem is expected to be alleviated by completion of the 8,653-kilometer long West-East Project II in 2011, since its sub-lines in the eastern section would connect with West-East Project I and vertically link several provinces, from Shanghai to Guangzhou and Hong Kong. China is also planning to upgrade and expand the natural gas pipeline network that covers 31 provinces and supplies 95 percent of the country’s major cities and build several north-south pipelines, including one from Zhongwei in the Ningxia Hui Autonomous Region to Guiyang in southwest Guizhou province.

The Pricing Mechanism

Developing infrastructure for natural gas transmission and distribution is one thing; setting a price for that gas is something else altogether. The current price of natural gas actually impedes infrastructure development. Chinese consumers — people and industries — have enjoyed low natural gas prices for almost a decade. The ex-factory price of industrial natural gas is presently 33 percent of the international crude oil price. In contrast, the ratio usually stands at 65 to 80 percent. This low price is partly due to the government’s effort to boost natural gas consumption. Meanwhile, as China has become increasingly dependant on imported natural gas and more intent in its search for new sources, the current pricing mechanism has been outpaced. Low prices also have led to the disorderly expansion of demand, with many manufacturers shifting from oil to gas and some cities blindly promoting the use of natural gas, adding even more pressure to gas shortages. In 2005, the NDRC did away with the long-standing dual-pricing system for natural gas controlled by the government. Still, there is little flexibility in price, which is adjusted annually. In June, the NDRC raised the price of onshore natural gas price by 25 percent, a new high, which led to price rises for residential usage in major urban areas. The ultimate goal for natural gas price reform in China is to link the price of natural gas with international price of crude oil and raise the gas price to a level similar to the price of gas in Western countries. This means that China may have to raise the price by 60 to 100 percent in the coming years. By raising the price, Beijing would further incentivize new production and the building of more infrastructure, thus helping to alleviate the domestic shortage. However, raising the price suddenly could create social problems, since households account for more than 20 percent of total natural gas consumption in China, and raising the price for industrial consumption would eventually be passed to the end user. Aware of the consumer ramifications and determined to prevent social unrest, Beijing will likely opt for a gradual price increase. In the meantime, China is bracing for another gas shortage this winter. Whether it will be as severe as last year’s is unclear, but regional-scale shortages are expected. And such shortages will be a fact of life in China for the next two or three years, as the country strives to create a more comprehensive pipeline and storage network and come up with a price that everyone can live with.