China s Natural Gas Market

Report China s Natural Gas Market China s gas market is hitting new highs; this report will detail the growth of China s natural gas market and illustrate how its success depends on developing pipeline infrastructure. A fter a high growth in 2010 on all fronts reached 10.0 bscf/d in 2011. This growth was a bit slow production, imports, and demand China as compared to 11.2% achieved in 2010 and pale scored another year of rapid expansion in compared to the average growth of some 18% per year the natural gas market in 2011, during which from 2003-2008, but it was still impressive (Figure 1). the Second West-East gas pipeline (WEGP II) was fully PetroChina is still the leader in total natural gas completed; China commissioned two more LNG receiving terminals; and the gas demand grew even production in 2011 (Figure 2). Its production increased output in China, accounting for 73% of the total gas faster. For overseas investment, China achieved a by only 4.2% from 2010, with a major contribution breakthrough in winning projects in the area of shale coming the from Changqing field, while production gas. Looking toward 2012 and beyond, China s growth from the Sichuan and Tarim basins declined. Compared to 2010, Sinopec s natural gas output experi- may be slowing down, but the absolute volumes of incremental demand will still be huge and the growth enced a rapid growth of 17.2%, with almost all growth is likely to be in the double digits. In this report, we coming from the Puguang field in the Sichuan and provide an update of the gas sector and market Chongqing area. CNOOC and other producers also developments of the past year with near-term forecasts for 2012 and the coming contributed significantly to the growth in 2011. years. Production Growth Continues; PetroChina Still Leads the Race Unlike oil, which has seen stagnation of growth for years, China s gas production increased by 8.7% and For 2012, we expect China s natural gas production to go up by 8.3% to reach 10.8 bscf/d. In the long run, there is a huge potential for China to produce more natural gas, which is in contrast with the prospects for oil where the output is expected to be stagnant. However, 16 JAN-MAR 2013 Visit our websites at www.safan.com

there will still be potential big swings in gas production, ranging between 13.9 bscf/d and 22.6 bscf/d by 2020, and between 17.0 bscf/d and 36.4 bscf/d by 2030 under the low- and high-case scenarios (Figure 3). LNG prices paid by the Chinese companies continued to be widely spreaded over the range of US$3-19/ mmbtu in 2011. LNG and Pipeline Gas Imports are Surging, so are Losses due to Government Control on Prices In 2011, China s LNG imports jumped by 31% and reached 12.2 million tonnes (mmt) as PetroChina commissioned its very first two Rudong and Dalian LNG receiving terminals and became the country s second major LNG importer after CNOOC established its monopoly since 2006. Of the total LNG imports in 2011, about 3.6 mmt (29%) was sourced from Australia s Northwest Shelf LNG project under the 25-year longterm contract by CNOOC, 2.0 mmt from Qatargas, includin PetroChina s newly started 25-year long-term contract with Shell from Qatargas IV and the original 25- year term contract between CNOOC and Qatargas III, another 2.0 mmt of import was from Indonesia s Tangguh LNG, 1.3 mmt from Malaysia LNG long term contract, and 0.7 mmt from Total s Yemeni portfolio supply under a newly started 15-year long-term contract with CNOOC. The average LNG prices of the Australian, Indonesian, Malaysian, Qatari and Yemeni long term cargoes were US$3.35/mmBtu, US$4.04/mmBtu, US$7.54/mmBtu, US$17.09/mmBtu and US$17.09/mmBtu. China has also purchased around 2.6 mmt of spot/shorter-term cargoes from Alaska (US), Australia, Malaysia, Nigeria, Qatar, Trinidad & Tobago, Egypt, Equatorial Guinea, Russia, Peru, possibly Yemen and others at an average price of US$9.80-17.60/mmBtu (Figure 4). Overall, the In 2012, LNG imports are forecast to further rise to above 16 mmt as PetroChina s Jiangsu and Dalian LNG terminals gradually ramp up to full capacity and CNOOC is set to commission its 3.0 mmtpa Zhejiang LNG receiving terminal. While volumes under the existing long-term contracts are expected to rise further to full contractual levels, there will be no additional volumes from new contracts until 2014 when Shell s portfolio supply from the Australian Gorgon project starts. As a result, China may need to seek expensive LNG cargoes from the spot market to fulfil its growing natural gas requirements in the next two to three years. In the near term, the imported gas will be mainly sold to the industrial and residential sector. PetroChina and CNOOC are likely to pool the expensive Qatari and spot LNG gas with domestic onshore and offshore pipeline gas to safeguard their bottom lines. Currently, domestic gas delivered from the first West-East Pipeline to Jiangsu province is priced at around US$9.50/mmBtu at the city gate. In 2011, China imported about 14.8 billion cubic meters (1.4 bscf/d) of Turkmen gas, up from 4.4 bcm/y (426 mmscf/d) in 2010. The entire WEGP II project was completed in mid-2011, extending Turkmenistan gas to the Guangdong Province. The Turkmen gas price is linked to international crude prices, which are far above domestic prices regulated by the government. In 2011, PetroChina s losses from importing pipeline gas and LNG JAN-MAR 2013 17

amounted to 21.4 billion yuan (US$3.4 billion), of which the portion of Turkmenistan gas imports was substantial. We forecast that China s pipeline gas imports will increase to 1.9 bscf/d in 2012 and PetroChina may inccur a heavier loss over it. Extraordinary Demand Growth Seen in 2011 and Continues into 2012; Future Growth will be Robust In 2011, total natural gas demand reached an alltime high of 12.7 bscf/d, up by 22% from 2010 (Figure 5). Between 2000 and 2011, China s natural gas use expanded by a factor of over five with an impressive average annual growth rate (AAGR) of 16.5%, far higher than the AAGR of 8.8% for primary energy consumption as a whole. Of the total natural gas use in 2011, the industry and residential & commercial sectors accounted for 34% and 32%, respectively (Figure 6). Meanwhile, natural gas for the power sector only accounted for about 21% of the total gas use, expanding sharply from 12% in 2005. In 2012, we expect that natural gas demand will continue to grow by around 14% to reach 14.5 bscf/d. Over the long run, industrial, residential/commercial, and power are three pillars in driving the future growth of natural gas in China, raising the total to 29.1 bscf/d in 2020 and 43.2 bscf/d in 2030. However, as suggested by the uncertainties over domestic production, there are swings in natural gas imports as well. As a result, the natural gas demand outlook under the low-case and high-case scenarios will be notably different from that of the base-case scenario (Figure 7). Infrastructure Expansions Key to China s Future Gas Sector Growth The Chinese NOCs (mainly CNPC/PetroChina and Sinopec) continue the rapid expansion of their domestic gas infrastructure. By the end of 2011, China had 43,100 km of natural gas pipelines, of which CNPC/PetroChina accounted for 76%, Sinopec for 12% and CNOOC/ Others for 10%. In the past 17 years, China built new pipelines that were more than four times as long as all those lines built in the previous four decades. In 2011, three key natural gas pipelines started: On June 30, 2011, CNPC/PetroChina commissioned the 2,454 km east section trunkline of the WEGP II, marking the completion of the full 4,978 km domestic trunkline of WEGP II. In addition, a total of 509 km of related major branch lines were completed during 2011. By the beginning of 2012, the WEGP II has sent gas from Central Asia to 15 provinces and regions in China, including Jiangsu, Zhejiang, Hunan, Hubei, Guangdong, 18 JAN-MAR 2013 Visit our websites at www.safan.com

Shanghai in the east and many others in the west, with an average capacity of 3.4 bscf/d. CNPC/PetroChina has also commissioned the 335 km Tai an-qingdao section of its 1,311 km gas pipeline network project in Shangdong Province, which is connected to the WEGP II. By April 2011, Qingdao has successfully received Central Asian gas sent via the WEGP II and the Shangdong pipeline network project. A third major pipeline that was commissioned during 2011 was CNPC/PetroChina s 406 km Qinhuangdao-Shenyang gas pipeline in Liaoning Province, which connects the north-eastern cities in China with the WEGP II and Shaanxi-Beijing pipelines. The Qinhuangdao-Shenyang gas pipeline has a designed capacity of 774 mmscf/d and has been transporting gas from Central Asia and the Changqing gas field to Liaoning since June 2011. The rapid expansion of natural gas pipeline infrastructure continues in 2012. In March 2012, CNPC commissioned the Third Shaanxi-Beijing gas pipeline after two years construction. The 896 km trunkline runs from Yulin in Shaanxi Province to Beijing with a capacity of 145 mmscf/d. In addition, we expect another five lines to come online in 2012, all of which are major branch lines of WEGP II, including a 20 km Shenzhen-Hong Kong subsea gas pipeline (Figure 8). The commissioning of all six pipelines will mark the completion of the entire WEGP II project. Experimental Price Regime Likely to be Expanded Nationwide: Impacts on Individual NOCs May Vary China s natural gas prices have long been regulated. Toward the end of 2011, China s NDRC announced a pilot program for a new natural gas pricing mechanism and implemented it in the Guangdong and Guangxi provinces. The NDRC has since prepared to roll out the new price scheme nationwide and extend it to upstream gas pricing this year. Under the experimental scheme in Guangdong and Guangxi, the price of natural gas is linked to the price of imported fuel oil and LPG instead of production costs, therefore bringing more flexibility and market-based factors into domestic natural gas pricing. In addition, the traditional source-to-source price differentiations being extended to different consumers have now been abolished and only one city gate price will be charged. Even though the impacts of such changes cannot be fully assessed yet as Central Asian gas has just reached Guangdong this year and there is almost no gas consumption in Guangxi now, PetroChina is expected to benefit the most in the long run under the new gas program, since a single market-based price would act in favor of its strategy of resource pooling and price pooling as it has been doing in the past, thereby allowing its expensive imported LNG cost to be absorbed by the cheap domestic gas it produces. CNOOC, who is already more experienced than other players in managing its LNG portfolio, is likely to enjoy even higher profits than before as a result of the full price reform, especially in the short run when most of the gas it supplies is still from the inexpensive long term LNG contracts it signed before 2008. Under FGE s price forecast, CNOOC is expected to pay a weighted average of around US$7.80/mmBtu for its LNG imports under long-term contracts in 2012, which is way below the current city gate price caps of 2.75 yuan/m 3 (US$12.2/mmBtu) and 2.57 yuan/m 3 (US$11.4/mmBtu) in Guangdong and Guangxi under the pilot program. Of course, some of CNOOC s natural gas supplies to end users have fixed, low prices under the long-term contracts CNOOC signed with them. On the other hand, PetroChina has to import LNG at a high price US$18.90/mmBtu from Qatar in 2012. By 2020, CNOOC s benefit from the domestic gas reform may be reduced, as new LNG contracts will bring its average LNG import price up to around US$11.00/mmBtu. However, CNOOC is still expected to stay ahead of the curve in the LNG business while it is hard to predict for PetroChina and Sinopec even with the domestic price reform in place. By 2020, PetroChina and Sinopec are expected to pay an esti- 20 JAN-MAR 2013 Visit our websites at www.safan.com

mated price of US$19.4/mmBtu and US$11.4/mmBtu, respectively, for its long term LNG imports. China had many failed attempts to overhaul the natural gas regime completely. The last time the Chinese government adjusted prices for natural gas was on May 31, 2010, when the NDRC announced that the explant baseline price of the domestic on-shore natural gas increased by 230 yuan/km3 (US$0.94/mmBtu) across the board. However, locally regulated retail gas prices took time to be adjusted to reflect the upstream hikes. The new top-down gas pricing system may change the situation, but FGE believes that a full national rollout will likely to be slow and gradual. Places to see the price reform first are likely to be the coastal gas consumption centers such as the lower Yangtze region, which are already paying high prices for the expensive WEGP II gas imported from Central Asia. Overseas Investment: More Active than Ever In 2011, the Chinese NOCs have made 8 gas-related overseas acquisition and investment offers, which amounted to around US$12 billion. As China increases its dependence on imported natural gas over the years, CNPC/PetroChina, CNOOC and Sinopec have sped up their quests for overseas gas-related projects. Particularly in the area of LNG, both Sinopec and PetroChina are keen to bundle overseas upstream gas asset investment with their long term LNG procurements. This strategy may help them in negotiating for favorable terms and prices in their long term LNG procurement contracts, as their support on upstream financing is often needed by the LNG sellers to kick start certain high-cost projects. In addition, it will also boost the Chinese companies equity-sourced gas volumes, which is in line with the Chinese government s energy policy. As a result, getting the government s approval for new long term LNG contracts will be a much easier and faster process when the company holds some upstream equity. Another incentive for investing in overseas unconventional gas assets could be to develop core skills in unconventional gas exploration and development from their joint-venture partners in order to apply them to the domestic unconventional gas fields. The aggressive overseas investments continue this year. In January 3, 2012, Sinopec announced that the company has agreed to acquire a third of Devon Energy s interest in five developing shale oil and gas fields in the US. On April 27, 2012, Sinopec successfully completed transaction of the US$2.44 billion deal with Devon Energy. Earlier in February this year, PetroChina sealed and completed another deal with Shell to buy a 20% stake of its Groundbirch shale assets located in British Columbia, Canada. This investment is understood to have supported Shell to launch its nearby LNG Canada export project later on May 15, 2012, in which PetroChina is also taking a 20% stake together with Shell (60%), Korea s KOGAS (20%) and Japan s Mitsubishi (20%). Concluding Remarks 2011 was a remarkable year for the Chinese gas industry as PetroChina completed the mega pipeline project of WEGP II and started importing LNG for the first time. During the year, China s gross natural gas consumption witnessed a 22% growth, highest since 2006. The Chinese NOCs have also become key players in the global merger and acquisitions (M&A) business including natural gas, particularly shale gas. Looking forward, reform of the domestic natural gas prices has been underway on an experimental basis. If extended to the country for a while, the impact of the new price regime on individual NOCs vary from one to another, but overall these impacts will be positive. For LNG imports, PetroChina s Zhejiang Ningbo LNG terminal is likely to be the only commissioning terminal of the year. Chinese NOCs are unlikely to rush in on new LNG contracts before domestic natural gas reform takes shape. However, they are expected to continue to aggressively acquire upstream gas assets, particularly in shale gas to secure equity volumes and acquire knowledge and experience in management and exploration. In 2012, China s overall pipeline gas and LNG imports are forecast to reach just under 1.9 bscf/d and over 16 mmt, respectively, up from 1.4 bscf/d and 12.2 mmt in 2011. Chinese natural gas output and demand is likely to increase by 14%, notably below last year s growth but still impressive. In the long run, demand will grow continuously where supply will come from all three sources: steadily increased domestic production, expanding pipeline gas imports, and rising LNG imports. PP This publication thanks Facts Global Energy, headquartered in Singapore, for providing this article. 22 JAN-MAR 2013 Visit our websites at www.safan.com