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Proper pricing needed to make China's gas push work

Beijing must go beyond stop-gap measures to control pollution and meet demand

| China
China's blanket ban on residential coal use in certain areas and resulting severe gas shortage left many families without legal means to heat their homes.   © Reuters

Families living in northern China are having a difficult winter, and the government's plans for air pollution prevention and control appear to have come unstuck.

A blanket ban on residential coal use and an over-ambitious attempted roll-out of gas-fired boilers has led to a 14% nationwide leap in gas demand and severe shortages. As temperatures fall below already low seasonal norms, many families have been left without sufficient gas or even a gas boiler. The combination with the coal ban, they have been effectively forbidden from heating their homes.

What is more, despite these efforts, air pollution targets remain in danger of being missed. On Dec. 12, the country's second highest pollution alert was sounded for 10 of Hebei Province's industrial cities.

But while over-zealous officials may have pushed through short-term measures without due care, the real story is not one of missed targets: It is one of unintended consequences and of the networked nature of energy systems, which require careful coordination.

Attempts to plug the shortfall with gas diverted from other provinces merely extended shortages south. Curtailing gas usage by non-residential users has, by some measures, affected economic output and led to three-hour waits for compressed natural gas at refueling stations. Relaxing the prohibition on coal burning and restarting some coal-fired power stations subverted the intent of the policies.

It appears that China has neither the gas available nor the infrastructure necessary to handle the necessary volumes. Three main factors have conspired to undermine the policymakers' best intentions: storage, transport and industry expectations.

Peak winter gas demand in China is roughly three and a half times the summer trough. While the U.S. and the European Union have gas storage facilities equal to 20-25% of demand, China's gas storage accounted for only 3% of total consumption at the end of 2016.

There has been prolonged underinvestment in gas storage, in part because of a lack of clarity about how companies would be recompensed for building and operating storage facilities. Incentives are further undermined by flat pricing for gas across the year for most users.

Despite plans for Russian gas imports from the north, China's gas pipelines are not optimized for north-south distribution. The focus behind pipeline construction has been bringing gas from Central Asia to market: Coastal cities are well provided for, but the north much less so.

Local distribution pipeline networks are in many places largely missing. Coastal regasification terminals for liquefied natural gas help, but only partially. Chinese offshore energy producer CNOOC has resorted to trucking 2,000 tons of LNG by road from Guangdong Province to Hebei, 2,400km to the north.

Price remains key

Low international prices and a slowdown in gas demand in 2015 dampened corporate interest in gas exploration and production. Despite gas-promoting policies, the market appears to have underestimated 2017's consumption spike. With few new domestic production projects coming on-stream, the industry has been constrained in boosting production; with limited storage, it has been unable to tap major reserves.

Instead, China has reached out to international LNG markets, pushing prices up and pulling in cargo diversions from suppliers hungry for arbitrage profits. LNG imports surged 43% in 2017, but the country's poor gas infrastructure has hobbled efforts to get the gas to where it is needed.

The three factors have made it difficult for China's gas industry to respond to this winter's cold temperatures. The immediate stop-gap measures and the relaxation of the prohibition on coal burning have helped -- and are clear signs that environmental policy is tempered by sympathy for socioeconomic reality -- but for provinces such as Hebei it has become a game of catch-up as officials juggle with the annual dilemma of warmth versus pollution.

The awkward truth is that, despite a realization that "crude and simple" policies are not always the best, and that outright bans -- of any fuel -- can backfire, China has yet to demonstrate acceptance that until gas is properly valued there will always be a risk of shortages. Whatever the government's social and environmental priorities, both will be undermined if the industry lacks incentives to deliver. The insufficient storage, the patchy distribution pipeline network, the lack of corporate interest; at heart these stem from skewed incentives and pricing.

Yet if Beijing is facing a temporary setback in its environmental agenda, there are no indications that it is surrendering. The country's emission trading scheme, though delayed, is now expected in 2018. A new "polluter-pays" environmental compensation scheme has been announced, to take effect in 2020. Committees have been formed to ensure clean energy for heating in future winters, and to promote expanded gas storage and network infrastructure.

Beijing's response to the crisis has been positive: pragmatic in the short-term with a redoubling of stated long-term environmental goals. But while Beijing has restated its intent to clean up its environmental footprint, to deliver a "beautiful China" and "harmonious society," the question remains whether it will accept the need to continue to reform pricing. In China, as in all countries, a balanced industry comes from the right set of incentives. For now, all eyes will turn to next winter.

Liutong Zhang is a senior manager at the Lantau Group, an energy consultancy in Hong Kong. Leo Lester is a principal at the company.

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