Cefc china energy focus natural gas 2013 (full report) by China Energy Fund Committee

CEFC China Energy Focus Natural Gas 2013

China Energy Fund Committee (CEFC) is a nongovernmental, nonpartisan Chinese think-tank registered in Hong Kong. It has Special Consultative Status with the United Nations Economic and Social Council (UN ECOSOC). With partners and associates in China and overseas, CEFC conducts research and related activities focusing on transnational topics such as energy security, issues relating to Chinaâ&#x20AC;&#x2122;s emerging place in the world, and Chinese culture and thought. CEFC is dedicated to promoting international dialogue and understanding via offices throughout China and the United States.

Published by China Energy Fund Committee Hong Kong Office 34/F, Convention Plaza Office Tower, 1 Harbour Road, Wanchai, Hong Kong, China Tel: (852) 2655 1666 Fax: (852) 2655 1616 E-mail: com@chinaenergyfund.org U.S. Office 25/F, 1100 Wilson Boulevard, Arlington, VA22209, U.S.A Tel: +1-703-260-1828 Fax: +1-703-666-8081 www.chinaenergyfund.org

CEFC China Energy Focus Natural Gas 2013

Editorial Board (编辑委员会) Chairman: YE Jianming (叶简明) Executive Vice Chairman: HO Chi Ping, Patrick (何志平) Vice Chairman: CHAN Chau To (陈秋途) Member: LO Cheung On (路祥安) Editor-in-Chief (主编) HO Chi Ping, Patrick (何志平) Deputy Editor (副主编) LO Cheung On (路祥安) Executive Editors (执行编辑) LIU Yadong (刘亚东) ZHANG Ya (张雅) Guest Editor-in-Chief (客座主编) Edward C. CHOW (周哲予) Guest Editors (客座编辑) CHOW Chuen Ho, Larry (周全浩) CHEN Weidong (陈卫东) Editorial Assistants (编辑助理) WANG Dingli, Leo (王鼎立) LEE Yim, Jeremy (李炘) FONG Yau Kwan, Roger (方友群) CHOW Siu Tong (周肇堂) Clare Richardson-Barlow (鲍珂瑞)

ISSN 2310-8010 © China Energy Fund Committee 2013. All rights reserved. No part of this publication may be reproduced in any form or by any means without the written permission of the publisher. More details about the terms of the use of the report could be referred to: energyfocus2013.cefc.org.hk

Table of Contents 目錄

CEFC China Energy Focus Natural Gas 2013

Table of Contents 目錄

Prologue 前言

Guest Editor’s Note 客座主編語

Acknowledgment 鳴謝

P10

Executive Summary 執行摘要

P12

Part One: CEFC Survey Article on Natural Gas Development in China and its 12th Five-year Plan 上篇： CEFC中國天然氣發展及十二五規劃調查報告

P16

Methodology 調查方法

P17

List of Interlocutors 受訪專家資料

P18

Section One: Natural gas consumption in China 中國天然氣消費

P20

Section Two: Natural gas production in China 中國天然氣生產

P28

Section Three: Natural gas imports in China 中國天然氣進口

P38

CEFC China Energy Focus Natural Gas 2013

Table of Contents 目錄

Section Four: Natural gas pricing in China 中國天然氣定價

P43

Section Five: An outlook for natural gas development in China 中國天然氣發展展望

P50

Summary: 調查觀點總結

P54

Part Two: Perspectives on China’s Natural Gas Development 下篇：中國專家觀點文章

P56

The New Changes in the World’s Energy Structure: Impact on China’s Energy Security 世界能源格局的新變化及其對中國能源安全的影響 P57 By WANG Haiyun (王海運) The Supply Situation and Outlook of Natural Gas in China 中國天然氣供應形勢與發展 By ZHANG Kang (張抗)

P72

Natural Gas Production Outlook in China Before 2020 2020年前中國天然氣生產展望 By XU Bo (徐博)

P84

The Path to Shale Gas Development in China and the United States--a comparative study 中美頁岩氣發展路徑比較研究 P100 By ZHU Kai (朱凱) Will the “Oil and Gas Revolution” Pass China By? “油氣革命”與中國擦肩而過？ By Jonathan, CHANIS (喬納森．強尼斯)

P113

Reform’s Key Role in China’s Shale Oil and Gas Development --a Commentary on Jonathan Chanis’article “Will the ‘Oil and Gas Revolution’ Pass China by?” 改革是頁岩油氣發展的關鍵——評 “ ‘油氣革命’ 與中國擦肩而過？” P116 By ZHANG Kang (張抗) 4

Table of Contents 目錄

CEFC China Energy Focus Natural Gas 2013

Prospects for Unconventional Gas Development in China: a Summary of the 2012 Global Unconventional Gas Summit 中國非常規天然氣發展前景：2012全球非常規天然氣峰會總結 P120 By Beijing Energy Club (北京能源專家俱樂部) China’s Natural Gas Imports 天然氣進口縱橫談 By CHOW Chuen-ho, Larry (周全浩)

P128

A Socio-economic Introduction to Natural Gas Extraction in China: Actors, Networks and Institutions 中國天然氣開發的社會經濟角度介紹：行為主體，網路及制度 P146 By LEUNG Chun-kai, Guy (梁俊佳) New Changes in the LNG Market: Will U.S. Export of LNG Influence the LNG Market Price in Asia? LNG市場新變化：美國LNG出口是否會對亞洲LNG市場價格產生影響 By ZHANG Meng (張萌)

P159

Natural Gas Pricing Mechanism Evolution in China 中國天然氣價格形成機制的演變 By LIU Yijun (劉毅軍)

P165

Prospects for Natural Gas Development and Energy Transformation in China 展望中國未來天然氣發展及能源轉型 By CHEN Weidong (陳衛東）

P173

CEFC China Energy Focus Natural Gas 2013

Prologue 前言

Dr. HO Chi-ping, Patrick (何志平) Editor-in-Chief Deputy Chairman and Secretary General of China Energy Fund Committee

Fueling China’s Future: Hot Air or Hot Gas? Fueled by the U.S. shale boom and the promise of a green economy in China’s 12th Five-year Plan, natural gas, a highly efficient thermal fossil fuel source with much lower greenhouse gas emissions, emerges as a hot topic and the epicenter of the changing energy landscape, creating new opportunities and challenges for governments as well as multinational energy corporations. Natural gas appears to be a most feasible and accessible option to aid in resolving China’s energy dilemma. However, considering the relatively high cost of natural gas it remains uncertain whether China’s industrial and residential users could afford the rise in energy cost. On the other hand, despite the exponential growth of United States’ shale gas production in recent years, the prospects for developing unconventional gas production in China appear meek. Noting the opportunities and challenges in China’s energy strategy of substituting coal with gas, the China Energy Fund Committee (CEFC), a Chinese think tank anchored in Hong Kong, with special consultative status with the United Nations Economic and Social Council (ECOSOC), now presents this report to introduce to a wider audience the outlook for natural gas development in China and its progress to date. This publication, which compiles the opinions and arguments of leading Chinese experts in English, aims to foster the exchange of views between Chinese energy researchers and their foreign counterparts. By introducing China’s natural gas industry and market conditions to foreign energy industry professionals and investors, this report also makes available firsthand information on the growing foreign investment opportunities in China’s gas industry. The report consists of two main sections. The first is a summary of the views and opinions of China’s leading energy experts collected and collated by us in a detail survey carried out in September 2013. The second part contains a series of articles written by Chinese scholars and experts who provide their analyses from multiple perspectives. Both sections of the report cover the five major aspects of natural gas development in China: consumption, production, imports, 6

Prologue 前言

CEFC China Energy Focus Natural Gas 2013

pricing system and an outlook for its near-term development. This report confirms China’s earnestness in substituting coal with natural gas, a much cleaner and efficient fuel, in her energy consumption profile mainly through increased domestic production of conventional natural gas and importation. Development of unconventional natural gas in China had just merely begun in the midst of a multitude of challenges which are yet to be resolved. Some of the more notable elements quoted as unconducive to rapid development of unconventional gas production included the dominance of state enterprises in the upstream energy market, difficulties with exploration right acquisition, gas pricing system, and electricity pricing system. With China’s commitment to increase natural gas consumption, and the radical reform of the gas pricing system implemented most recently to replace the old cost-based approach, in addition to the re-confirmation of the overall open market approach of its economy by China’s Third Plenum this November, we consider China’s natural gas development has ample room to grow in the near future, and offers golden and attractive opportunities to investors, entrepreneurs, collaborators, and keen professionals. Our findings will be released in a press conference in Washington D.C., USA, on December 16, 2013, and during a luncheon forum in New York City, USA on December 17, 2013. Professionals, scholars, media and industrialists will be invited to attend the two sessions to receive the report’s key findings and participate in discussions with leading energy experts from China. These two events together augurs a landmark occasion which signifies the first time ever that a Chinese think tank organizes a release of its own report on China’s energy development to the American public in the United States.

CEFC China Energy Focus Natural Gas 2013

Guest Editor’s Note 客座主編語

Mr. Edward C. Chow (周哲予) Guest Editor-in-Chief Senior Fellow, Energy and National Security Program, Center for Strategic and International Studies (CSIS)

The Future of Natural Gas in China – Why the World Cares

Thirty-five years ago China embarked on a new policy path of “Reform and Opening Up.” One cannot but marvel at the tremendous economic progress which has been made since, as well as at the pace and scale of change experienced by Chinese society. Some time this decade China will become the world’s largest economy; it is already the world’s largest energy consumer (and consequently its largest greenhouse gas emitter); and China will almost certainly surpass the United States as the world’s largest oil importer in 2014. What happens to energy in China matters very much to global markets, as we have already witnessed with oil and other commodities. At the same time, as China climbs the income ladder, its population increasingly demands better quality of life after basic necessities are met. Chinese citizens (and therefore their leaders) will no longer tolerate the sort of environmental degradation the previous development path has wrought, particularly in air and water pollution. This is why the future of the natural gas industry in China is an important topic for both the country and the world. Today natural gas is severely under-represented at 4% of China’s energy. Yet it provides the best option for a cleaner fuel to satisfy increasing energy demand, without further reliance on coal and before clean renewable alternatives can be available at sufficient quantities. However, unless China can produce significantly more natural gas from conventional and unconventional sources, rapidly hiking the share of natural gas in the energy mix (as is planned) may repeat the experience of oil with great leaps in import demand for gas, which can disrupt international markets as well as raise energy security and cost concerns for China itself. There is a lot of international interest in the future of natural gas in China that goes beyond estimates of technically recoverable reserves, which appear to be abundant particularly for shale gas. Unfortunately, most foreign researchers do not have good access to Chinese data and, even when they do, may not interpret them accurately given the vagaries of national statistics. Therefore, the China Energy Fund Committee has contributed mightily by commissioning a survey of Chinese expert opinion on natural gas and compiling articles written by well-respected Chinese scholars, researchers, and energy industry practitioners, having them translated into English from the original Chinese, and making them available to enhance international understanding of issues related to the future of natural gas in China. It was my distinct privilege and pleasure to have reviewed these articles and participated in their editing. I take this opportunity to offer some personal observations gleaned from the articles before encouraging you to read all of them carefully for the insights they provide. First of all, one is struck by how thoroughly Chinese scholars understand their internal situation and are willing to discuss it, including all the deficiencies in the Chinese system that can be significant barriers to achieving targeted domestic production levels and optimal utilization of natural gas. From seemingly

Guest Editor’s Note 客座主編語

CEFC China Energy Focus Natural Gas 2013

minute details – illogical classification of unconventional gas and other statistical definitions that inhibit both central planning and a functioning market – to broader and more difficult issues: • Reform of gas pricing from a complicated cost-plus system, including cross-subsidization; • State-owned enterprises exercising monopoly power; • Overlapping mineral rights; • Limited access to exploration acreage for domestic and foreign private capital; • Unbundling petroleum service contractors from the major Chinese oil companies to gain efficiency; • Fair access to critical infrastructure and direct access to consumers, etc. they were all well covered. The critical need to introduce more competition into the natural gas sector was reiterated by our authors. Although these papers were written long before the recently concluded Third Plenum of the 18th Congress of the Chinese Communist Party, they resonate with its call for the market [or market forces] to play a “decisive role” in the allocation of resources. This apparent consensus between the expert community and policymakers in China explains perhaps my second observation, which is the overall sense of optimism and confidence from our authors that China will realize its goals for increasing domestic natural gas production from unconventional sources and utilize a lot more natural gas, particularly in power generation, in spite of the numerous obstacles that they delineated which will not be overcome easily. Thirdly, Chinese experts recognize very well that the conditions that gave rise to the American shale gas revolution, i.e., mineral rights for private landowners, deregulated pricing, small to medium-size exploration and production companies and service contractors, regulations governing the natural gas industry developed over decades, well-defined division between state and federal authorities, industry access to investment capital, etc., are very different from China’s current circumstances. Consequently, China will need to adapt the lessons learned from the American experience and adjust them to fit Chinese conditions. Chinese pragmatism, “crossing the river by feeling the stones,” is so central to the entire reform process and will serve China well in succeeding in shale gas with “Chinese characteristics.” The demonstration effect of foreign investment can serve a useful purpose that goes along with the provision of capital and technology, which is why “opening up” must accompany reform. Incidentally, this pragmatic approach is not so different from the American experience of constant experimentation and refinement of techniques applicable to different shale plays, driving down costs to remain profitable even when prices decline with abundant supply, and shifting to tight oil or liquids-rich plays. The entrepreneurial spirit, nimbleness and cost-consciousness required are reasons why small to medium-size companies appear to be more successful than large companies or organizations in shale operations. My last observation on these papers is that it was striking how little concern there was over the level of Chinese natural gas imports. The authors seem to agree that the planned increases in pipeline and liquefied natural gas (LNG) import capacity will be needed through 2020, but after that increased domestic production from unconventional sources will mostly take care of China’s future gas needs. There was little consternation over the reliability of gas import sources, unlike a similar discussion in Europe or Japan. Imports from specific countries, such as Russia, were hardly mentioned. To the extent that gas supply security was discussed, it was over security of maritime supply routes more than insecurity of import sources. It seems our authors have great faith that most of the policy recommendations they made to advance the domestic natural gas industry will be implemented during the 13th Five Year Plan period from 2015 to 2020. Given China’s track record since 1978 of executing economic policies and adjusting them as necessary, foreign observers like me are in no position to question this faith and indeed should wish China well, as the consequences of success or failure would be so important to China and the global community. We will certainly be watching closely and with deep interest. 9

CEFC China Energy Focus Natural Gas 2013

Acknowledgment 鳴謝

This report serves to introduce the latest natural gas development in China to overseas audience. It was prepared by the Hong Kong Office of the China Energy Fund Committee, under the direction of our Secretary General, Dr. Patrick, HO Chi-ping (何志平), as Editor-in chief. The contents and materials have been duly examined by our Guest Editor-in-chief, Mr. Edward C. CHOW (周哲予), Senior Fellow of the Center for Strategic and International Studies (CSIS). We are also grateful to the professional advice provided by Professor Larry, CHOW Chuen-ho ( 周全浩), Director of the Hong Kong Energy Study Center, Hong Kong Baptist University, and Mr. CHEN Weidong (陳衛東), Chief Energy Analyst of the Energy Economic Research Institute, China National Offshore Oil Corporation (CNOOC) as guest editors of the report; both Mr. Chow and Mr. Chen are also key contributors to the report. As a publication intended to convey the Chinese views to the world, we must also thank all the Chinese experts who share with us their most candid and insightful views by granting telephone interviews and/or contributing their articles. Without their effort, this report would not have been possible. The individuals and institutional contributors from China are: Maj. Gen. WANG Haiyun (王海運), Senior Adviser to China Institute for International Strategic Studies and former Chinese defense attache to Russia; Mr. ZHANG Kang (張抗), Deputy Director of the Consultant Committee of the Exploration and Production Research Institute (EPRI) , China Petrochemical Corporation (Sinopec); Mr. XU Bo (徐博), Senior Economist at the Economics and Technology Research Institute, China National Petroleum Corporation (CNPC); Mr. ZHU Kai (朱凱), Researcher at the Energy Economics Institute (Office for Policy Research) of the China National Offshore Oil Corporation (CNOOC); Beijing Energy Club (北京能源專家俱樂部), a non-governmental, not-for-profit, high-level expert group in Beijing; Prof. CHOW Chuen-ho, Larry (周全浩), Director of the Hong Kong Energy Studies Centre and visiting professor at the Department of Geography, Hong Kong Baptist University; 10

Acknowledgment 鳴謝

CEFC China Energy Focus Natural Gas 2013

Mr. LEUNG Chun-kai, Guy (梁俊佳), Doctoral Researcher, Geography Department, Durham University, UK; Mr. ZHANG Meng (張萌), Researcher and Head of the Energy Division of the Research Institute of China Business News (CBN); Prof. LIU Yijun (劉毅軍), professor at the China University of Petroleum (Beijing) and Deputy Director of China Oil and Gas Industry Development Research Center; Mr. CHEN Weidong (陳衛東), Senior Economist and Chief Energy Analyst of the Energy Economic Research Institute, CNOOC; Mr. LIU Wenlong (劉文龍), Senior Consultant for the China Energy Fund Committee and former Chief Economist/Assistant General Manager of Sinopec; We would thank in particular Prof. Jonathan A. CHANIS, adjunct professor at the School of International and Public Affairs, Columbia University, who provided us a stimulating U.S. perspective on whether the next oil and gas revolution will pass China by. His thoughtful ideas have caused equally inspiring response from Mr. ZHANG Kang, who contributed a direct response to Prof. Chanis’s arguments. We would also like to thank Dr. Xavier CHEN Xinhua (陳新華), President of the Beijing Energy Club (BEC), for facilitating us to translate a chapter of BEC’s 2012 annual report on unconventional gas development in China. The chapter has been duly incorporated into this Report with kind permission of BEC. We also owes particular thanks to Ms. YANG Chaohong, Chief Editor of the International Petroleum Economics and the China LNG magazine for their kind support in giving us access to their networks with energy scholars in China. We need to acknowledge our appreciation for the editorial support from Ms. Connell Mary Ellen (US), Ms. Clare Richardson-Barlow (US) and Mr. James Fong (Hong Kong), who all spent countless hours on the English editing work. We also thank the voluntary translators from Colombia University and other U.S. institutes. Last but not least, the entire project has been closely attended by our staff officer, Mr. Leo D.L. Wang (王鼎立), whose commitment and dedication is much appreciated. Andrew C. O. LO (路祥安) Deputy Secretary General China Energy Fund Committee for and on behalf of

the Editorial Board

CEFC China Energy Focus Natural Gas 2013

Executive Summary 執行摘要

Background: Coal and oil has fueled China’s economic success over the past thirty years. Energy generated from coal and oil enabled China to achieve double-digit economic growth rates for more than a decade but has also left the country with worsening environmental problems such as air pollution, water contamination, and the low energy efficiency of its coal-dominated energy structure. Faced with its worst-ever air quality and rising public demand for cleaner and more efficient sources of energy, China is now striving to reduce its dependence on coal and mitigate the severe environmental costs caused by the imbalance in the country’s energy mix. Since the alarming levels of smog appeared in Northern China in early 2013, both policy makers and the general public are seized with a sense of urgency that China must shift its energy consumption and reduce reliance on coal. As a result, natural gas, a highly efficient thermal fossil fuel source with much lower green house gas emissions (GHS), emerges as a central theme of the country’s 12th Five-year Plan for energy development. Natural gas, with which China is potentially richly endowed, is regarded as the most feasible and accessible option to aid in resolving China’s energy dilemma, particularly as renewable energy is still in its nascent stage of development and there is concern about the safety of nuclear energy following the Fukushima melt-down. According to the “12th Five-year Plan for Natural Gas Development” issued by the National Development and Reform Commission (NDRC) and the “12th Five-year Plan for Energy Development” issued by the State Council, the share of natural gas in China’s total primary energy consumption mix will rise from the current 4.4% to 7.5% by the year 2015 with the total consumption volume reaching 230 billion cubic meters (bcm). Total gas production will rise from its 2010 level of 94.8 bcm to 176 bcm and the installed power capacity of natural gas power plants is expected to climb from 26 Gigawatt (GW) in 2010 to 56 GW over the same period. Population with access to natural gas will also be increased from 188 million to 250 million. Massive gas transmission pipeline projects and liquefied natural gas (LNG) receiving terminals will also be constructed and new plans and favorable policies for gas production and consumption will be implemented. To substitute coal with gas is becoming a nationally acknowledged theme for the energy industries in China. However, despite government support and the public’s willingness to promote the use of natural gas, difficulties still remain which impede gas consumption in China. The country was the largest coal consumer and the second largest oil consumer of the world in 2012. These two fossil fuel sources still accounted for over 66 per cent and 19 per cent respectively of China’s primary energy consumption. To reverse the dominant position of coal in the near future is unlikely, if not impossible. 12

Executive Summary 執行摘要

CEFC China Energy Focus Natural Gas 2013

Furthermore, considering the relatively high cost of natural gas in both China’s domestic market and the global gas market, it remains uncertain whether China’s industrial and residential users could afford the inevitable rise in energy cost which would occur if more natural gas were to be included in the national energy mix. Also, China’s development goal for the unconventional gas sources such as shale gas and coal-bed methane (CBM) by 2015 will need careful study in view of the less than satisfactory progress made in geological surveying, pipeline network development, and domestic gas price reforms. All the above factors add to the uncertainty regarding increased use of natural gas in China in the near term. Noting the opportunities and challenges in China’s energy strategy of substituting coal with gas, the China Energy Fund Committee (CEFC), a Chinese think tank enjoying special consultative status with the United Nations Economic and Social Council (ECOSOC), decided to present this report to introduce to a wider audience the prospects for natural gas development in China and its progress to date. This publication, which syntheses the opinions and arguments of leading Chinese experts and makes them available in English, is intended to foster the exchange of views between Chinese energy researchers and their foreign counterparts. The publication also introduces China’s natural gas industry and market to foreign energy industry professionals and investors and provides information for investors to aid decision-making on issues related to the Chinese gas market. In addition, the study makes available to the United States energy business sector firsthand information on the growing foreign investment opportunities in China’s gas industry. The volume contains two main parts. The first is a summary of the views and opinions of China’s leading energy experts collected by CEFC in a survey carried out in September 2013. The second part consists of a series of articles written by Chinese scholars and experts who provide their analyses from multiple perspectives. Both sections of the study cover the five major aspects of natural gas development in China: consumption, production, imports, pricing system and an outlook for its near-term development

Summary of Key Findings: 1. Timing is right for natural gas development in China. The future development of China’s economy is being obstructed by the dual impact of worsening environmental conditions and a tight resource base. How to transform its inefficient and highly polluting energy pattern to a more sustainable form will be critically important for the China’s long-term interest. The Chinese government is expected to unfold a new round of urbanization planning in order to promote its urbanization rate further to 60% by 2020; at the same time, China’s total energy demand is likely to keep a rapid growth rate due to the potential energy demand increase from its enlarged urban population. Natural gas, as a highly efficient thermal fossil fuel source with much lower green house gas emissions (GHS), will emerge as a most feasible and accessible option to aid in resolving China’s energy dilemma. 2. The 2015 goal of promoting natural gas consumption to 230 bcm is largely attainable 13

CEFC China Energy Focus Natural Gas 2013

Executive Summary 執行摘要

under the current policy scenario and may even be exceeded. Referring to the historical data of consumption growth, and in view of China’s potential GDP growth rate, natural gas consumption could reach as high as 242 bcm by 2015. However, as a coal-rich country where 70% of primary energy consumption comes from coal, the share of natural gas in China’s energy mix is unlikely to exceed 15%. 3. The 2015 production goal of increasing total natural gas production to 176 bcm is likely to be fulfilled and conventional gas will continue to be the major contributor to domestic gas supply. Assuming an 8% annual growth rate, total conventional gas production in China can be expected to reach as high as 134 bcm in 2015 and near 200 bcm in 2020. According to the experts polled by CEFC, by 2030, with the potential of an additional 10 tcm of proven gas reserves, conventional gas production in China will peak at 240 to 280 bcm. 4. The unconventional gas production goals are more uncertain. China’s unconventional gas reserves, a massive resource base, offer a bright prospect in the long term. However, challenges such as exploration rights acquisition, geological survey, pipeline infrastructure, drilling and exploration technologies and even accurate statistics for commercial supply clouds the future of China’s unconventional gas development. Whether the national plan of having 6.5 bcm shale gas output and 16 bcm coal-bed methane (CBM) surface extraction by 2015 can be achieved still remains highly uncertain in the view of the experts interviewed. Further achievements in unconventional gas development will require more state-of-art drilling technologies, pipeline network development, and a market-oriented approach for gas pricing and development rights. 5. More competitions should be allowed in natural gas production in China. With reference to the U.S. experiences, it was commonly agreed by the interviewed experts that monopoly of upstream gas production would not be beneficial for the long-term development of the industry in China. The vertically integrated state firms may have an edge in technologies, capital strength and exploration experiences now, but considering the long-term interest of the industry, more competitors in the market will be a prerequisite for a continual improvement in production efficiency. 6. Gas imports will continue to grow due to the increased capacity in Liquefied Natural Gas (LNG) receiving terminals and import pipeline expansions. China’s LNG terminal receiving capacity is likely to reach 40 million tons per annum while the land pipeline capacity is likely to total 67 bcm per annum. As most of the infrastructure will be completed in the next few years, further increase in the total gas import volume will become possible. Considering the domestic gas supply and demand growth potential, the total import volume in China is likely to be 93.8 bcm by 2015, close to the number projected in the nation’s 12th Five-year Plan. 7. Radical reform of the gas pricing system is being implemented in China to replace the old cost-based approach. In July 2013, the old cost-plus pricing approach was replaced by a new pricing mechanism in China that divides national gas prices into two tiers. Prices for the first tier is based on the 2012 real consumption volume of 112 bcm, under which the ceiling city-gate prices will be increased by no more than Chinese Yuan 0.4/cbm and price negotiation will be allowed under this 14

Executive Summary 執行摘要

CEFC China Energy Focus Natural Gas 2013

cap. The second tier will be for any excess gas consumption above the 2012 level, and the prices will be linked by heating values to fuel oil and liquefied petroleum gas (LPG) prices (with 60% and 40% weighting respectively) with a 15% discount to ensure a price advantage for natural gas. The approach for the second tier gas prices is also called a net-back approach. Under the new pricing mechanism, the pressure on the major gas importers in China can be expected to be relieved. 8. Gas price reform must be synchronized with electricity price reform. Most of the experts consulted by CEFC agreed that gas price reform will not be successfully achieved without also adopting an electricity price reform that accommodates the differing fuel costs of various power plants. The current price gap between the generation cost and the on-grid tariff in China is unaffordable for gas-fired plant operators. If the government were to promote the share of gas-fired plants in its power system, a market oriented on-grid tariff system will be urgently needed.

Concluding Remarks: The importance of natural gas to China’s future energy scenario can hardly be exaggerated. As the largest energy consumer with an astonishing high level of GHS emission, China is desperately in need to enlarge the share of natural gas and other clean energies to optimize its polluting and unsustainable energy profile. Under the current policy scenario, most of the objectives outlined in China’s 12th Five-year Plan for natural gas development could be expected to be accomplished in a timely manner. But the unconventional gas development, particularly shale gas development in China, due to a confluence of factors including the geological surveying progress and the limited scale of production, are still in an experimental stage. As the report findings indicate, the future success of China’s natural gas industry will depend on the reform of currently monopolized upstream gas market and the domestic gas pricing mechanism. Certain tax issues pertaining to natural gas and other natural resources will also need to be solved. Given China’s rapid gas consumption growth and the government’s determination to promote the share of clean energy in its energy mix, a golden era for natural gas development in China is emerging. Domestic gas producers are witnessing the dawn of a new gas era on their homeland. Foreign investors will also find their opportunities in the massive and inclusive gas market in China with favorable conditions confirmed in several recent government documents. Though difficulties will continually exist in the fields of geological surveying, exploration technologies and high gas development costs, substituting gas for coal will persist as a central theme for China’s energy industry at least in the near term future. As domestic gas market is likely to continue its rapid growth, natural gas is likely to be the next fueling energy to propel the Chinese economy to reach a more sustainable and prosperous end.

CEFC China Energy Focus Natural Gas 2013

Part One: CEFC Survey Article on Natural Gas Development in China and its 12th Five-year Plan 上篇：CEFC中國天然氣發展及“十二五”規劃調查報告

Part One:

CEFC Survey Article on Natural Gas Development in China and its 12th Five-year Plan 上篇：

CEFC中國天然氣發展及 “十二五”規劃調查報告

Methodology: 調查方法：

CEFC China Energy Focus Natural Gas 2013

Methodology: 調查方法：

This article is based on the interviews conducted with six distinguished energy experts in China from various sectors and industries. The views and opinions presented in this report are based on the experts’ responses and comments to a questionnaire prepared by the China Energy Fund Committee (CEFC) obtained during the period September 9-September 23, 2013 via telephone interviews and written replies. The questionnaire contained 30 questions and also provided the experts with relevant graphs and tables. The telephone interviews lasted between 1 hour and 1.5 hours and were conducted in Chinese. Based on the transcription of the audio records from these interviews, this report summarizes and synthesizes the opinions and views collected from Chinese experts for the benefit of those outside of the country interested in the future of natural gas development in China. This report also includes the latest market news and government issued data, which were not available prior to the interviews, in order to provide additional context. The biographies of the interviewed experts are listed below. Many of them are also guest contributors to this publication. Questions pertaining to each section have also been listed at the beginning of each section.

CEFC China Energy Focus Natural Gas 2013

List of Interlocutors 受訪專家資料

(In alphabetical order by surname )

Prof. CHOW Chuen-ho, Larry (周全浩) was a professor of Geography at Hong Kong Baptist University from 1976 to 2012 and a visiting professor from 2012 onwards. He established the Hong Kong Energy Studies Centre at the University in 1998 and has served as the Centre Director till now. He published numerous scholarly articles in international journals like Energy Policy, OPEC Review, China Quarterly and Economic Bulletin for Asia and Pacific, in addition to writing a large number of book chapters, book reviews and opinion pieces in popular magazines and newspapers. He is also a member of the international editorial board of Energy Policy and served on the editorial board of Energy Sources. He obtained his Ph.D. from the University of Kansas, U.S.A.

Mr. CHEN Weidong（陳衛東）is a senior economist and the chief energy analyst of the Energy Economic Research Institute, China National Offshore Oil Corporation (CNOOC). He also served as the executive vice-president and chief strategic officer of China Oilfield Services Limited (COSL). He has over 31 years experience in China’s oil and gas industries and has received multiple awards. He is also an Honorary Researcher at the Chinese Academy of Social Sciences.

Mr. LIU Wenlong（劉文龍）served as a Chief Economist/Assistant General Manager of Sinopec, as well as a Distinguished Expert of the Sinopec Science and Technology Committee. He has extensive planning and leadership experience in the energy sector and is a key player in the Corporation’s Sino-foreign jointventure negotiations. He graduated from Beijing Petroleum University with a Master’s degree in Refinery Engineering. He is also a graduate of the China University of Petroleum. He is currently a senior consultant for the China Energy Fund Committee.

List of Interlocutors 受訪專家資料

CEFC China Energy Focus Natural Gas 2013

Prof. LIU Yijun（劉毅軍）is a professor at China University of Petroleum (Beijing) and the deputy director of China Oil and Gas Industry Development Research Center. His research focuses on the economics and risks of the natural gas industry chain and has published over 50 academic papers in China. He also published several books themed on natural gas industry chain in China, including the “Research on the Downstream Market Risks of the Natural Gas Industry Chain (Chinese)” and “Risk Research on Upstream Development Plan of Natural Gas Industry Chain (Chinese)”. He holds a PhD from China University of Mining and Technology (Beijing).

Mr. XU Bo（徐博）is a senior economist at the Economics and Technology Research Institute, China National Petroleum Corporation (CNPC). His research area focuses on the supply and demand interplay of natural gas in China and overseas markets, natural gas price formulation and policy studies. He has been engaged in and presided over more than 20 research projects at national and corporate levels in China and has published over 30 academic papers. He also translated more than one million words of foreign research literature on natural gas into Chinese. XU Bo holds a Master’s degree in Economics.

Mr. ZHANG Kang（張抗）is the deputy director of the Consultant Committee of the Exploration and Production Research Institute (EPRI) of Sinopec. Until his retirement, he formerly served as the chief engineer of the Institute. His major research works include: “the Life Cycle of Oil and Gas Fields and Tactics and Strategy to Succeed (Chinese)”, “Strategies for China’s Oil and Gas Development (Chinese)” and “The Geopolitical Aspect of Oil and Gas of China and the World (Chinese)”. He graduated from the Department of Geology, Peking University in 1963 and earned a Master’s degree from the Chinese Academy of Sciences in 1981.

CEFC China Energy Focus Natural Gas 2013

Section One: Natural Gas Consumption in China 第一部分：中國天然氣消費

Section One: 第一部分：

Natural Gas Consumption in China 中國天然氣消費

Consultation questions: Q1. In 2012, the Chinese government announced its 12th Five-year Plan for Natural Gas Development. Do you think the goals outlined by the Chinese government are attainable? Q2. If Beijing were to achieve these targets, what measures will be urgently needed? Q3. If the above targets are achieved, will they affect the overall energy structure of China and shift its national energy supply from largely coal-based to a more diversified one? Q4. What are the looming barriers that may prevent the Chinese government from attaining its goal for natural gas development, particularly for consumption? Q5. Currently, 37% of China’s natural gas consumption is utilized in industrial production (chemicals), 30% in residential usage, and only 17% in power and heat generation, while in the U.S., power generation accounted for more than 36% of its total consumption. What comment do you have regarding such difference in the natural gas consumption pattern in the two countries? Will a wider use of natural gas in the power sectors help China to achieve its energy goal of promoting efficiency and reducing waste emissions? Q6. The majority of energy consumption in China takes place in the eastern coastal provinces and cities while the majority of natural gas production sites are based in western provinces such as Xinjiang and Sichuan. Please comment on the potential difficulties China faces with such a geographical mismatch of the production centers and consumption centers. How can it be resolved? Q7. As China’s 12th Five-year Plan for Energy Development is reaching the halfway point and the next five-year plan is to be formulated soon, what do you anticipate will be the role of natural gas in the next five-year plan for 2015 to 2020?

Responses and opinions: According to China’s 12th Five-year Plan, the share of natural gas in China’s total primary energy consumption mix will rise from the current 4% to 7.5% by the year 2015. Total gas production will rise from its 2010 level of 94.8 billion cubic meters (bcm) to 156.5 bcm and the installed power capacity of natural gas power plants will be expected to climb from 26 Gigawatt (GW) in 2010 to 56 GW over the same period. The Chinese population with access to natural gas will also grow from 180 million to 250 million. More details of the state plan can be found in Table 1.1 20

CEFC China Energy Focus Natural Gas 2013

Section One: Natural Gas Consumption in China 第一部分：中國天然氣消費

Table 1.1. Natural gas development in China under the 12th Five-year Plan Items

2010 Level

2015 Targets

Proven Natural Gas Reserves

9.13 trillion cubic meters (tcm);

To explore 3.5 tcm additional conventional reserves; To explore 1 tcm more coal-bed methane reserves; To have 600 bcm proven reserves of shale gas;

Coal-bed methane reserves totaled at 273 bcm; Total Natural Gas Demand

107.5 bcm

230 bcm

Domestic Gas Production

94.8 bcm (of which 9 bcm from coal-bed methane).

176 bcm, of which 138.5 bcm conventional, 15-18 bcm coal gasification, 16 bcm coal-bed methane, 6.5 bcm shale gas.

Natural Gas Imports

17 bcm

93.5 bcm

Population With Access To Gas

188 million, 14% of the total population

250 million, 18% of the total population

Installed Capacity of Natural Gas Power Plants

26.4 Gigawatt (GW)

56 GW

Gas Pipelines

Trunk line length 40 thousand kilometers (km)

To add 44 thousand km pipelines to its current length; Transmission capacity to grow by 15 bcm annually;

Underground Gas Storage Capacity

1.8 bcm

To add 22 bcm capacity

CEFC China Energy Focus Natural Gas 2013

Section One: Natural Gas Consumption in China 第一部分：中國天然氣消費

Six Driving Forces for Growth in Natural Gas Consumption

In the view of the experts interviewed, six critical factors constitute the major driving forces behind the promotion of natural gas development in China: 1. Domestic environmental pressure: the hazardous air pollution and the smog in Beijing and elsewhere in early 2013 once again proved the urgency for China to use cleaner energy sources. Increasing the share of natural gas in China’s energy mix, as well as the capacity of the gas-fired plants, are widely agreed as critical measures to reduce particulate matter levels and sulfur dioxide emissions in the near-term. 2. Low-carbon economy has become an international priority. China has made international commitments to lower carbon intensity by 40-45% from the 2005 level by 2020 and to improve per unit GDP energy-efficiency by 16% from the 2010 level by 2015. Natural gas, as a cleaner and more efficient source of energy (especially considering the higher thermal efficiency of gas-fired power than coal-fired power), can help China fulfill its pledge to the global community. 3. Development of unconventional gas: although China has limited natural gas reserves, its unconventional gas resources appear to be significant and can possibly address the issue of insufficient domestic supply. 4. Gas import infrastructure built in recent years (liquefied natural gas receiving terminals and pipelines) makes it possible for China to expand gas import volume. In particular, imported gas will supply increasing demand in urban areas. 5. Energy security: China has been seeking ways to alleviate pressure caused by energy security issues since it became an oil importer in 1993. Using more gas to replace coal and oil will help diversify its energy mix while balancing the tension between using cheap coal and an increasing need for cleaner fuel. 6. Uncertainty in clean energy sources: as the reliability of nuclear power came into question after the Fukushima nuclear crisis, natural gas has become a more attractive solution for building a lowcarbon economy until such a time as renewable energy sources become commercially viable for mass application. Natural gas is therefore regarded as a bridging fuel between the post-oil era and the prerenewable era.

Projection of China’s Natural Gas Consumption in 2015: An Attainable Target but Further Expansion is Less Feasible

The 12th Five-year Plan projects that by 2015 natural gas consumption will reach 230 bcm and population with access to natural gas in urban areas will reach 250 million (approximately 18% of the total population). The 230 bcm forecast is based on estimates of achievable domestic production and imports. By assuming the annual gas consumption growth rate at 16% and looking at China’s potential GDP growth rate, some experts speculate that, based on the current policy scenario, natural gas consumption in 2015 could reach as high as 242 bcm.

Section One: Natural Gas Consumption in China 第一部分：中國天然氣消費

CEFC China Energy Focus Natural Gas 2013

While expressing optimism regarding the 2015 consumption goal, most of the experts interviewed are skeptical about the further expansion of gas consumption. Due to China’s limited gas resource endowment, it is not likely that the share of natural gas in China’s energy mix could reach the world average level of 22%. As a coal-rich country where 70% of primary energy consumption comes from coal, these experts believe that China will continue to rely on coal for the foreseeable future, with any reversal of this reliance unlikely in the near-term. Even with the national policy to substitute gas for coal, the experts believe that coal consumption will still account for two-thirds of China’ primary energy consumption in 2015 and do not expect its share to decline by more than 3%. In addition to resource endowment issues, other experts maintain that the lower cost of coal creates a price advantage over natural gas. The severe recession in Europe combined with the lower carbon and coal costs have resulted in a substantial increase in coal consumption. Some of the experts interviewed believe that a country enters the “age of petroleum” when the share of oil and gas exceeds 50% of its energy mix. China’s oil and gas consumption is still far from reaching that point. Some experts contend that China should acknowledge that its economy cannot yet afford expensive but clean energy sources to provide the majority of its supply. An evident contrast is Japan; while Japan possesses few natural resources, its economy is strong enough to afford the high cost of natural gas.

Natural Gas Consumption Pattern: Higher Transportation Use than the World Average

According to the 2012 data presented in the “China Energy Development Report 2013”, more than 36 % of natural gas consumption was in the industrial sector; 17.22% in chemical industries; 29.63% in the residential sector, which grew significantly from 17.6% in 2000; and 16.92% went into power generation, which grew even more dramatically from only 4.1% in 2000. (Figure 1.1) Figure 1.1: Natural gas consumption by sectors in China 2000 and 2012 Source: data for China from China Energy Development Report 2013 by China Energy Research Society; data for the US from the Energy Information Administration;

CEFC China Energy Focus Natural Gas 2013

Section One: Natural Gas Consumption in China 第一部分：中國天然氣消費

The relatively high share of natural gas consumption in the transportation sector in China is worth noting. In 2012, 12.7% of natural gas consumption went into the transportation sector, higher than the world average of 5.1% (Figure 1.2).1. Experts predicted that vehicles using Liquefied Natural Gas (LNG) and Compressed Natural Gas (CNG) will continue to drive natural gas consumption in the transportation sector. It is also expected that as more Chinese municipal governments begin to realize the importance of air quality improvement, natural gas powered vehicles will have brighter market prospects due to their lower carbon emissions compared to traditional gasoline-powered cars. In 2012, total natural gas vehicle ownership in China exceeded 1.4 million, according to the available market data. Figure 1.2: Comparison of international natural gas consumption by purposes in 2010 Source: China Energy Development Report 2013 by China Energy Research Society

Natural gas consumption in power generation Boosting the share of gas-fired power generation is widely regarded as an effective way to reduce carbon emissions in the short-term. By 2015, the share of gas consumption in China’s power generation sector is expected to climb to 30% from the 2012 level of 16.92%. However, the country’s limited gas-fired power capacity remains a hindrance to its further expansion, as it now accounts for only 4% of the nation’s total power capacity. Similarly, natural gas power generation only represents 2% of the nation’s total power generation, and is mainly used as a supplementary source during peak hours (Figure 1.3). 1Due

to the different original statistical sources referenced, the natural gas consumption in the transportation sector was not covered in figure 1.1.

Section One: Natural Gas Consumption in China 第一部分：中國天然氣消費

CEFC China Energy Focus Natural Gas 2013

Figure 1.3. Share of Natural Gas in Power Generation 2012 Source: GE Global Strategy and Analytics, 2013

Despite the government’s willingness to expand natural gas power generation to replace less efficient coal power plants, the price gap between the gas power cost and the on-grid tariff remains the key factor in determining the future market of gas-fired electricity. Under the existing gas pricing and on-grid tariff system, gas-fired power plants cannot generate profit without government subsidies. In Guangdong province, for example, the average power generation cost of using gas is approximately RMB 0.81 per kilowatt hour (kwh), much higher than the RMB 0.74 per kwh mandated on-grid tariff. As a result, the gap needs to be subsidized by the provincial and local governments. However, the practice of relying on government subsidies is considered to be unsustainable and inequitable. Due to the differing financial capacities of Chinese provinces to afford gas power, this power source has become a luxury available only to the comparatively richer coastal provinces. In the foreseeable future of sustained high gas prices, most of the experts interviewed opined that the future of gas power generation in China will remain uncertain, particularly if the current on-grid tariff system is not reformed. Meanwhile, considering the makeup of China’s natural resource endowment, some experts also asserted that coal power plants will continue to be the main power source for the country’s electricity supply. The real cost of gas power appears to be too high for general utility users in both China’s residential and non-residential sectors. While the U.S. has the distinction of being the world’s largest gas producer and was able to keep the average wellhead price of natural gas in 2012 as low as RMB 0.57 per cubic meter, China can hardly expect to enjoy such a low cost for natural gas based on the current development of its gas industry. 25

CEFC China Energy Focus Natural Gas 2013

Section One: Natural Gas Consumption in China 第一部分：中國天然氣消費

Natural Gas Consumption in the Residential Sector The majority of the experts interviewed maintained that residential gas use will further increase from current levels by 2015. Price issues are said to be the major factor in determining the future of residential gas consumption in China. Government incentives and policies will be indispensable as well. Considering the massive infrastructure projects approved by the government for residential gas development, it is safe to assume that the population with access to natural gas will rise from 180 million people to 250 million in 2015. Natural Gas Consumption in the Industrial Sector The industrial sector accounted for 36.24% of natural gas consumption in 2012 – the highest among all sectors, but lower than its previous level. Most experts forecast that the percentage of industrial gas consumption will diminish in the near future, particularly for chemical industries due to the government’s awareness of the excess production capacity of chemical products such as fertilizers. It was also mentioned that the gas prices for industrial users in China were kept at an artificially low level, in the hopes that a fringe subsidy to industrial production would ultimately serve to stimulate exports and domestic consumption of industrial goods. However, as the country is reforming its export-oriented development model and is putting more emphasis on expanding its domestic market, gas consumption in the chemical sectors is expected to be kept low.

Outlook for the 13th Five-year Plan According to the experts interviewed, natural gas consumption will remain at double-digit percentage growth annually in the upcoming 13th Five-year Plan period (2016 to 2020) but at a slightly lower rate than previously experienced. Based on different growth scenarios, natural gas consumption in 2020 will range between 350 bcm to 450 bcm. Factors that affect natural gas consumption are listed below: 1. International commitments to reduce carbon emissions: China has committed to reduce per GDP unit CO2 emissions by 40% to 45% in 2020 compared to the 2005 level. Assuming the average annual economic growth rate ranges from 7% to 9%, natural gas consumption needs to reach 350 bcm to 450 bcm in 2020 to achieve this emissions target. 2. Increased domestic supply: production of unconventional gas is currently going through a trial period, and it will take some time to reach the targeted production capacity. The earliest estimated time for the unconventional gas to reach its planned production level for 2016 may need to be extended to 2020. 3. Scale-up of unconventional gas development: the United States took 20 years to succeed in shale gas production. It will take China 7 to 8 years to keep pace with the U.S. given its current technological level. 4. Continuous improvement in pipeline infrastructure: pipelines are used to transport natural 26

Section One: Natural Gas Consumption in China 第一部分：中國天然氣消費

CEFC China Energy Focus Natural Gas 2013

gas from the production site to consumers. Pipeline construction is time-consuming and capital intensive. To have a well-developed pipeline network in 2020 would require considerable time and money. China started planning its national gas pipeline network as early as in the 1980s, but construction is not likely to be finished before 2020. Furthermore, development of a natural gas distribution network in urban areas started late. Therefore, continuous improvement of pipeline networks will serve to increase natural gas consumption by urban populations. 5. Price restriction: major natural gas importers and gas utility firms are losing money, currently at more than RMB 1 per cubic meter. It is therefore not realistic to expect the natural gas industry to boom as aggressively in the 13th Five-year Plan as it was in the 12th Five-year Plan. Under the current pricing mechanism, there is no incentive for suppliers to reduce the retail gas price due to the high resource cost, while on the other hand, consumers might reduce natural gas consumption if the gas price keeps surging. This dilemma is already experienced in Guangdong Province due to the significant gas price increase after a pioneer price reform in 2011. As China is likely to be more reliant on foreign gas imports to complement the widening gap between domestic gas supply and demand, the rising share of imported gas and its higher cost, will only make the current price dilemma even worse.

CEFC China Energy Focus Natural Gas 2013

Section Two: Natural Gas Production in China 第二部分：中國天然氣生產

Section Two: 第二部分：

Natural Gas Production in China 中國天然氣生產

Consultation questions: Q8. China has set a goal to expand its annual domestic natural gas output to 176 bcm by 2015, which is 70% higher than the current level. Do you think this goal is attainable? What measures do you suggest the Chinese government adopt to attain this goal? Q9. Shale gas is now becoming a subject that cannot be circumvented in discussions about natural gas. In China’s 12th Five-year Plan, a survey underway is expected to confirm 600 bcm proven shale reserves and 200 bcm technologically-recoverable reserves. Shale gas production is also expected to reach 6.5 bcm by 2015. Please comment on China’s goal for shale gas development. Considering China’s late entrance into this particular field, do you think this is an aggressive goal? Q10. In its latest report, The Energy Information Agency of the United States ranked China as the leading country that possesses the largest shale gas reserve in the world: some 32.2 trillion cubic meters (tcm). This estimation differs from the Chinese government’s estimation of 25 tcm. Please comment on the disparity between the two governments’ estimation of China’s shale resources. Could the U.S. mode of shale gas development be modified and repeated in China? Q11. With more data becoming available from the operating wells in the U.S., the economics of shale gas is becoming questionable and it may not appear as optimistic as some media reports trumpeted earlier. For example, the average production capacity of the wells built prior to 2011 in the largest shale gas play of the US, the Haynesville play, has declined by 52% between 2010 and 2012. It is estimated that in order to compensate for declining production in the old wells an annual capital input of USD 7 billion will be needed, exclusive of the leasing and other infrastructure costs. But currently the price of natural gas in the U.S. is well below $4/mcf, and this calls into question the return on investment (ROI) of the shale gas projects that require such massive capital input. Please comment on the ROI of shale gas development. Do you think shale gas is still a sustainable energy option that can provide China the sources needed before we reach the era of renewables? There are some voices in the U.S. questioning whether “the shale bubble” has mainly been propelled and trumpeted by Wall Street investors. Do you have a comment on that? Q12. The Chinese government is now opening shale gas development to small and medium private investors. But, in the past, it was the large SOEs that dominated natural gas development in China. In your view, would the small or large company business model work better to promote shale gas promotion in China? 28

Section Two: Natural Gas Production in China 第二部分：中國天然氣生產

CEFC China Energy Focus Natural Gas 2013

Q13. The successful story of shale gas in the United States can largely be attributed to the passage of the Energy Policy Act 2005, which clearly stated that hydraulic fracturing activities would be excluded from the regulations of the underground injection control (UIC). If China were to widely apply the fracturing technology in shale gas exploration and exploitation, what legal factors should it consider seriously beforehand? Does China’s current environmental law provide sufficient regulation regarding the underground injection issues? Will a similar lobbying group comprised of the leading energy companies emerge in China and put pressure on the legislation procedures for new environmental laws? Q14. Besides shale gas, the Chinese government also planned to have 16 of the 176 bcm total production in 2015 from the coal-bed methane, meaning a 158% increase on the current level. Also, China had 30 bcm output of tight gas in 2012, which can be expected to grow further to 50 bcm in 2015. Please comment on the near-term trend for unconventional gas development in China. Will unconventional sources be sufficient to fill China’s demand-supply gap?

Responses and opinions: Natural Gas Production in 2015: Ample Domestic Supply Natural gas production in China has experienced a remarkable growth in the past decade. In 2012, total natural gas production reached a historically high level of 106.7 bcm, almost four times the volume seen in 2000. In the past decade, annual production growth averaged an astonishing rate of 12.5%, making the country the world’s 7th largest producer, now close behind Norway (Figure 2.1 and 2.2). However, the relatively smaller endowment of natural gas resources in China was obvious too. In 2012, its reserve-production ratio (R/P ratio) was only 28.9, much lower than the world’s average level of 55.7 (table 1.1).

CEFC China Energy Focus Natural Gas 2013

Section Two: Natural Gas Production in China 第二部分：中國天然氣生產

Figure 2.1 China Natural Gas Output and Annual Growth Rate, 2006 – 2012 Source: 2006-2011 data is cited from China Energy Statistical Yearbook 2012, 2012 data is cited from 2012 National Economy and Social Development Statistical Report

Figure 2.2 World’s top 15 Natural Gas Producers, 2012 (bcm) Source: BP Statistical Review of World Energy, 2013

CEFC China Energy Focus Natural Gas 2013

Section Two: Natural Gas Production in China 第二部分：中國天然氣生產

Table 2.1 Natural Gas R/P Ratio of China and the World, 2012 Source: BP Statistical Review of World Energy, 2013 Reserve (bcm)

Production (bcm)

R/P Ratio

World

187300

3363.9

55.7

Non-OECD

168600

2152.5

78.3

OECD

18600

1211.5

15.4

Russian federation

32900

592.3

55.5

8500

681.4

12.5

China

3100

107.2

28.9

Country

According to the policy goals outlined in China’s 12th Five-year Plan for Natural Gas Development, by 2015 total domestic gas production will be increased to 176 bcm, of which 138.5 bcm will come from conventional gas production. Coal gasification capacity will be expanded to 15 bcm to 18 bcm, and the coal-bed methane production capacity will be expanded to 16 bcm. It is also expected that shale gas production will be 6.5 bcm. Considering the rapid development achieved in recent years, the experts expect that the conventional gas production goal stated in the state’s five-year plan is likely to be attained. However, as to the unconventional sources, especially shale gas and coal-bed methane, the experts are more cautious regarding the actual production numbers by 2015. Synthesizing the historical data for China’s gas production, and the projections made by the experts interviewed, China’s total natural gas production can be expected to reach 185 bcm to 196.5 bcm by 2015 (higher than the target outlined in the 12th Five-year Plan) and 360 bcm to 410 bcm in 2020. Without considering the impact of fluctuations in gas retail prices and the uncertainties in commercial supply volume, the estimated domestic production capacity in 2015 is likely to fulfill 80% of the stated 230 bcm natural gas consumption target in China’s 12th five-year plan. Taking into account the additional gas supplied by existing long-term gas import contracts, the expanded domestic production capacity is likely to result in ample gas supply in China if the planned capacity becomes fully operational and domestic consumption does not exceed the 12th Five-year Plan’s target. Thus, as indicated by the interviewees, there will be less pressure for China to import expensive natural gas from overseas sources. There are also some experts opining that a tax reform is necessary in order to strengthen the long-term health of the natural gas industry in China. Currently, natural gas sales are enjoying an average tax rate of 13%, against the 17% rate of national value-added tax (VAT). Such favorable tax rate, according to those Chinese experts, will render an excessive and sometimes even aggressive production and consumption of natural gas. It is also mentioned by some experts in our interview 31

CEFC China Energy Focus Natural Gas 2013

Section Two: Natural Gas Production in China 第二部分：中國天然氣生產

that under the current tax system, the local governments have difficulty in collecting tax from natural gas production and are thus less willing to allocate resources to local natural gas projects. In Sichuan, for example, the provincial government of this important gas province had not collected a dime of value-added tax from the gas production activities between 2000 and 2012. These experts are now calling for raising the natural gas tax at least on par with the national VAT.

Conventional Gas Production: To Reach 200 Billion Cubic Meters by 2020 China’s conventional gas (including tight gas) production reached 94.72 bcm in 2012, and constitutes the largest portion of China’s overall domestic natural gas supply. More than half of the conventional gas output now comes from the four major producing basins, namely: the Ordos Basin, the Sichuan Basin, the Tarim Basin and the South China Sea (Figure 2.3). According to state policy documents, the volume of conventional gas production is planned to increase further to 138.5 bcm by 2015, and the output from the four major production basins will account for more than 90% of this total (Figure 2.4). Considering the rapidly growing recoverable gas reserves discovered in China over the past few years (annual growth rate of 6.9% since 2005), most of the experts interviewed deem this policy goal to be attainable. By assuming an 8% annual growth rate, some of the experts predicted the real production volume of conventional gas might reach as high as 134 bcm in 2015 and near 200 bcm in 2020 (Table 2.2). Some even predicted that by 2030, with the potential of an additional 10 trillion cubic meters of proven gas reserves, conventional gas production in China will peak at 240 to 280 bcm in the coming two decades. Figure 2.3 Four Major Conventional Gas Production Basins in China

Tarim Basin

Ordos Basin

Sichuan Basin

South China Sea 32

CEFC China Energy Focus Natural Gas 2013

Section Two: Natural Gas Production in China 第二部分：中國天然氣生產

Figure 2.4 Major Conventional Gas Production Basins in China Source: the 12th Five-year Plan for Natural Gas Development

Table 2.2 Conventional Gas Production Outlook, 2010-2020 Source: Data of 2010 and 2012 were derived from the National Bureau of Statistics; data of 2013 was estimated by the CNPC Economics and Technology Research Institute; the 2015 and 2020 data were the predictions by the interviewed consultants

Production

2010

2012 (bcm)

Annual growth rate %

2013 (bcm)

Annual growth rate %

2015 (bcm)

Annual growth rate %

2020 (bcm)

Annual growth rate %

94.8

106.7

6.07

115

7.77

134

8.00

197

8.00

It is also worth noting that tight (sandstone) gas already contributes a significant portion to China’s overall conventional gas output. Though it is categorized as an unconventional source in the US, under China’s energy statistical system it is instead classified as a conventional gas source. In 2012, total tight gas production in China was recorded at 32 bcm, thereby accounting for more than one third of China’s total output of conventional gas (Figure 2.5). Considering China’s experience in tight gas exploration and extraction, future tight gas production can be expected to rise, especially if more favorable policy measures are adopted.

CEFC China Energy Focus Natural Gas 2013

Section Two: Natural Gas Production in China 第二部分：中國天然氣生產

Figure 2.5 China’s Natural Gas Production by Sources, 2012 (bcm) Sources: State Council Development Research Center.

Despite the achievements made in conventional gas exploration, the experts also expressed their concerns regarding efficiency problems existing in the current state owned enterprise (SOE)-led natural gas development model. In their view, the major SOEs must pay close attention to their low-efficiency and cost-control in their land acquisition procedures. Also, along with the market reform, the SOEs’ principal mission must be shifted from solely focusing on guaranteeing supply volume to an integrated approach that balances concerns of efficiency. The interviewees believe that market forces should determine the future of gas exploitation in China. Therefore, over time, the role of government and the existing cumbersome regulatory regime should be minimized in favor of a liberalized gas market and allow more competition.

Unconventional Gas Production and the 12th Five-Year Plan The potential for unconventional gas production in China will be a major factor in determining the future supply stability of China’s gas market. Currently, China’s unconventional gas mainly comprises coal gasification, coal-bed methane and shale gas. The central government has outlined ambitious plans for all three sources. With respect to coal gasification, the National Development and Reform Commission (NDRC) has approved one project in Xinjiang and three projects in Inner Mongolia, with total production capacity at 15.1 bcm. Coal-bed methane production in 2012 was 12.5 bcm, and it is planned to reach 30 bcm by 2015, of which 16 bcm will come from surface extraction. As for shale gas, China is targeting to have 6.5 bcm output by 2015. Almost all the experts interviewed agreed that unconventional gas development in China is still in its infancy. A systematic geological survey of unconventional sources is urgently needed. Additionally, more facilities will need to be built to support commercial utilization and pipelines will need to be built and connected to the national grid. Besides, problems concerning mineral rights, domestic gas price distortions, exploration and production technologies and the monopoly 34

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CEFC China Energy Focus Natural Gas 2013

positions of state-owned enterprises, remain unsolved and can be major obstacles to China increasing unconventional gas production in the future.

Shale Gas Among all the unconventional gas sources in China, shale gas has both the greatest potential and the greatest uncertainty. The potentially large resource base could supplement China’s limited gas reserves. However, recent exploration and extraction data make its future largely uncertain. Almost all major organizations are optimistic about the shale gas resource in China. The U.S. Energy Information Administration (EIA) estimated the technically recoverable shale gas resource in China to be 32 trillion cubic meters (tcm), while the Ministry of Land and Resources of China estimated the amount at 25 tcm. The number of recoverable shale reserves announced by the Chinese Academy of Engineering (CAE) was 10-13 tcm. Whether actual reserves are found to be on the higher or lower end of these estimates, these figures are nonetheless impressive. Access to technologies will not be a major obstacle for China to succeed. According to the experts interviewed, China is a large tight-oil producing country and has already gained significant experience in the use of technology in unconventional oil and gas development, including the use of horizontal drilling, hydraulic fracturing, and the development of essential equipment, such as the 2,500 horspower (HP) fracturing pump already deployed and the 3,000 HP fracturing pump under research. This growing level of expertise in the right technologies and techniques will help China meet its shale gas development needs. It could be said that in shale development, China is well prepared in both resources and technology. In terms of comparative geological conditions, China is in many ways different from the United States, by far the most advanced nation in shale gas exploitation. However, there are no major geological obstacles preventing China from replicating the shale revolution in the US. Admittedly, unlike the U.S. where marine facies constitute the majority of the country’s shale gas reservoir, China needs more time and efforts to prove the economic viability of exploring shale gas in its primarily continental facies. Although exploring shale sources in such dissimilar geological conditions will certainly require different technologies and measures, China has experience in exploiting massive conventional oil and gas from the continental facies. As such, there should be no insurmountable obstacles in replicating this success in shale development. However, the progress of shale gas development in China is not as significant as expected. In 2012, China had only 35 million cubic meters of shale gas pass through the national gas distribution pipelines. While its production in 2013 is expected to reach 0.2 bcm, the pace will lag behind the intended goal of 6.5 bcm by 2015. Considering both America’s experience and China’s situation, Chinese experts believe it is necessary for China to put more effort into the exploitation of shale gas in the future. As an important source of unconventional gas, the reserve of shale gas could be exponentially larger than that of conventional gas. However, the more significant factors that 35

CEFC China Energy Focus Natural Gas 2013

Section Two: Natural Gas Production in China 第二部分：中國天然氣生產

may impede its future prospect in China mainly lie in the “soft conditions”, such as the mineral rights, market price reform, and the monopoly position of the big three national oil companies. Furthermore, a vibrant financial sector will also be a key determinant in the long-term prosperity of unconventional gas exploration and development by its willingness to provide risk capital.

Coal-bed Methane (CBM) As an important unconventional gas source, business groups and governments in China have closely followed new developments in coal-bed methane. In 2012, China’s CBM production was at 12.5 bcm. On the surface, this total production amount might appear to be impressive, but when considering its final utilization rate the CBM industry disappoints. According to data provided by the experts interviewed, only 5.2 bcm CBM was recorded to be delivered to end-users in 2012, accounting for only 41% of the total output. Though its production capacity is now planned to expand further to 30 bcm in 2015, in which 16 bcm will come from surface extraction, the low utilization rate impedes prospects for future consumption. In the experts’ view, the low utilization rate of CBM in China can be attributed to two factors: 1. the major SOEs’ monopoly control over major gas pipelines makes it difficult for local CBM developers to sell the CBM through pipeline transmission; 2. It is difficult for CBM developers to put CBM directly into gas power generation, as a result of low on-grid purchase prices mandated by the state-owned grid companies and the lack of connectivity of small power plants to the national grid. In addition, overlapping mineral rights in CBM is another troubling aspect hindering future development. As we learned through the interviews, China’s Mineral Resources Law states that the Ministry of Land and Resources should regulate the mineral rights of coal-bed methane, while both the Ministry and provincial level agencies should regulate that of coal. This leads to a common phenomenon whereby the mineral rights of coal and coal-bed methane in one mining field can be distributed to different companies thus causing confusion over who has the authority to exploit which resource. As coal-bed methane is usually an affiliated resource with coal, the prospect of producing coal or coal-bed methane without impacting the other is unlikely. Such administrative incongruities are now a major obstacle for CBM development in China. Recently, the State Council started planning to reverse the negative trends seen in CBM development. In 2012, it announced new policies for coal-bed methane development by promoting government subsidies from RMB 0.2 per cubic meter to RMB 0.6 per cubic meter. However, until the lack of sales channels and the unresolved mining rights issues can be adequately addressed, the near-term production outlook for CBM may not appear to be as optimistic as the state plan depicts it to be by 2015.

Coal Gasification China has more advanced technology in coal gasification than the other unconventional fossil 36

Section Two: Natural Gas Production in China 第二部分：中國天然氣生產

CEFC China Energy Focus Natural Gas 2013

fuels, especially in terms of the conversion efficiency, water consumption, and related aspects. It was widely agreed by the experts that the growth of coal gasification in China could be expected to occur faster than that of shale gas. Given the recently approved pipelines for transporting coal gas from its production centers in Xinjiang and Inner-Mongolia to the eastern coastal provinces, it is anticipated that the commodification rate of coal gas will also exceed the less optimistic outlook for coal-bed methane and shale gas. Relaxed government restrictions on coal gas production are a major contributor to its growth. As of August 2013, the state government has approved four coal-to-gas projects with a total production of 15.1 bcm; these are roughly equal to the targets in the “12th Five-Year Plan for Natural Gas Development”. The state government also issued permits for four projects, for a total capacity of 18 bcm/year. By now, the first phase of a coal gasification project in Xinjiang is already operational run by the Xinjiang Qinghua Group with its total designed capacity to reach 5.5 bcm/y. Taking into account the construction period required for the other projects, the actual coal gas commercial supply volume in China is likely to reach 5 bcm by 2015. Under high estimation, coal gas output would ideally account for about 15% of China’s natural gas supply, totaling 60 bcm/year by the end of the 13th Five-year Plan. According to the views of the experts interviewed, the reasons for continued government support in coal-gasification can be summarized in three major points: 1. As natural gas prices are on an upward trend, the profit margin for coal-gasification projects could be significant; 2. Coal-gasification has higher conversion efficiency than many other coal-chemical products; 3. Utilizing coal gas is still a much cleaner option than other fossil fuel sources. Nevertheless, while acknowledging the production gains, some of the experts expressed deep concerns about the environmental cost of coal gasification. In their view, while the economic cost of coal gasification might appear to be affordable, its yet unproven environmental costs might be unaffordable for China’s already frail eco-system in the long-term. The experts also noted that during former Premier Wen Jiabao’s administration, coal-gasification projects were actually strictly controlled due to the government’s cautious attitude toward the potential environmental ramifications. If the current administration fails to fully understand the environmental costs and sustainability of coal-gasification projects, it is possible that a more serious environmental problem might loom ahead -- one is far worse than the projected environmental cost of shale gas development.

CEFC China Energy Focus Natural Gas 2013

Section Three: China’s Natural Gas Imports 第三部分：中國天然氣進口

Section Three: 第三部分：

China’s Natural Gas Imports 中國天然氣進口 Consultation questions: Q15. In 2012, the net natural gas import for China totaled at 41.2 bcm with an import dependence rate of 30%. By 2015, net imports are expected to grow further to 93.5 bcm. For a country that is already heavily reliant on foreign oil imports, will this additional increase in natural gas imports further undermine China’s fragile capacity for energy self-sufficiency? Q16. China is now constructing both long-distance land pipelines and coastal LNG terminals to expand its capacity to import natural gas. Please comment on these two modes of importing natural gas. In your view, which one better fits China’s need? Q17. The LNG receiving capacity in China has been expanded rapidly in recent years. By 2012, China had 6 receiving terminals in operation, with a total receiving capacity of 21.9 million tons per annum (mmtpa). By 2015, this number is expected to grow further to 40 mmtpa. Do you think expanded LNG imports will be sufficient to catch up with the increased domestic demand for natural gas? Considering the premium that long existed in Asia’s natural gas market, is it still a good idea for China to continue to expand LNG imports despite the high fuel costs? Do you think China’s increased share in world LNG trade will be able to mitigate the current imbalance in the price of LNG in Asia? Q18. Parallel to the development of LNG terminals, the scale of land pipeline construction is also very impressive. According to the NDRC’s 12th Five-year Plan for Natural Gas Development, between 2011 and 2015, 44 thousand kilometers of new pipelines will be completed, with an additional capacity of 150 bcm per annum to be attained. Please comment on the massive scale of China’s land pipeline development. What are the advantages of land pipelines as opposed to the coastal LNG terminals? Are they more secure and reliable sources than imports via sea?

Responses and opinions: Natural Gas Imports Likely to Reach the Planned Goal of 93.5 bcm by 2015 Given China’s rapid gas consumption growth and the limited potential to further expand its production capacity, the country will likely need to increase natural gas imports in the near future. In 2012, the gap between China’s domestic natural gas supply and demand reached a historic high of 40 billion cubic meters (bcm). By synthesizing the views collected from the Chinese experts and data from the National Development and Reform Commission (NDRC), the gap between domestic 38

Section Three: China’s Natural Gas Imports 第三部分：中國天然氣進口

CEFC China Energy Focus Natural Gas 2013

production and consumption is expected to further widen to 93.8 bcm, more than double the 2012 level (Figure 3.1) if China is to realize the policy target of 230 bcm in natural gas consumption in 2015. This is close to the state’s plan of having 93.5 bcm gas imports by 2015. Considering China’s recent moves to promote unconventional gas exploration, the growth in gas imports may be moderated by increased domestic supply from the unconventional sources. However, less than satisfactory progress in China’s unconventional gas development now makes the future of domestic production uncertain, and there is yet to be conclusive evidence that unconventional sources will be commercially viable to supplement an ever-growing supply-demand gap in the near term. Figure 3.1: Natural Gas Production and Consumption in China 2000-2015 (bcm) Source: China Energy Statistical Yearbook 2012, the production data of 2015 was derived from the interviewers’ predictions

From 2000 to 2012, China transitioned from being a net gas exporter to being a net gas importer. While in 2000, China exported 3.14 billion cubic meters of natural gas, by 2012 China imported 40.8 bcm of natural gas (Table 3.1). This made China one of the most dynamic importing countries in East Asia. In the first six months of 2013, the total gas import volume in China reached 24.7 bcm, which was 24.6% higher than the previous year. Assuming that such a high 6-month growth rate could be sustained, China’s total gas import volume can be expected to stay around 55 bcm by the end of 2013, nearly 35% higher than the previous year.

CEFC China Energy Focus Natural Gas 2013

Section Three: China’s Natural Gas Imports 第三部分：中國天然氣進口

Table 3.1: Natural Gas Imports of China 2000-2013 (billion cubic meters) Source: data for 2005-2012 were derived from the National Bureau of Statistics of China, data for 2013 was estimated by an interviewed expert Year

2000 2005 2006 2007 2008 2009 2010 2011

2012

2013 (estimated)

Imports

1.0

4.0

4.6

7.6

16.5

31.4

40.8

Exports

3.14

2.9

2.6

3.2

4.0

3.2

2.9

2.0

Net imports

-3.14

-3

-1.9

1.4

1.2

4.4

12.5

28.2

37.9

Import dependency rate

---- -3.5% 2.0% 1.7% 4.9% 11.6% 22.0% 26.2%

31.5%

China’s rapidly increasing reliance on foreign gas imports is making the domestic gas market more sensitive to fluctuations in the global gas market. In 2012, the gas import dependency rate of China climbed to 26.2% and is expected to reach 31.5% in 2013. With China’s domestic gas market becoming increasingly dependent on the supply of foreign imports, it is likely that its exposure to the global gas market will also be further intensified. Regarding China’s policy goal of having 93.5 bcm natural gas imports by 2015, most of the interviewees deemed this goal to be largely consistent with their estimation of domestic production and consumption. Presently, natural gas imports to China are mainly transmitted through two methods: 1) the pipelines connected to Central Asian gas exporting countries, Turkmenistan, Kazakhstan, and Uzbekistan, and recently to Myanmar and 2) the sea routes for liquefied natural gas (LNG) transportation from Qatar, Indonesia, and Australia. The following sections will combine the analysis given by the interviewees on the advantages and disadvantages of these two import channels.

Land Gas Imports to China: A Stable but Less Flexible Source of Supply

China has built up two major cross-border gas import pipelines: the Central Asia-China pipeline on its northwestern border, and the Myanmar-China pipeline on its southwestern border (Table 3.2). The Central Asia pipeline is currently China’s largest single source of gas imports, providing the country with about 20 bcm of gas in 2012, and accounting for half of the country’s total imports. With its total length extended over 1,833 km, the transmission capacity of the dual-line Central Asia-China pipeline is now at 30 bcm per annum and can be expected to expand further to 55 bcm by 2014 should the 25 bcm Line C project be completed on time. By the end of August 2013, China’s total gas imports from the Central Asia pipeline exceeded 60 bcm since 2010. China’s second land gas pipeline, the China-Myanmar gas pipeline, was completed in July 2013. This pipeline has been under construction since 2010. Starting from Kyaukpyu City in Myanmar, the pipeline enters China through Ruili in Yunnan Province and then reaches Guangxi Province via Guizhou Province, measuring 2,500 kilometers. Officially operational as of July 31, 2013, this

CEFC China Energy Focus Natural Gas 2013

Section Three: China’s Natural Gas Imports 第三部分：中國天然氣進口

pipeline is already supplying gas for six cities in Guizhou Province and is projected to reach its designed capacity of 12 billion cubic meters by 2015. It is expected that with the completion of the China-Myanmar pipeline, it will serve to further diversify the country’s import sources by enabling gas supplies to be directly transported from the Indian Ocean. Table 3.2: List of China’s Existing Cross-Boundary Natural Gas Pipelines Source: CNPC and Reports from the Xinhua News Agency Pipeline name

Designed capacity

Operating company

Receiving end

Central Asia-China Pipeline

30 bcm (Line A&B) 25 bcm (Line C)

CNPC

Khorgos (Xin Jiang) connected to the second West-east gas pipeline

China-Myanmar Gas Pipeline

12 bcm

CNPC

Rui Li (Yunnan)

Based on expert opinion, the advantages and limitations of the land pipelines in China’s gas import pattern can be summarized in three points: 1. China enjoys a price advantage in its land pipeline gas imports. This price advantage, suggested by the interviewees, can be attributed to the economic and political leverages China enjoys over the Central Asia states and Myanmar. By keeping its comparative advantages in the economic sector and further cultivating political relationships with the Central Asian states, this price advantage (compared to LNG sources) can be expected to continue in future negotiations of gas sales agreements (GSAs). The average import price of land gas in China was recorded at RMB 2.22/ cubic meter in the first eight months in 2013, 14% lower than the average RMB 2.54/ cubic meter price of LNG imports. 2. Land gas supply is a more stable option than LNG imports for China, especially when considering the relatively weak position of the country in the global LNG market. Land gas imports allow China to circumvent the market risks of LNG trading. Differing from LNG imports, where market fluctuations can easily and significantly impact the final destination price, land gas pipelines, due to the fixed pricing system, insulate the importers from market price risks. However, due to the commonly used “take-or-pay” contract used in pipeline gas trades, it also leaves China with little room to adjust the total volume of imports to match ever-changing domestic gas demand. As an importer under such an agreement, China’s obligation to take delivery of goods must be strictly fulfilled. 3. The severe price gap between gas imports and domestic retail prices remains a major stumbling block for China’s future gas imports. According to the latest data disclosed by the Ministry of Commerce, the average price of the imported gas from Central Asia in the first eight months of 2013 was near RMB 2.22/ cubic meter. This is significantly higher than most ceiling prices in Chinese cities even after the recent price reform (averaging at RMB 1.95 per cubic meter after the latest price adjustment). Under such a distorted price system, the major gas importers, such as CNPC, 41

CEFC China Energy Focus Natural Gas 2013

Section Three: China’s Natural Gas Imports 第三部分：中國天然氣進口

recorded huge capital losses in their natural gas import businesses. The price distortion between the demand side and the supply side are expected to be relieved by the central government’s latest measures in gas price reform.

LNG Imports to China: Domestic Prices Remain the Dominant Factor By 2012, China constructed six LNG receiving terminals with a total designed capacity of 18.8 mmtpa, enabling the country to import over 20 billion cubic meters of gas. This figure is almost 20 times of the country’s total import volume in 2006. By 2015, seven LNG receiving terminals are scheduled to be completed, further expanding the country’s import capacity to 40 mmtpa (equivalent to 54 bcm) (Figure 3.2). Figure 3.2: LNG receiving capacity in China, 2006-2015 (mt) Source: China Energy Development Report 2013 by China Energy Research Society

According to the experts, the future of LNG imports might continue to be impeded by the gas pricing system wherein the domestic price of gas is much lower than the market clearing level. This problem can also be seen in pipeline gas, but it is much more pronounced in the LNG market. Currently, the average destination price (usually the Cost-Insurance-Freight or CIF price) of LNG imports in China is around $15 per million British thermal unit (mmbtu, approximately RMB 3 per cubic meter), which is markedly higher than the country’s average city-gate gas price ceilings. Even after the government raised the domestic gas prices by 15% from RMB 1.69 per cubic meter to RMB 1.95 per cubic meter through the 2013 price reform, the LNG imported to China remains more than RMB 1 higher than the newly adjusted retail prices. Regardless of the mandated political factors imposed on the major state-owned importers, under the current pricing system it remains uncertain whether the LNG importers in China will have the business justification required to sign new LNG contracts or continue to execute existing LNG contracts.

Section Four: Natural Gas Pricing in China 第四部分：中國天然氣定價

CEFC China Energy Focus Natural Gas 2013

Section Four: 第四部分：

Natural Gas Pricing in China 中國天然氣定價 Consultation questions: Q19. Please comment on the latest price reform in 2012 that introduced a net-back approach to the existing system. Is it a good starting point for building a market-oriented natural gas price system? What kind of impact may it have on the current natural gas market? Q20. After the latest price reform, the city-gate prices of natural gas in more than 10 provinces/ municipalities have risen by 10% to 23%. If further price reform were to be carried out, do you think the natural gas price will keep surging in China? What impact will the surging prices cause for the development of natural gas in China, positive or negative? Will price become a deterring factor that may actually prevent capital from being invested in natural gas? Q21. Will the rising prices of natural gas hamper its application in industry and power generation? Q22. China has already had a wide application of natural gas in the transportation sectors, especially for heavy trucks. Will the surging natural gas price become a deterrent to its application in the transportation sectors? Q23. The NDRC implied that by 2015, price reform will be extended to the non-residential sectors, where the prices are now still deliberately kept at a low level by the government. In your view, how will an extended reform affect natural gas development in China? Q24. China in 2012 launched its first spot market for natural gas on the Shanghai Petroleum Exchange. This was widely seen as an important step toward further market price reform and allowing prices to be set “depending on rate of supply and demand fundamentals” without being influenced by other markets such as crude. What role will the Shanghai spot market play in China’s natural gas market? Will it be able to temper the rising LNG import price that China faces?

Responses and Opinions: To understand natural gas pricing in China, it is important to know that it usually includes the wellhead price, city-gate price, and end consumer price. Wellhead prices vary in different production regions. For example, the average wellhead price in Changqing (the largest gas producing basin in China) in 2012 was RMB 1.022 per cubic meter, while in the Tarim Basin in Xinjiang it was RMB 1.015 per cubic meter. Due to the price variation at the well-head stage, the city-gate prices in China differ as well. For instance, the city-gate prices in Guangxi and Guangdong provinces were set at RMB 2.74 per cubic meter and RMB 2.57 per cubic meter respectively, while the city-gate 43

CEFC China Energy Focus Natural Gas 2013

Section Four: Natural Gas Pricing in China 第四部分：中國天然氣定價

price in Beijing was set at a much lower rate of RMB 1.472 per cubic meter. As the consumption structure varies in different cities, the end consumer price will be different among sectors and regions as well (Table 4.1). Table 4.1: End-User Gas Prices in Major Cities of China, 2012 (RMB per cubic meter) Source: China Energy Development Report 2013, by China Energy Research Society Residential

Commercial

Electric Power

Vehicle Usage

Beijing

2.28

2.84

2.28

4.73

Nanjing

2.2

2.95

2.099

4.6

Guangzhou

3.45

3.7

1.610-2.4

Urumqi

1.37

1.76

2.11

2.08

Chengdu

1.89

2.2

2.22

City

Since 2009, the difference between residential and industrial gas prices started to widen (Figure 4.1). In 2013, following the price reforms, industrial gas prices recorded even higher prices than the 2012 levels. To illustrate this point we can look at the average industrial gas price in Beijing in September 2013. It was recorded at RMB 3.23 per cubic meter, which represented an increase of more than 10% than the previous year. In some other major gas consuming provinces like Guangdong, Zhejiang and Shanghai, the industrial gas prices were recorded at RMB 4.85, 4.84, and 4.59 per cubic meter respectively. Figure 4.1: Trend of Price Change in 36 Major Cities in China from 2009 to 2012 Source: China Energy Development Report 2013, by China Energy Research Society

CEFC China Energy Focus Natural Gas 2013

Section Four: Natural Gas Pricing in China 第四部分：中國天然氣定價

Compared with global natural gas prices, the residential price in China is at the lower end of the spectrum. In 2012, it was only half the residential price paid in France. Conversely, the industrial price in China is at the higher end in the global market –slightly lower than South Korea, and about the same as France (Figure 4.2). Figure 4.2: Comparison of Global Prices of Natural Gas in 2012 Source: China Energy Development Report 2013, by China Energy Research Society

Canada

France

S. Korea

USA

China

Residential ($/Mmkcal)

34.4

82.4

65.9

72.7

40.0

40.6

Industrial ($/Mmkcal)

10.3

50.6

61.0

37.3

10.4

50.0

The Pre-Reform Cost-Based System Before the latest price reform was implemented in July 2013, China employed a cost-plus approach in its domestic natural gas pricing system. Under such a system, the final price of natural gas was based mainly on the following three elements: 1.The ex-plant (wellhead) price; 2.The pipeline transportation tariff; 3.End-user price, including for fertilizer producers, industrial users and city gas users (both industrial and residential); The ex-plant (wellhead) price was proposed by the project developer and was regulated by the central government. The final ex-plant price valuation was mainly based on the production costs of natural gas plus an appropriate margin for the producer. This price served as a baseline, and the producer and buyer could negotiate up to 10% above it. While this methodology allowed for a common approach to domestic fields and allowed for more expensive fields to be developed as long as the costs can be passed along, it also created a different price for each field, which complicated the regulatory handling of pricing when the number of producing fields increased.

CEFC China Energy Focus Natural Gas 2013

Section Four: Natural Gas Pricing in China 第四部分：中國天然氣定價

Under this system, the pipeline transportation price is also set by the central government. Prices of pipeline transportations were determined based on three main elements: 1. The pipeline cost (construction and operation), 2. An appropriate profit margin, and 3. The transport distance from each gas source to each city gate. The pipeline operators in China were guaranteed a fixed internal rate of return at 12% by the central government, which is relative high compared to global averages. As suggested by the interviewed experts, one intention of the higher IRR level was to compensate for losses by the state-owned energy companies on imports, production and sales where capped prices usually lie below the real production and sales costs. However, this level of cross-subsidization serves to hinder the domestic wholesale markets as it generally leads to a competitive advantage for vertically integrated companies. There have been signs recently that the IRR level for the newly constructed pipelines in China might be fixed at 9%, so as to lessen the monopoly power of the major state companies who have control over the trunk pipelines. For end-user prices, they do not only differ depending on the gas supply, but also differ depending on the final gas usage (e.g. residential, commercial, industry or fertilizer). Also, gas delivered to different end-users was introduced with different levels of tariffs in different sectors, adding another layer of complexity to the gas price system. One evident example was the long subsidized gas prices for fertilizer producers.

The 2013 Gas Price Reform The Chinese government has been working hard to update pricing policies to incentivize infrastructure development while protecting consumers. In order to further liberalize the natural gas pricing system and shift it from a government-regulated model to a market-oriented model, the National Development and Reform Commission launched a nation-wide price reform for natural gas in July 2013. This program was intended to primarily target non-residential gas users. In this newly implemented price reform, natural gas prices in China are to be separated into two tiers. The first tier is based on the 2012 consumption volume of 112 billion cubic meters (bcm). Under this tier, the ceiling city-gate prices will be increased by no more than RMB 0.4 per cubic meter and price negotiation will be allowed under this cap. The second tier will be for any excess gas consumption above the 2012 level, and the prices will be linked by heating values to fuel oil and liquefied petroleum gas (LPG) prices (with 60% and 40% weighting respectively) with a 15% discount to ensure a price advantage for natural gas. The detailed pricing formula for the excess gas consumption is as follows:

Section Four: Natural Gas Pricing in China 第四部分：中國天然氣定價

CEFC China Energy Focus Natural Gas 2013

Pnatural gas – citygate natural gas price (tax included), RMB/m3 K – discount factor, currently at 0.85 ɑ, β — weighs of fuel oil and LPG, at 60% and 40% respectively Pfuel oil, PLPG – importing price of fuel oil and LPG, RMB/kg Hfuel oil, HLPG, Hnatural gas – net heat value of fuel oil, LPG and natural gas, at 10,000 Kc/kg, 12,000Kc/kg and 8,000Kc/m3 respectively R – value-added-tax (VAT) rate for natural gas at 13% as of now According to those interviewed, following the 2013 price reform the cost-burdens of the gas supply side in China, particularly for the pipeline gas importers, are expected to be relieved. Several respondents indicated that China will have to raise its domestic gas prices by at least 25% to fully compensate the capital loss in land gas imports. The currently mandated average 15% rise of national city-gate gas prices in China from RMB 1.69 per cubic meter to RMB 1.95 per cubic meter may not be able to fully offset all the capital losses of gas imports, but can nevertheless go some way towards mitigating the cost burdens shouldered by most gas import firms. Currently, the financial losses for importing gas from Central Asia are around RMB 1 per cubic meter and the maximum price increase allowed for the existing gas consumption volumes in China is only RMB 0.4 per cubic meter, leaving a RMB 0.6 per cubic meter price gap unfilled. Regarding this new round of price reform, the experts suggest that it might have three major policy impacts on the natural gas industry in China: 1. It reaffirmed the government’s attitude and determination to reverse the unsustainable artificially low gas prices that can be harmful to the long-term goal of expanding the share of natural gas in China’s overall energy profile; 2. It marked the beginning of a new round of marketization of natural gas prices in China, and can be expected to stimulate the interest of the gas importers; and 3. It demonstrated the government’s firm stance to further liberalizing pricing while minimizing the impacts to the residential users.

Contending Views of the 2013 Price Reform While acknowledging the positive impact of the 2013 price reform, some of the respondents also indicated some unfavorable factors that may hinder further liberalization of gas prices in China: 1. It remains uncertain whether the 2013 gas price adjustment can serve its original purpose of promoting natural gas consumption in China. It cannot be ruled out that when natural gas prices exceed a certain range, price-sensitive gas consumers may switch to cheaper fuel sources (such as coal or other alternative fuels) for cost reasons. Such concerns have been recently evidenced by the 47

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Section Four: Natural Gas Pricing in China 第四部分：中國天然氣定價

increased coal consumption in Europe. Due to a confluence of factors such as economic decline and gas price increases in 2011, the annual natural gas consumption in OECD-Europe was 8% lower than in 2010, while coal consumption increased by 6%. Electric power producers with the capacity to use coal-fired generators in Europe have also opted to reduce their natural gas consumption (Figure 4.3). 2. Through this round of price reform, interest of the integrated firms in China’s natural gas industries may have been further solidified. After this reform, the basis for gas pricing in China will be shifted from the ex-plant level to the city-gate level, which means the interest and the negotiation power of the pipeline companies in the entire gas value chain will be further strengthened. As the majority of gas pipelines in China were either built, operated, or managed by the major energy SOEs, their monopoly control of the pipelines will conflict with the government’s goal of the liberalization of the natural gas market. Some experts expressed the view that a core pre-condition for China to fully liberalize its natural gas market would be to separate the gas production from the transportation sectors, thereby encouraging more companies to enter the natural gas industry. However, through this reform, the pricing approach that bundled the upstream production sectors and the gas transmission sectors remained intact, which is harmful to long-term gas market reform.

Figure 4.3: OECD-Europe Natural Gas and Coal Consumption (Jan 2010-May 2013) Source: EIA

There are also divergent views that see value in keeping the monopoly of gas transmission pipelines in the hands of major SOEs. Some of the experts interviewed believe that the integration of the gas transmission and production sectors is critical to China maintaining its bargaining power in international gas trade negotiations. Respondents holding this view believed that: A) gas 48

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CEFC China Energy Focus Natural Gas 2013

transmission pipelines have always been a classic example of a natural monopoly where relatively high cost structures exist. Private investors are less interested in and less capable of being engaged in such capital- and technical-intensive industries, and B) integrating the upstream production sectors and the mid-stream pipeline management is necessary to allow major SOEs to retain their negotiation power in global gas trades.

Gas Price Reform Alone Will Not Be Sufficient As some of the experts consulted for this report indicated, if China were to promote the utilization of natural gas, particularly in the power generation sectors, it would need to take a synchronized approach with electricity price reforms. It is widely agreed that the power generation sectors will be one of the most dynamic fields for natural gas utilization in the 12th Five-year Plan and the forthcoming 13th Five-year Plan, but the real key will be to have a more liberal electricity pricing system. Currently, the cost of operating most gas power plants in China is much higher than the on-grid electricity tariff. For example, in Guangdong, the average generation cost of a gas power plant after the price reform remained close to RMB 0.81 per kilowatt hour (kwh), which was much higher than the RMB 0.74 per kwh local on-grid tariff. Facing potential further gas price increases after the latest round of reforms, the gas power plants may have to shoulder an even larger gap between their operating cost and the on-grid tariff. Although many local governments alleviate the price shortfall by providing subsidies, the subsidy level varies significantly among regions. Also, whether the local governments will be interested or fiscally capable of providing subsidies is questionable. As most of the experts indicated, the gas price increase after the 2013 reform may bring higher risks to China’s gas power plants. Despite some integrated measures taken in individual provinces like Zhejiang to adjust gas prices and electricity tariffs, an integrated nation-wide electricity pricing system that can reflect the real operating costs of the plants using different fuels is desperately needed in China. As a solution, some experts believe that increasing the feed-in tariff for the gas power plants during the off-peak hours may be a stepping-stone toward a larger scale gas/power price reform.

CEFC China Energy Focus Natural Gas 2013

Section Five: An Outlook for Natural Gas Development in China 第五部分：中國天然氣發展展望

Section Five: 第五部分：

An Outlook for Natural Gas Development in China 中國天然氣發展展望

Consultation questions: Q26. The IEA projected in a 2011 report that the near energy future will be a “golden era of natural gas”. The White House also sees its domestic natural gas resources as capable of sustaining the American economy for 100 years. Such views inevitably provoked discussion in other major energy consuming nations, particularly in China, as to whether natural gas resources could be an excellent alternative to the coal before renewable energies can be economically and widely installed. Do you agree with this argument? What is the position or importance of NG in China’s future energy profile? Will it ever take the place of coal or liquids? Will such over-emphasis on natural gas divert our energy and attention away from developing renewable energy and clean-coal technologies? Q27. In addition, natural gas, a carbon fuel, retains a carbon footprint. To what degree would switching over to NG consumption help the reduction of carbon emissions? Q28. What part/weight do environmental concerns play in greater gas usage in China, not just for GHGs, but also SOX, NOX, particles, and water pollution that directly touches people’s lives every day? Q29. Under the current system of establishing the price of electricity in China, how will the price adjustment to natural gas affect its end-use application in the power sectors? Will the price of electricity be adjusted accordingly and will the adjusted electricity price be found affordable by the end users? Q30. In the price-chain of natural gas, the middle-stream pipeline price is an important part. Do you think China needs to establish a separate pipeline company to undertake comprehensive monitoring and regulation of pipeline transportation costs?

Responses and Opinions: Development of China’s natural gas industry, still in an early stage, will help to improve the future competitiveness of China’s energy system. Weaning the country off coal and increasing the share of gas has almost been unanimously agreed upon as an important measure to reform the pollution-intensive inefficient energy structure in China. China’s current over-reliance on 50

Section Five: An Outlook for Natural Gas Development in China 第五部分：中國天然氣發展展望

CEFC China Energy Focus Natural Gas 2013

coal and the country’s worsening environmental problems, such as the notorious ‘smoggy days’ in Beijing in early 2013, have added urgency to the need to shift toward more clean energy sources if China wants to realize its sustainable development plan and promote the urbanization rate to 60% by 2020. The strategy of “substituting coal with gas” may be a reasonable option for China, as there are considerably fewer greenhouse gas emissions and other air pollution generated from gas consumption. However, as previously mentioned, the price of natural gas will remain the key to the success of this strategy. It is not only China, but the entire world, that is entering into a natural gas era, as outlined in a special report issued by the International Energy Agency (IEA) in 2011 entitled “Are We Entering a Golden Era of Natural Gas?” If China were to expand its natural gas consumption, it would be necessary to both increase its gas imports and invest more in exploration and development of domestic sources of unconventional gas. China’s vast estimated shale reserves and CBM resources, supplemented by its rapidly growing coal-gasification capacities, can hopefully supply its domestic consumption for another hundred years. However, the concern over the potential environmental costs of exploring for unconventional sources remains, and the price differential between gas supply and electricity tariffs weighs on its long-term viability. Summarizing the views of the experts interviewed, the major challenge to China’s future gas development will mainly depend on the sustainability of the supply and demand sides. After the latest price reform of July 2013, the commercial viability of the supply side can potentially be ameliorated due to the average 15% increase given to the national city-gate gas selling prices. On the demand side, due to the risks to affordability for the major gas users, particularly the gas power plants, it remains to be seen whether the latest price adjustment can realize its designed objective of promoting natural gas consumption.

The Share of Natural Gas Likely to be Capped at 15% Considering the existing government policies that support natural gas development and the business interests in natural gas industries, the share of natural gas in China’s energy mix can be expected to rise as high as 15% from its current very low base of 4%. However, in the view of the experts, considering the limitation of China’s resource endowment, it is unrealistic to expect the country to reach the world average level of 22%. Any target above 15% will be difficult, if not impossible, for China to realize. Nevertheless, China’s limited resource endowment of natural gas should not be taken as a significant impediment to the nation’s goal of expanding natural gas consumption. The experiences of other developed economies, such as Japan and South Korea, demonstrate that the core elements in determining the share of natural gas in the national energy mix lies more in overall economic strength and affordability than domestic supply capacity. 51

CEFC China Energy Focus Natural Gas 2013

Section Five: An Outlook for Natural Gas Development in China 第五部分：中國天然氣發展展望

Political Determination will be an Indispensable Force Unlike previous policies formulated to reform China’s energy structure, many experts believe that the recent decision to increase the supply and demand for natural gas was largely driven by the central government’s perception of the deteriorating environmental conditions and the rising public discontentment over the pervasive and persistent pollution problems. The central government is well aware that, in the current political climate, public concerns over environmental problems can easily spill over into political activism, calling for reforms in many other areas. The central government therefore sees employing its political clout to enforce a higher gas consumption share at the provincial and municipal levels both politically feasible and economically viable, especially while renewables are still in a nascent stage of development.

Price Influence: Central to the Future of Natural Gas Development in China It is critical to emphasize the need to liberalize natural gas prices in China and free them from government regulation -- an ‘invisible hand of the market’ approach. The current artificially low price of natural gas, a contributor to the gas consumption boom between 2005 and 2010, and the recent demand-supply trend have proven again that promoting consumption by means of subsidies is not a sustainable practice. The 2013 price reform marked a good starting point towards fully liberalizing gas prices in China. By raising the city-gate price ceilings by RMB 0.4 per cubic meter and introducing a net-back approach system for the incremental gas consumption nationally, China has made a major breakthrough in liberalizing its gas pricing system and moved toward a more vibrant market orientation. On the other hand, the lack of measures adopted pertaining to the mid-stream pipeline sectors may disappoint those advocating for un-bundling pipeline transportation from production. As some experts interviewed indicated, the current monopoly in pipeline transmission cannot be broken up easily without causing turbulence in the overall supply stability. Also, a strong argument has been made that having pipelines owned or operated by the SOEs will benefit the nation as a whole in international gas trade negotiation (particularly the land gas trades with Russia and the Central Asian states).

Needed: Improved Commercial Gas Statistics and Research Due to the long-term impact of a planned economy system, in the past China did not separate the concept of real energy supply from that of production, and also failed to include the idea of commercial supply volume in its energy statistics. Take natural gas statistics for example - the total wellhead production of the companies in the gas fields now serves as the primary source of data. Based on this figure, cumulative proven recoverable reserves, total production, and remaining recoverable reserves are deducted. The production data can vary significantly from 52

Section Five: An Outlook for Natural Gas Development in China 第五部分：中國天然氣發展展望

CEFC China Energy Focus Natural Gas 2013

the real supply amount, because not all the produced gas reaches the supply side. Underground reinjection, in-field consumption, and sometimes even flaring could consume newly produced gas. Even the gas that goes into the pipelines could also have losses as a result of transportation. Therefore, considering the inability of the current production data to reflect the real supply of gas in the market, it will be necessary for China to introduce the gas commercial volume to measure the supply chain of natural gas, particularly when the central government is providing subsidies to low production wells (including unconventional wells at the beginning stage). It is the view of many of the experts that these subsidies must be calculated based on the real commodity amount instead of the wellhead production amount, as subsidizing the gas used in flaring and re-injection at the wells does not make sense. In view of these concerns, the experts suggest conducting a thorough study of the commercial gas supply volume in China. Under the 12th Five Year Plan, there are voices pushing for the adoption of a 90% commercial rate to act as the benchmark standard for further research, but most of the experts believed this level is too high as the current world average commodity rate of natural gas is between 80-85%, according to the data from CEDIGAZ.

CEFC China Energy Focus Natural Gas 2013

Summary: 調查觀點總結

Based on the responses gained from the interviewed experts, views toward the natural gas development in China can be summarized as the following: Firstly, timing is right for natural gas development in China. The future development of China’s economy is being obstructed by the dual impact of worsening environmental conditions and a tight resource base. How to transform its inefficient and highly polluting energy pattern to a more sustainable form will be critically important for the China’s long-term interest. The Chinese government is expected to unfold a new round of urbanization planning in order to promote its urbanization rate further to 60% by 2020; at the same time, China’s total energy demand is likely to keep a rapid growth rate due to the potential energy demand increase from its enlarged urban population. Natural gas, as a highly efficient thermal fossil fuel source with much lower green house gas emissions (GHS), will emerge as a most feasible and accessible option to aid in resolving China’s energy dilemma. Secondly, the 2015 goal of promoting natural gas consumption to 230 bcm is largely attainable under the current policy scenario and may even be exceeded. Referring to the historical data of consumption growth, and in view of China’s potential GDP growth rate, natural gas consumption could reach as high as 242 bcm by 2015. However, as a coal-rich country where 70% of primary energy consumption comes from coal, the share of natural gas in China’s energy mix is unlikely to exceed 15%. Thirdly, the 2015 production goal of increasing total natural gas production to 176 bcm is likely to be fulfilled and conventional gas will continue to be the major contributor to domestic gas supply. Assuming an 8% annual growth rate, total conventional gas production in China can be expected to reach as high as 134 bcm in 2015 and near 200 bcm in 2020. According to the experts polled by CEFC, by 2030, with the potential of an additional 10 tcm of proven gas reserves, conventional gas production in China will peak at 240 to 280 bcm. Fourthly, the unconventional gas production goals are more uncertain. China’s unconventional gas reserves, a massive resource base, offer a bright prospect in the long term. However, challenges such as exploration rights acquisition, geological survey, pipeline infrastructure, drilling and exploration technologies and even accurate statistics for commercial supply clouds the future of China’s unconventional gas development. Whether the national plan of having 6.5 bcm shale gas output and 16 bcm coal-bed methane (CBM) surface extraction by 2015 can be achieved still remains highly uncertain in the view of the experts interviewed. Further achievements in unconventional gas development will require more state-of-art drilling technologies, pipeline network development, and a market-oriented approach for gas pricing and development rights.

Summary: 調查觀點總結

CEFC China Energy Focus Natural Gas 2013

Fifthly, more competitions should be allowed in natural gas production in China. With reference to the U.S. experiences, it was commonly agreed by the interviewed experts that monopoly of upstream gas production would not be beneficial for the long-term development of the industry in China. The vertically integrated state firms may have an edge in technologies, capital strength and exploration experiences now, but considering the long-term interest of the industry, more competitors in the market will be a prerequisite for a continual improvement in production efficiency. Sixthly, gas imports will continue to grow due to the increased capacity in Liquefied Natural Gas (LNG) receiving terminals and import pipeline expansions. China’s LNG terminal receiving capacity is likely to reach 40 million tons per annum while the land pipeline capacity is likely to total 67 bcm per annum. As most of the infrastructure will be completed in the next few years, further increase in the total gas import volume will become possible. Considering the domestic gas supply and demand growth potential, the total import volume in China is likely to be 93.8 bcm by 2015, close to the number projected in the nation’s 12th Fiveyear Plan. Seventhly, radical reform of the gas pricing system is being implemented in China to replace the old cost-based approach. In July 2013, the old cost-plus pricing approach was replaced by a new pricing mechanism in China that divides national gas prices into two tiers. Prices for the first tier is based on the 2012 real consumption volume of 112 bcm, under which the ceiling city-gate prices will be increased by no more than Chinese Yuan 0.4/cbm and price negotiation will be allowed under this cap. The second tier will be for any excess gas consumption above the 2012 level, and the prices will be linked by heating values to fuel oil and liquefied petroleum gas (LPG) prices (with 60% and 40% weighting respectively) with a 15% discount to ensure a price advantage for natural gas. The approach for the second tier gas prices is also called a net-back approach. Under the new pricing mechanism, the pressure on the major gas importers in China can be expected to be relieved. Eighthly, gas price reform must be synchronized with electricity price reform. Most of the experts consulted by CEFC agreed that gas price reform will not be successfully achieved without also adopting an electricity price reform that accommodates the differing fuel costs of various power plants. The current price gap between the generation cost and the on-grid tariff in China is unaffordable for gas-fired plant operators. If the government were to promote the share of gas-fired plants in its power system, a market oriented on-grid tariff system will be urgently needed.

CEFC China Energy Focus Natural Gas 2013

Part Two:

Perspectives on China’s Natural gas Development

下篇：

中國專家觀點文章

Part Two: Perspectives on China’s Natural Gas Development 下篇：中國專家觀點文章

CEFC China Energy Focus Natural Gas 2013

The New Changes in the World’s Energy Structure: Impact on China’s Energy Security (世界能源格局的新变化及其對中国能源安全的影响) By WANG Haiyun (王海運) 王海運，上海大學上合組織公共外交研究院兼職教授、博導，曾任中國駐俄羅斯前國防武官，少將。 WANG Haiyun (MG) served as a Chinese defense attaché to Russia. He is currently a senior adviser to China Institute for International Strategic Studies and vice-president to the SinoRussian Relations History Research Society. He is also director of the Energy Diplomacy Research Center, China Foundation for International Studies and a doctoral tutor at Shanghai University. His Chinese publications include “Russia in Yeltsin’s Era (5 volumes)” and “Introduction to Energy Diplomacy”. He graduated from the Military Academy of Shandong University. Abstract: The world’s energy structure faces significant new changes due to multiple factors. As China is a major stakeholder in global energy commerce, shifts in the world’s energy map affect China’s energy security in various and profound ways. In order to assure its national energy security, China should adopt innovative strategies in response to the opportunities and challenges arising from such major changes. Keywords: World energy, Structure, Impact, Measures Along with the drastic changes of the international structure, accelerated adjustment of the world order, as well as the breakthrough in the Shale Gas Revolution and the emergence of the third industrial revolution, the world energy structure is undergoing a series of major changes. It is of vital importance to take measures to enhance efficiency and sustainability in times of such strategic change; to conduct in-depth research and properly assess major changes and their impact on the future world energy structure, especially implications for China’s energy security; and to plan countermeasures taking into account energy diplomacy, development, and security strategies.

CEFC China Energy Focus Natural Gas 2013

Part Two: Perspectives on China’s Natural Gas Development 下篇：中國專家觀點文章

I.Major Factors Changing the World’s Energy Structure There are multiple factors bringing about significant change. These include the availability of new energy resources, economic and technological developments, as well as aspects of the international political economy. The following factors are the most prominent. 1.1 The Collective Rise of Emerging Countries Changes the World’s Economic Structure In the 21st century, a large number of developing countries, including China, are capitalizing on the relative ease of global tensions and economic globalization to implement social transformation and focus on economic development. They are creating their own unique development path with characteristics that are different from those of Western countries, and they are realizing rapid economic and social development. The collective rise of emerging countries has become a bright spot in the international relations of the new century. The BRICS (Brazil, Russia, India, China and South Africa) are prominent in such a rise, forming a new cooperation mechanism for emerging powers and increasing their collective participation in world affairs on issues of common interest. Rapid development of emerging countries, especially the progress brought about by industrialization, urbanization and modernization, has resulted in a substantial increase in global energy consumption. Meanwhile, financial crises emanating from the United States have caused the worst global recession in decades. The U.S. economy was plunged into depression while that of Europe suffered from a sovereign debt crisis, and a large number of developed countries were severely impacted. Such a disaster has the characteristics of institutional crisis, so it may take a very long time to recover while inhibiting energy consumption. Energy is a major foundation of economic development. The rise of emerging countries and change in the world’s economic structure impact the global energy sector and lead to significant changes in the world’s energy consumption.

1.2 The U.S. Shale Gas Revolution and Energy Independence Thanks to the technological breakthrough of horizontal well drilling and hydraulic fracturing, America has seen an unprecedented Shale Gas Revolution in recent years. Due to massive exploitation of shale gas, the U.S., with annual production of 624 billion cubic meters (bcm), has surpassed Russia and, in 2009, became the biggest producer of natural gas. Development of shale oil, or tight oil, along with shale gas has also greatly increased U.S. oil production. According to data released by the American Petroleum Institute, the U.S. recoverable conventional and unconventional natural gas reserves rank first in the world, which is 24% more than that of Saudi Arabia. Other unconventional natural gas, such as tight sandstone gas and coal-bed methane, is also abundant in the U.S. With large-scale development of Canadian oil sands and the accelerated exploitation of oil and gas in the Arctic and deep-water areas, the American dream of energy independence is expected to be realized gradually. Although

Part Two: Perspectives on China’s Natural Gas Development 下篇：中國專家觀點文章

CEFC China Energy Focus Natural Gas 2013

energy independence is relative and it is impossible to completely halt importing oil from other countries, America is diminishing its dependence on oil imports and will become an exporter of liquefied natural gas (LNG). It is commonly acknowledged in the international geological field that reserves of unconventional oil and gas in the world are much larger than that of conventional ones. The latter is like the top of a pyramid; while the former is the foundation, which is larger by one or two orders of magnitude. According to an Energy Information Agency (EIA) assessment, global recoverable reserves with current shale gas technology are 187.4 trillion cubic meters (tcm), among which China (36 tcm), the U.S. (24 tcm), Argentina, Mexico and Australia are the top five countries. Inspired by the American Shale Gas Revolution, development of unconventional oil and gas across the world is heating up. With the decline of recoverable conventional fossil fuel in the new century, the world’s oil and gas supply will be significantly enhanced by extensive development of unconventional oil and gas. Also, global oil and gas production will face major changes due to the Shale Gas Revolution and North American energy independence. Massive production of shale gas at relative low cost would also change global energy consumption and pricing systems. Natural gas may gradually take a dominant place in world energy consumption. 1.3 New Energy Development and the Advance of Energy Saving Technologies New energy development and the advancement of energy saving technologies are also important factors bringing change to the world’s energy structure. In recent years, the expectation of conventional fossil fuel shortages, rising oil and gas prices and increasing demand for clean energy development all brought anticipation of new energy technologies and technological breakthroughs in energy saving and efficiency. Development costs of alternative energy resources such as solar, wind, and biomass energy are decreasing and their effects on replacing conventional fossil fuels are increasingly obvious. Development and utilization of high-cost new energy technologies such as nuclear fusion energy and methane hydrate are also coming to a new age. The Obama administration believes that whoever leads in clean energy technology for the 21st century will lead the global economy. Energy Revolution will be more significant and profound than that of the information technology revolution in the 20th century, and will cause the largest economic, social and environmental transformation of the 21st century. Realizing that new energy development may lead to the third industrial revolution in human history, the U.S. government launched the Blueprint for a Secure Energy Future on March 30, 2011, which laid out Obama’s new energy strategy. Its main objective is to establish America’s core competitiveness in new energy fields while coping with economic crises and recapturing leadership in global energy. Other major powers of the world also became aware of the impact of new energy development on the global economy and technology, and they are increasing investment in energy technology.

CEFC China Energy Focus Natural Gas 2013

Part Two: Perspectives on China’s Natural Gas Development 下篇：中國專家觀點文章

Indeed, an industrial revolution focused on new energy development is unfolding. The proliferation of new energy development and applications will impact the world’s energy production and, more significantly, the world’s energy consumption. Consumption of renewable clean energy is on the rise and this has a profound impact on energy consumption. Advancement in energy saving technology is affecting the world’s energy profile in another direction as well. Not only does it decrease the intensity of energy consumption and ease pressure on global energy supply, it also has a substantial impact on changing the world’s current energy structure that relies on massive consumption of fossil fuels.

II.Possible Changes to the World’s Energy Structure Under the joint effects of the various factors listed above, there is a likelihood that the world’s energy scenario will be subject to substantial changes in the next decades.

2.1 Possible Changes to the World’s Energy Production Pattern The current world energy production structure can be described as one Superpower and several Major Powers. The one energy Superpower is the Persian Gulf, which is the main producing area of world oil and gas. Other major producing areas include North America, Latin America, the recently developing areas of the Caspian Sea, and African oil and gas producing areas. The emergence of the Shale Gas Revolution and growth of the North American energy sector may see the world energy production structure evolving toward two energy Superpowers – the Gulf and North America -- and several Energy Producing Centers. The Persian Gulf has the most abundant oil and gas resources, accounting for more than onethird of the world’s proven oil and gas reserves. Due to the relatively low development cost, the Persian Gulf has been the world’s major producing area of oil and gas for decades. Despite the Iraq War, democratic unrest in West Asia and North Africa, and the Iran Nuclear Crisis and consequent hit on oil and gas production in some countries in the region, the Middle East remains the center of world energy production. Upheaval in West Asia and North Africa might well persist but it is unlikely that several major producing countries would be simultaneously disrupted. For the next few decades, this region will remain the foremost important oil and gas producing area in the world. North America has always been an important oil and gas producing center. Now the U.S. leads in shale gas exploitation and that development is bringing prosperity to the oil and gas industry by significantly increasing their reserves and production in North America. In 2011, U.S. oil production reached 10 million barrels per day, thus making the U.S. the number three producer after Saudi Arabia and Russia. Coupled with Canada’s enormous potential for additional oil sands development and oil and gas development in the Arctic Region, North America may become the second major oil and gas producing area after the Persian Gulf. The Citibank 2020 Global Energy Report predicts that North America will become the New

Part Two: Perspectives on China’s Natural Gas Development 下篇：中國專家觀點文章

CEFC China Energy Focus Natural Gas 2013

Middle East of world oil and gas supply by 2020. The International Energy Agency (IEA) forecasts that by the middle of 2020 the U.S. will surpass Saudi Arabia as the largest oil producing country in the world; by around 2030, the U.S. will be energy independent although 20% of its current energy demand still relies on importation. According to the forecasts of BP’s 2030 World Energy Prospect, countries in North and South America will increase their daily oil production by 8 million barrels due to advances in production technology, of which oil sands in Canada represent 2.2 million barrels per day, deep water oil of Brazil 2 million barrels per day, and shale oil of America 2.2 million barrels per day. In addition, the U.S. and Brazil contribute more than half of the world’s total increment of bio-fuel production by 3.5 million barrels per day. It is clear that long-term U.S. dependence on imported oil and gas is declining and is also anticipated to becoming capable of supplying petroleum products and gas to Europe, Japan, Korea, India, and other areas. This development reinforces its stature in the world’s energy map and its influence on the world economy. This trend will also accelerate the refocusing of the international oil trade toward Asia and draw greater attention to the issue of security of strategic maritime trade routes between the Middle East and Asia. Oil and gas production in other areas of the world will also increase due to technological progress in conventional oil and gas production and the launch of unconventional oil and gas development. However, compared with the Middle East and North America, these regions’ ranking in terms of the world’s energy production may decline. Therefore, due to the substantial rise in North American world oil and gas reserves, it will not take long to transfer the world’s energy production from “one Superpower and several Major Powers” to “two Superpowers and several Major Powers”. 2.2 Possible Changes to the Pattern of World Energy Consumption Currently, developed countries dominate in the consumption of the world’s energy and in the global energy governance. This is due to the fact that not only do developed countries far exceed developing countries in both total consumption and per capita consumption, but also because developed countries acquired stronger decision-making power, regulatory power and financial control. The Group of Seven industrialized nations comprises 11.5% of world population but accounts for 45.2% of world oil consumption – the United States alone accounts for 25.5%. In recent years, the world’s oil market has been volatile. Developed countries represented by the U.S. are responsible for 70% of oil price changes through capital speculation. However, the contrast of energy consumption between developed countries and developing countries is undergoing great changes. On the one hand, as a result of deep economic recession in developed countries and energy-saving measures they have taken, a turning point in energy consumption may come in the near future. The increase in energy consumption by developed

CEFC China Energy Focus Natural Gas 2013

Part Two: Perspectives on China’s Natural Gas Development 下篇：中國專家觀點文章

countries will become stagnant to declining. In other words, it will not take long to see the peak of energy consumption of developed countries. On the other hand, in developing countries, and especially among emerging powers, energy consumption will continue to grow. This is due to these nations’ rapid economic development, lower industrial base, inefficient energy utilization as well as population growth, accelerating urbanization, and improvement in standards of living. The IEA predicts that by 2035 total world energy demand will reach 16.96 billion tons of oil equivalent driven by the emerging economies. Consistent with the trend that the world’s economic center is moving to Asia Pacific, Asia, where emerging economies are mostly concentrated, shows the greatest energy consumption growth. According to IEA forecasts, 90% of oil exports from the Middle East will go to the Asian markets by 2035. The divergent trends in energy consumption in developed and developing countries will lead to great changes in the structure of global energy consumption and energy trade. Consequently, the total energy consumption of developing countries may gradually surpass that of developed countries.

2.3 Possible Changes to the World’s Energy Sources The possible change in the world’s energy source is from coal and oil to natural gas and other types of clean energy. The key factors of the change are as follows: First is the development and utilization of shale gas. As production of U.S. shale gas increases, the price of natural gas decreases. As a result, in 2011 U.S. coal-fired capacity utilization decreased by 19% while gas-fired capacity utilization increased by 38%. Forecasts suggest that by 2030, U.S. natural gas use may exceed that of oil to become the largest energy source. Many other countries in the world have begun to think about keeping up with the U.S. development of shale gas. Estimates of technically recoverable unconventional natural gas resources are growing substantially worldwide and may have a broad impact on the world’s energy production scenario. As predicted by the IEA, unconventional natural gas production will be approximately half of global natural gas production by 2035, most of which will be coming from China, the U.S. and Australia. Massive commercial development of shale gas will possibly have a sizable adjustment in energy structure and affect the current demand and supply interplay of natural gas and thus its prices globally. Under a much lowered gas price scenario, countries around the world will have more incentive to increase the share of natural gas in their energy consumption. The second factor is the demand for clean energy development. It is mainly due to energy consumption, especially the extensive utilization of coal and other fossil fuels that sharply increased CO2 and other greenhouse gases in the atmosphere, leading to higher global temperature and frequent natural disasters. In order to cope with dangerous global climatic changes, there is a pressing need to accelerate the development of clean energies: not just greater efforts in

Part Two: Perspectives on China’s Natural Gas Development 下篇：中國專家觀點文章

CEFC China Energy Focus Natural Gas 2013

energy savings and emissions reduction, but also expanding the development and utilization of clean energy resources. According to a 2012 report by the IEA, by 2035 renewable energy can account for one-third of global electricity generation. Technological progress leading to new energy sources and extensive utilization of renewable energies will reshape global energy. The third factor is the emergence of the third industrial revolution. Similar to the first two industrial revolutions marked by the advent of steam-powered technology and the internal combustion engine, the third one is foremost manifested by an energy revolution, too. The core concept of the revolution is to solve the challenge of clean energy development and sustainable utilization. Thus, many world experts also call the energy revolution a low carbon revolution. Its significance can be summed up in one sentence: whoever leads in the low carbon revolution will be able to lead world economic development. Today major countries in the world are increasing their investment in clean energy and low carbon development. In terms of the production scale of the renewable energy equipment, China is taking the lead globally. However, concerning the core renewable technologies, countries in Europe and America remain to be the leaders. Due to the factors outlined above, in the future natural gas may catch up with or even pass oil and coal to become the world’s most important fossil fuel. Clean energy resources such as solar, wind, bio-fuel, nuclear energy and hydroelectric power will occupy a greater share in world energy.

III.The Influence of the Changing World Energy Patterns on China’s Energy Security Changing world energy patterns is a key issue for China. China is not only a large energy consuming country, but also a large global energy producer. The new changes in world energy patterns will have wide and significant impact on China’s energy security. 3.1 Impact on China’s Energy Supply China’s energy consumption is growing continuously. In 2012, China’s consumption accounted for 20% of the world’s total energy consumption and spurred debates on whether China remains the second largest energy consumer or has ascended to be the largest. Although China’s energy production is first in the world, its energy resource endowment is rather limited. The country’s conventional oil and natural gas reserves per capita are relatively low, and energy resource limitations are obvious. China has a large share of high energy-intensive industries and inefficient energy utilization. Energy consumption per unit of GDP growth is far higher than even some emerging economies, not to mention that of the developed countries. The general recovery rate of coal resources in China is only 30%, and efficiency in the transmission and end-use process is only 36%. In 2011, more than 13% of China’s total energy supply required imports from other countries. In particular, the share of imported oil increased from 32% to 57%. Besides oil, natural gas and uranium resources, China has also switched from being a net

CEFC China Energy Focus Natural Gas 2013

Part Two: Perspectives on China’s Natural Gas Development 下篇：中國專家觀點文章

exporter to a net importer of coal in the past ten years. China’s cumulative increases in energy consumption represent 53% of the world’s total energy consumption increase - at a growth rate three times faster than the world average. In the next decade, China will enter into a key development period of industrialization, urbanization, and modernization, and any reform of its less efficient coal-oriented energy structure will only become more difficult. In addition, due to the long-existing institutional problems in China’s energy industry, it will not be possible to quickly re-direct the massive energy demand to cleaner energy sources. It has been anticipated that under the current-policyscenario, the total primary energy consumption of China will reach 4.1 billion tons of coal equivalent and have 70% of its oil supply from imports by 2020. China’s aggressive growth in energy consumption presents structural challenges to the world’s slowly increasing energy supply. This will obviously make it more difficult and expensive for China to obtain imported energy. It could result in conflicts between China and other countries. If the trend continues, it is just a matter of time before China’s energy security will reach a tipping point: energy from foreign sources will be increasingly hard to get, challenges will increase and national energy security will not be maintained. While for other reasons some countries exaggerate the idea of a “Threatening China,” the fact is China could easily be placed in a strategically disadvantageous position if its dramatically growing reliance on imported energy cannot be slashed. The current changes in the world’s energy patterns are like the two sides of a coin as far as China is concerned. On the positive side, in view of the large scale of worldwide unconventional fossil fuel resources, the international energy market will see a boom in supply. Since the major developed countries have relatively stable or even decreasing energy demand, global trade dynamics are moving in the direction of ample energy supply. Moreover, China has been making breakthroughs in energy efficiency technologies and its plan for new energy development can also be expected to lead the world some day. Plus, China’s negotiation powers in energy deals are improving, and the capital cost of it in obtaining energy resources can also be expected to decline. Furthermore, the “Shale Revolution” in the United States puts pressure on that country’s geopolitical rivals such as Iran and Russia. Especially in natural gas, the rapid development of shale gas in the U.S. has not only stopped Russian gas from flowing into the North American market, but it has also lowered world gas prices, diminishing the possibility of Russia demanding a high price for natural gas to China. Under such circumstances, China will probably be able to take accelerated advantage of Russian efforts to initiate energy cooperation with China. Fiona Hill, an expert on Russian issues at the Brookings Institution, believes that the time has passed when Russia could control the European natural gas market. A report entitled “Shale Gas and US National Security” published by the Baker Institute of Rice University, suggests that the “Shale Revolution” will ultimately reduce Russia’s share in the European natural gas

Part Two: Perspectives on China’s Natural Gas Development 下篇：中國專家觀點文章

CEFC China Energy Focus Natural Gas 2013

market from 26% in 2007 to the level of 13% by 2040. The energy independence of North America may even encourage energy exporting countries in the Middle East, Central Asia, and Latin America to cooperate more proactively with China. Meanwhile, more problems will arise as well. First, China’s growing energy demand and strong desire for reliable energy supply will put it in an even more difficult position to refute the so called “China swallows the world’s energy” statement. China is growing to be the world’s largest energy consuming country, and, in another couple of years, the world’s largest energy importer. What is worse, China still could not exert sufficient influence on the order of global energy trade to reflect its economic clout. The growing price of whatever energy China buys from the international markets really costs China more compared with the price paid by Western countries. As the U.S. is going to be “energy independent” it will depend less on oil supply from the Persian Gulf. Thus the United States will have greater flexibility to create problems in the Middle East, in order to prevent the rise of emerging countries. However, due to the growth in energy demand, China will have to rely on the Middle East for more than 50% of its oil imports. In order to maintain stability, China will have to make greater effort and take more responsibility in carefully tackling international issues. Another point of concern is the fact that the Shale Revolution in the U.S. is disrupting world LNG supply patterns, and potentially allowing previously regional LNG markets to converge. The large supply of U.S. natural gas will enable the United States to export its natural gas to European and Asia-Pacific markets, thus transferring the world’s price benchmark to the U.S. Given the fact that the U.S. already holds a predominant position in global energy and finance, if the United States assumes the predominant place in world’s natural gas supply and transport value chain, U.S. hegemony in the global natural gas market would grow. Once the U.S. possesses the ability to set the global price of natural gas, it will surely propose to maintain the use of U.S. dollars for pricing and settlement in order to further enhance the U.S. dollar’s dominant position in the global currency system. In that case, if China wants to obtain natural gas supplies at a reasonable price, it will have to face the serious challenges in the natural gas trade and finance sector. In addition, the U.S. Shale Revolution also results in significantly cheaper oil and gas prices in the United States as compared to European and Asian markets. This will provide the United States with relatively cheap and clean energy sources and the raw material for its chemical industry. This will result in an expansion of the chemical industry and a return to the U.S. (“re-shoring”) of other energy intensive manufacturing industries, thus revitalizing the American economy. A former head of China’s National Energy Agency noted that the natural gas price in the U.S. is “almost as low as one third that of China and one sixth that of Japan.” Cheap energy supplies will widen the gap between energy costs for U.S. domestic industries and those of other countries, giving American products a greater comparative advantage. This

CEFC China Energy Focus Natural Gas 2013

Part Two: Perspectives on China’s Natural Gas Development 下篇：中國專家觀點文章

“re-industrialization” is proceeding in the United States and with improved manufacturing of export products U.S. goods will represent new competition for China and a challenge to Chinese international trade in manufactured products for export.

3.2 Impact on China’s Energy Transportation The current world energy transport system features large volume and concentrated routes. According to statistics from the Maritime Journal, maritime transportation of goods accounts for 75%-80% of the world’s total goods transportation. In 2011, more than 50% of the world’s total crude oil and liquid fuels consumed was shipped via tankers. The world’s seven major maritime transportation routes include the Persian Gulf to East Asia routes, the Persian Gulf to Western Europe and the Americas routes, and the Persian Gulf to Western Europe and North America routes, North Africa to Western Europe and Scandinavia routes, West Africa to North American routes, the West African route to Western Europe, and Latin America to North America and Caribbean routes. Since some of these routes overlap, some of the world’s shipping choke points are formed, such as the Mandeb Strait, Hormuz Strait, and the Strait of Malacca. To a large extent these choke points affect the proper functioning of the global transportation system, and thus constitute special risks in terms of global energy transportation security. If any one of these shipping choke points were blocked, the global energy transportation system would become paralyzed, and crises would occur in global energy markets. The world’s most important maritime transposition choke point is the Strait of Hormuz. The daily volume of crude oil transported through this strait was 17 million barrels in 2011, constituting 35% of the world’s total maritime transported oil volume, and 20% of world oil supply. Some 85% of that transported volume flows to Asian markets such as Japan, India, and China. It was indicated by many Chinese scholars that “If the Hormuz Strait were cut off, basically it would mean that the valve of world’s oil reservoir would be switched off.” The world’s oil supply would drop by one third, and the global energy market would witness extreme volatility. The Strait of Malacca is another important global maritime transportation choke point. The strait is located between the Malay Peninsula and Sumatra, connecting the Andaman Sea and the South China Sea, an area that is the transport hub for Eurasia, Africa and Australia. It is also the scene of maritime military maneuvers and a channel for the transport of strategic material for the U.S., Russia and Northeast Asian countries. More than 80,000 ships pass through the Malacca Strait, accounting for more than 25% of the world’s trade volume. Some 90% of Japan’s oil and other raw materials from Africa and Middle East are shipped through the Malacca Strait, so is 80% of China’s crude oil imports. Since the economy in the Asia-Pacific Economic Cooperation (APEC) area is growing rapidly, the economic and strategic importance of Malacca Strait will be even greater.

Part Two: Perspectives on China’s Natural Gas Development 下篇：中國專家觀點文章

CEFC China Energy Focus Natural Gas 2013

The Arctic waterway also draws attention as a potentially important maritime route. The Arctic waterway goes across the Arctic Ocean, connecting the Atlantic and Pacific Ocean. It includes mainly the northeastern route and northwestern route. If the Arctic waterway is open, it will have significant impact on the global geo-economy and oil and gas supply. This is not only because there are abundant oil and gas reserves in the Arctic area (according to a July 2008 report released by the United States Geological Survey, Arctic oil resources are around 900 billion barrels and natural gas resources are 47.3 trillion cubic meters, representing 13% and 30% respectively of global proven oil and gas reserves), but also the Arctic waterway will substantially shorten the transportation distance and time between Europe and East Asia. The new changes in the world’s energy patterns have the following features: large scale development of unconventional fossil fuels in Northern America and regional “energy independence” will significantly decrease U.S. oil imports from other places in the world, especially the Middle East, and the U.S. will become less dependent on maritime transportation routes. This will diminish the demand for maritime transportation security for the U.S. so that it may be able to reduce its military presence in strategic areas such as the Middle East and, in doing so, save money. However, this may also liberate the United States to interfere more in this strategic area. For example, the U.S. will be less concerned about the negative impact of carrying out a military strike on Iran. Currently, the U.S. deploys its military forces along the world’s major maritime shipping routes and controls these countries and their neighbors. It is certainly hegemony. At the same time, we cannot deny that the U.S. plays a positive role in maintaining the security of global maritime transportation. It was estimated that the U.S. Fifth Fleet costs around 60-80 billion dollars per year to protect the Persian Gulf waterway. With less reliance on oil and gas from the Middle East and with the strategic focus shifting toward the Asia Pacific, together with a diminishing American national security budget, we can anticipate that the U.S. will spend less on the protection of Middle East transportation routes. However, the U.S. could not possibly reduce those military deployments if it wishes to maintain its strategic position as “world leader”. Under these circumstances, China, as a large energy importing country dependent on maritime transportation, must make an effort to fill in the blanks created by a U.S. military retreat from the Middle East. This means that China will have to break its ban on having overseas military bases. China will have to carry the burden of addressing greater military and political risks, so that it can directly take part in those geopolitical games with the U.S. and other Western countries. What is more, as the U.S. “pivots to Asia” in order to contain China, causing issues and tensions in the seas near China, it will be essential to preserve the absolute connection between the Malacca Straits and the South China Sea for China’s energy security. In order to avoid the risks stemming from maritime transportation, China has accelerated its onshore oil and gas transport corridor strategy. Currently, onshore oil and gas transport

CEFC China Energy Focus Natural Gas 2013

Part Two: Perspectives on China’s Natural Gas Development 下篇：中國專家觀點文章

corridors, including the Russian pipeline in the north, Central Asian pipelines in the west, and the Myanmar pipeline in the south have been formed. This will greatly help to avoid maritime transportation risks and increase energy transportation security. Even if China were to further develop onshore oil and gas transportation, one cannot exclude the possibility of interference by the U.S. For instance, the U.S. could stimulate a “democratic crisis” in West Asia and North Africa (WANA), redirecting Islamist extremism and international terrorism toward China and its nearby areas. Taking into account NATO forces will retreat from Afghanistan and countries in the WANA area, which have very similar social patterns and political forms. China will have to pay more attention to these challenges when considering whether to construct onshore corridors for oil and gas transportation, especially if Western countries do attempt to instigate “democratic unrest”.

3.3 Impact on China’s Energy Pattern The new changes in the world’s energy patterns will also have a very clear impact on China’s energy. China will significantly increase its share of clean energy usage and decrease its use of coal. China has become the largest CO2 emitter and the pressure to solve climate change problems is growing. In the next ten years to several decades, China’s economy will remain at the medium and low growth rate, and energy consumption will significantly increase. If China does not try to adjust its energy demand, its coal consumption and greenhouse gas emissions will greatly increase. Since the U.S. is generally substituting coal use with natural gas and renewable energies, China becomes the main target in international emission mitigation negotiations. There is pressure on China to change its coal-based energy consumption and reduce its CO2 emissions. In order to reduce the share of coal in China’s energy demand, alternative energy sources, including nuclear, natural gas, hydroelectricity, solar and wind power, must be developed. This is an urgent and challenging problem. The success of U.S. shale gas development and China’s abundant shale gas resources make it very promising for China to develop its unconventional natural gas on a large scale. However, China has more complex conditions than the U.S. The major shale gas resources in China are located in mountainous areas and in deserts where water is lacking. In addition to low technological capabilities and institutional problems, China will have to devote more effort to realizing commercial gas extraction. Therefore, it will take a long period of time to enhance China’s energy structure though shale gas development. Changes in global energy and international pressure from climate change, in particular, have resulted in China accelerating its renewable energy development. China has very strong equipment manufacturing capabilities for solar and wind and is currently the world’s number one producing country for both. In the past decade, China’s installed capacities for solar and wind have increased by 118 times and 67 times respectively. By October 2012, China’s connected wind capacity was 55.89 gigawatts (GW), the largest in the world. However, China’s

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CEFC China Energy Focus Natural Gas 2013

renewable energy share in its total energy consumption is still only at the world’s average level and there are technological difficulties in connecting sources of renewable energy production to the national grid. How to solve such technological and institutional problems and limitations are obvious problems that China faces.

IV.Thoughts on the Changing World Energy Patterns Energy security is the core of national security and is an important subject for sustaining peaceful development. Faced with the new opportunities and challenges that come with shifts in global energy patterns, China has to focus attention on possible changes in the mid to long term both domestically and internationally, and apply strategic measures in order to ensure national energy security and sustain its peaceful rise. First, China should draft a national energy strategy for the new era to adjust to the change in global energy patterns. The national energy strategy in the new era should fit the world’s energy security order. This order consists of a system of effective energy use, a safe and stable modern industrial system, efficient energy use, early warning and emergency response systems, and a cooperative security system for the development and utilization of the world’s energy resources. The core goal of this strategy is to improve China’s energy supply stability, reasonable demand management capability, risk control ability and the capability to deal with international impact on the energy market. In order to enhance energy supply adequately, stably, economically, cleanly and effectively, there must be further reform of the energy management system and the energy security system, together with a cap on total energy consumption. It will also require China to propose energy production reform, upgrade its energy consumption structure, and improve energy use efficiency and control energy intensity of its economy. Moreover, China should also enhance international energy cooperation and human resource building that matches its modernization, international energy development and energy diplomacy needs. Second, China should add defense of its national energy security to its general strategy of breaking containment by the U.S. Based on historical experience, the U.S. prevents its rivals’ development by disrupting their energy security. When the U.S. becomes “energy independent,” it will have better conditions to block China’s overseas energy development. Thus, the goal of defending China’s energy security must be included in the general strategy of breaking containment by the U.S. While we should continue the existing cooperation with the U.S. in the energy sector, in particular, on energy technology, on the other hand we should make necessary plans to defend China’s equal rights to use global resources and to play under WTO rules. Third, China should act more as a great power in promoting global energy governance and constructing a new international energy order. China should fully consider the strategic necessity of playing the role of a responsible great power, understanding the fact that global energy security cannot be divided. China should propose a concept of global energy security and enhancing the value of energy security cooperation, encouraging countries to cooperate in

CEFC China Energy Focus Natural Gas 2013

Part Two: Perspectives on China’s Natural Gas Development 下篇：中國專家觀點文章

various ways and work collaboratively to reassure each other. China should also act more as a great power on the global energy stage, with its special role of being both a large energy consumer and producer. It should also build relations within international energy organizations as well as with other countries, so as to enhance its own energy position in the world. It must build a new international energy order based upon general rights that are stable, mutually beneficial, reasonable and harmonious in order to ensure a good international energy environment. To achieve all these targets we should promote the establishment of new multilateral energy cooperation mechanism among consumer and transit countries; promote price coordination among resource producing and consuming countries in order to balance benefits; halt the ravages of resource colonialism; and maintain the stability of the world’s major energy supply; promote the world’s major economies working together to strengthen financial regulations in energy trading and reduce the volatility of international oil and gas markets; suppress resource nationalism and the spread of trade protectionism and promote the development of a more open international energy system; establish a re-distribution system for benefits from natural resources between emerging countries and developed countries, and strive to achieve greater energy development and energy security space for emerging countries; advocate energy cooperation to follow the rules of market economics, mutual benefit and win-win principles and oppose the “politicizing” of energy relations. Fourth, China should focus its international energy cooperation on more onshore areas. While preventing maritime energy transport from being interrupted or destroyed by hostile forces and reducing the possibility of conflicts with other great powers who deploy their military in the maritime transport choke points, China should put more emphasis on the onshore energy transportation in order to reduce its huge dependence on maritime transportation routes. China should prioritize building good relations with land bordering countries, and Chinese energy companies should also consider land-bordering countries as their primary foreign investment destinations. Bearing in mind that Central Asian countries and Russia are blessed with abundant energy resources, there is need for further development of friendship with these countries in order to build China’s geopolitical alliance in the way of friendship, stability and economic cooperation. In order to avoid energy security problems coming from long-term instability in the Persian Gulf, China has to transfer its energy cooperative strategy more toward Central Asia, Russia, and other friendly neighbors. By implementing the “Move West” and “Modern Silk Road” strategies, China will accelerate building land routes. In the short run, however, China will not be able to do without oil from the Persian Gulf, so China will also continue to build energy partnerships with major oil producers like Saudi Arabia in order to provide itself with more energy supply networks while it enhances collaboration with neighbors. Fifth, make the oceans the focus of energy development and future security strategies. The growing opportunities in global maritime energy development make China’s task of asserting maritime sovereignty and the sovereign rights over the oil and gas resources more difficult to

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CEFC China Energy Focus Natural Gas 2013

conduct. Whether China could be a real maritime great power is key to whether China is to rise or not. To develop more energy resources in the ocean, which is a core objective, both national energy security and maritime sovereignty should be enhanced. Since energy security is both an economic activity and an international political task, it should be well focused. We should fully understand the importance of oceans’ geo-economic and geo-political value and try to capitalize on the sea and ocean nearby as our strategic energy security replacement area. In order to accelerate oil and gas development in the ocean, we should raise the nation’s maritime awareness and preservation of marine sovereignty and awareness of marine resources. This will shift the nation’s geo-strategic positioning as a “big land power” to a “land and sea power”, requiring national oceanic strategy, changing the poor development of oceanic territory and oceanic resources, establishing regulatory incentives to assist ocean development, and designing a flexible and efficient oceanic resources management system. Sixth, China should lead the world’s new energy revolution. As an emerging country, China has to fully consider the energy revolution’s strategic impact on the country’s rise, attempt to lead the third industrial revolution, and lead the world’s technology development while reducing high energy consumption and environmental pollution. Therefore, the country should enhance technological innovation and systems to achieve low carbon, clean and green development on the one hand; and, on the other hand, it should enhance international collaboration and energy diplomacy in this area. In the field of technological innovation, China should fully exert the advantages of its politically centralized system and its exploration spirit seen in the nuclear and satellite testing in the 1960s to make substantive breakthroughs in key technology areas. Introducing green life styles is another way to greatly reduce energy consumption. We should enhance the nation’s ecological culture, propose low carbon life styles, and promote the application of the “green revolution.” At the same time, we should admit that the switch from fossil fuels as the major energy source cannot take place in the near future. Thus, an industrial breakthrough must be achieved by means that make structural adjustments, improve energy efficiency technologies, and reduce energy intensity so as to reduce energy consumption via a “bottom-up” approach and keep imported energy dependence within a reasonable range.

CEFC China Energy Focus Natural Gas 2013

Part Two: Perspectives on China’s Natural Gas Development 下篇：中國專家觀點文章

The Supply Situation and Outlook for Natural Gas in China (中國天然氣供應形勢與發展) By ZHANG Kang (張抗) 張抗，曾任中石化石油勘探開發研究院總工程師，退休後任諮詢委員會副主任。 ZHANG Kang is the deputy director of the Consultant Committee of the Exploration and Production Research Institute (EPRI) of Sinopec. He used to serve as the chief engineer of the Institute before his retirement. His major research works include: “the Life Cycle of Oil and Gas Fields and Tactics and Strategy to Succeed (Chinese)”, “Strategies for China’s Oil and Gas Development (Chinese)” and “The Geopolitical Aspect of Oil and Gas of China and the World (Chinese)”. He graduated from the Department of Geology, Peking University in 1963 and earned a Master’s degree from the Chinese Academy of Sciences in 1981. Abstract: Since the beginning of the 21st century, China’s annual production growth rate for conventional natural gas and tight sand gas reservoir has dropped from a double-digit rate to a growth rate in the single digits. Production is expected to reach 134 billion cubic meters (bcm) by 2015, and once the commodity rate achieves 90%, supply may reach 120.6 bcm. Shale gas, a new type of energy resource, is expected to contribute 0.6 bcm to China’s commercial gas supply in 2015. Coal-bed methane (CBM) production has fallen behind forecasts due to statistical flaws. On the basis of the increasing trend in usage, commercial CBM utilization is projected to reach 10 bcm by 2015. Development of coal gas has yielded many new results, and the supply in 2015 may rise to 5 bcm based on the achieved capacity. To sum up, by 2015 the overall domestic gas supply may amount to 136.2 bcm. If consumption is projected to be 242 bcm, imports should be 104 bcm. Based on the actual imports of pipeline gas, liquefied natural gas (LNG), and increased imports of both, there is the likelihood that natural gas imports will be available as projected. As part of the fundamental research for the 13th Five Year Plan (2016-2020), there is a need to improve statistical reporting on the actual supply of gas as a commodity. The key factor affecting the development and production of gas is whether China will make a timely breakthrough in the reform of its economic system. 72

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CEFC China Energy Focus Natural Gas 2013

Keywords: Natural gas, 12th Five Year Plan index, Commercial gas, Shale gas, Coal-bed methane, Coal gas The 12th Five Year Plan (2011-2015) to develop China’s national economy, now more than half way through its implementation, is in need of re-assessment to assist research for the 13th Five Year Plan. In particular, at issue is whether its targets can be fulfilled. For this purpose, the following article provides an analysis of the short-term situation of natural gas/fuel gas and, in the conclusion, makes a rough prediction on an achievable target as a reference. When doing research on the statistical system of China’s natural gas, there is a need to examine its specific characteristics, as is done in the following analysis: 1. The natural gas production statistics provided by China include tight gas with that of conventional gas, but tight sand gas more properly belongs in the category of unconventional gas. Upon China’s exploration of the reservoirs of macroscopic variance, it includes estimates for tight sand reservoirs, but only hydraulic fracturing and horizontal drilling can access the tight gas reservoirs. At present, there is neither a clear line to define a tight sand reservoir nor systematic statistics measuring tight gas reserves and production, so they are usually counted as constituents of conventional gas; 2. The current management of coal-bed methane reserves and production is inadequate. The statistics are retrieved from various sources and there are big differences among the figures; 3. There is a lack of serious statistics for commercial gas so many people equate well-head production with market supply. There will be an artificial gap between demand and supply if the production plan is composed in this way. The influence is more obvious with regard to the low-commodity rate of coal-bed methane; 4. At present, China’s gas fuel supply does not include coal gas (including coke oven gas), biogas, and other artificial gas; in the future, however, they will be produced in scale, at which point the supply cannot be ignored anymore. They will also appear on the list of suppliers, and the target of our research will be expanded from natural gas to fuel gas (also known abroad as gas fuel).

I.Change in the Recent Production Situation 1.1 Proven geological reserves of natural gas are expected to gain extra growth China’s modern natural gas industry entered a stage of rapid development in the last two decades of the 20th century, with an annual growth rate of geological reserves around 17.3% in the 1990s. However, as the base increases and new discoveries decrease, the growth rate declined to single digit percentages by the early 21st century, to approximately 9.47% between 2001 and 2005. The annual growth rate of geological reserves was 8.0% during 2005-2010, 7.99% in 2011 and 9.53% in 2012. The greater concern is the change in the assessment of recoverable reserves. The greater the proportion of tight sand gas in newly discovered and recoverable reserves, the lower the quality of those reserves. Besides, increased annual production has resulted in a declining annual

CEFC China Energy Focus Natural Gas 2013

Part Two: Perspectives on China’s Natural Gas Development 下篇：中國專家觀點文章

growth rate for the remaining recoverable reserves and diminished the recoverable reserves. The annual growth rate for the remaining recoverable reserves is lower than the annual growth rate for the geological reserves by 1.37% and 2.33% in 2011 and 2012 respectively (See Table 1). Based upon the above, the author assumes that the annual growth rate of geological reserves and the annual growth rate of remaining recoverable reserves are 8% and 7% in 2014 and 2015 respectively, and forecasts that the accumulative proven geological reserves and remaining recoverable reserves will be 13.616 trillion cubic meters (tcm) and 3.817 tcm in 2015; meaning that the increment will be 4.48 tcm and 1.09 tcm respectively in the period of the 12th Five Year Plan, and will exceed the target (3.5 tcm) in terms of geological reserves. Table 1. Change of Natural Gas Reserves 2005-2015 Source: National Oil and Gas Reserves Journal, the annual growth rate for 2015 was set at 8%/7%

Project / Unit

2005 (bcm)

2010 (bcm)

Annual 2011 Annual growth (bcm) growth rate/% rate/%

Geological reserves

6217.6 9138.5

8.00

9868.4

Remaining recoverable reserves

2818.5 2725.7

-0.67

2906.1

2012 (bcm)

Annual growth rate/%

2015 (bcm)

Annual growth rate/%

7.99

10808.8

9.53

13616.0

8.00

6.62

3215.4

7.20

3816.5

7.00

1.2 Growth of Conventional Gas and Tight Sand Gas Production Slows Down China’s natural gas production growth experienced a cyclical change in the last two decades. The production exceeded 20 bcm in 1996 and reached 35 bcm in 2003 with an annual growth rate of 7.23%-12.73% and average growth rate of 8.71%. Production further exceeded 40 bcm in 2004 and 80 bcm in 2008 with a high annual growth rate (15.97%-18.96% and 18.07% on average). After 2008, the production continued growing and exceeded 100 bcm by 2011; however, the growth rate then declined dramatically, averaging 7.37%, except for 2010 when growth was at 11.23%. The continuous decrease in the annual growth rate is related to the increased proportion of tight sand gas in the mix. The average annual growth rate between 2010 and 2012 is 6.07%, and the production was predicted to be 115 bcm in early 2013 while the corresponding annual growth rate was 7.77%. Based on the analysis above, the author assumes the annual growth rate as 8% and predicts that the production of conventional plus tight sand natural gas will be 134 bcm and 197 bcm in 2015 and 2020 respectively (See Table 2). Assuming that the production in 2015 will be 134 bcm, the annual growth rate during the 12th Five Year Plan will be 7.16%. To sum up, the changing trend of the natural gas reserves signals that China’s natural gas

CEFC China Energy Focus Natural Gas 2013

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development is undergoing transition from the stages of youth to maturity with a declining growth rate. China lacks the authoritative data of the natural gas commodity rate. According to unverified internal data, the commodity rate in 2012 was 85.4%. The recent world average is 85%. Assuming that it will reach 90% in 2015, commercial gas plus tight sand gas will total 120.6 bcm. Table 2. Changes of Natural Gas Production 2010-2020 Source: data for 2010 and 2012 were derived from the National Bureau of Statistics; The production data of 2013 was projected by China National Petroleum Corporation (CNPC) Economics and Technology Research Institute. The data for 2015 and 2020 are projected by the author. Natural gas in this table refers to conventional natural gas and tight sand gas. Project / Unit

2010/ bcm

2012/ bcm

annual growth rate/%

2013/ bcm

annual growth rate/%

2015/ bcm

annual growth rate/%

2020/ bcm

annual growth rate/%

Production

94.85

106.71

6.07

115.0

7.77

134.0

8.00

197.0

8.00

1.3 Shale Gas, Coal-Bed Methane and Coal Gas 1.3.1 Shale Gas The success of the U.S. shale gas revolution has aroused strong interest in China, but China’s current level of activity relating to shale gas is limited and the application of hydraulic fracturing to horizontal wells is even more limited. In March 2012, China released the Shale Gas Development Plan 2011-2015, which emphasizes conducting research and assessment of the resource potential, developing critical technology and equipment for exploitation, and establishing technological standards and an industrial policy system to lay a solid foundation for the 13th Five Year Plan in order to permit the rapid development of shale gas. It also sets goals of shale gas proven geological reserves at 600 bcm, recoverable reserves at 200 bcm, and production at 6.5 bcm in 2015. For the past few years, China carried out a geological survey in different types (marine, continental, marine interaction coal series) of shale gas at different geological eras (lower Paleozoic Erathem, upper Paleozoic Erathem, Mesozoic Erathem, Cenozoic Erathem), accomplishing the difficult task of exploratory well and horizontal well fracturing in a development trial. It is also notable that China has learned from the U.S. experience the benefits of shifting from shale gas to shale oil and will aim to develop shale oil and shale gas simultaneously from the very beginning. However, because of too little investment and insufficient work, under the current circumstances, it is only possible to realize trial development in a few experimental wells rather than industrialized development or production at scale. Measuring from the current dynamic situation, only 200 million cubic meters (mcm) of shale gas can be produced in 2013 and 600 75

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Part Two: Perspectives on China’s Natural Gas Development 下篇：中國專家觀點文章

mcm of commercial gas may be achieved by 2015. Many researchers believe that the current production target of 6.5 bcm by 2015 in the Shale Gas Development Plan may only be realized in 2020. The requirement for proven reserves of unconventional gas is different from that of conventional gas. Proven reserves of unconventional gas not only requires an effective control of dense drilling but also reliable data from trial development of a batch of single wells over a one to two year period. Apparently, it is impossible to accomplish by 2015 the targets of proven reserves of shale gas from the Shale Gas Development Plan described above. Ideally, we would finish measurement of shale gas reserves in a few areas and then formulate from those measurements a feasible draft standard for shale gas reserves.

1.3.2 Coal-Bed Methane As discussed at the beginning of this article, management of shale gas in China lacks standards and statistics provided by different units vary significantly. According to current regulations, exploitation and development areas of coal-bed methane should be treated by the central government. The National Reserves Management Committee is responsible for examining its reserves and publishing its balance sheet of reserves annually. Data for coal-bed methane are also included in the National Oil and Gas Reserves Journal. For example, the data for coalbed methane discoveries were provided in its 2012 journal: the cumulative proven geological reserves were 543 bcm; remaining recoverable reserve were 219.1 bcm; and production in 2012 was 1.053 bcm. According to the production summary provided by all companies, national coal-bed methane in 2012 was 12.5 bcm, of which surface extraction was 2.57 bcm. According to the record of a press conference of the National Energy Administration, in 2012 surface extraction was 2.7 bcm and 2 bcm was utilized, while coal mining was 11.4 bcm and 3.8 bcm was utilized. It can be noted from comparison that: (1) Production recorded and counted by the National Reserves Management Committee was only part of that developed by the companies. (2) Production and utilization statistics provided by different units varied significantly. During the period of the 11th Five Year Plan (2006-2010), the reserve growth only reached 60% of the target. In 2012, national coal-bed methane production should be 10 bcm (half surface extraction and half mine extraction) with a utilization rate of 80%, but the actual production was only 8.6 bcm (with surface extraction at only 1.57 bcm) and a utilization rate of 39.6%, with commercial gas at only 3.4 bcm. According to the requirements established in the 12th Five Year Plan, coal-bed methane production should be 30 bcm in 2015, with surface extraction of 16 bcm and a 100% utilization rate. However, in 2012 the utilization was only 5.2 bcm with its rate of 41.6%, which was even less than that of 2011 by 4.6%. In 2013, the main producer, CNPC, put into production 1000 fewer wells than specified by the plan, thus making the production situation worse. If the utilization statistics of 2011 and 2012 mentioned above were reliable, the author predicts that the quantity of CBM in 2015 should reach 12 bcm, assuming the annual

Part Two: Perspectives on China’s Natural Gas Development 下篇：中國專家觀點文章

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growth rate of commercial coal bed gas over two years as 23.7%. In order to be conservative, the author also believes that the annual utilization rate of coal-bed methane above (especially when converted into standard cubic meters) may be over-estimated. In addition, the 12th Five Year Plan requires that the new increasing reserves should be 10 tcm, which is approximately 3.66 times the total proven reserves of 2.734 tcm in 2010 according to the National Oil and Gas Reserves Journal, and 3.71 times the 2.696 tcm increment recorded between 2010 and 2012. As the actual production of coal-bed methane has fallen significantly short of the goals, it will be very hard to meet the requirement of the 12th Five Year Plan in two years. In terms of coal-bed methane reserves, the more important task is not about increasing production, but about establishing a standard management system for examination and certification of the reserves. 1.3.3 Coal Gasification In view of its rich coal resources, China’s coal chemical industry has been conducting pilot projects to develop a substitute for oil and gas and a path toward clean coal utilization. Coal gas is one relatively mature achievement. The established Hexigten Banner operations in Inner Mongolia has an annual production capacity of 4 bcm and is waiting for connecting pipelines to start producing. It will possibly provide gas to Beijing by 2015. China has approved projects for building coal gasification plants and special pipelines going east from Xinjiang’s Yining and eastern Juggar coal fields. Yet it may not be until the middle of the 13th Five Year Plan that the whole transportation system will be completed in order for coal gasification to go into production at scale. China has always maintained coal gas production and has made inspiring progress in the utilization of coke oven gas for industry. It is estimated that the commercial quantity of the two kinds of coal gas will be 1 bcm by 2015. At present, China only has a few pilot projects for biogas (methane) power generation. Further, due to a lack of statistics for commercial gas, production at scale may only be realized during the 13th Five Year Plan. To sum up, it can be predicted that by 2015 the total supply of natural gas (conventional natural gas, unconventional natural gas, coal gas) in China will be 136.2 bcm.

II.Recent Changes in Gas Consumption and Importation Trends 2.1 Natural Gas Consumption Growth at a Turning Point According to the National Statistical Bureau, natural gas consumption annual growth rates during the years 1995-2000 were 6.67%, during the years 2000-2005 the growth rate was 13.80% and during the years 2005-2010 it was 18.9%. In 2007, the growth rate hit 25.61% but in 2011 the growth rate was only 21.50% and this decline indicated an accelerating trend. In 2012, the growth rate dropped to 10.60%. In 2013, China’s annual consumption of gas will be around 168 bcm, thus at a growth rate of 16.21% over the 2012 consumption statistics. The author believes

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Part Two: Perspectives on China’s Natural Gas Development 下篇：中國專家觀點文章

that this change represents the consumption growth curve at its turning point, switching from a growing trend to a declining one. The relatively low gas prices in China have limited profits for importers and producers. If gas prices do not rise substantially, high growth in domestic production and imports will not be continued. To encourage production and imports, a higher retail price for natural gas will be required. However, absent other conditions, simply raising the price of retail gas would prevent consumption from growing as well. The fact is, if under the current constraints the rise of gas prices does not keep up with inflation and price increases will be limited. In such a dilemma, the author assumes that the growth rate of gas consumption will be 20% in the years 2014 and 2015, and 16% during the period of “13th Five Year Plan”, and that consumption will be 242 bcm and 475 bcm for year of 2015 and 2020 respectively (See Table 3). If the last two years of 12th Five Year Plan failed to reach a 20% annual growth rate, the projections for 2015 and 2020 will need to be adjusted as well. Table 3. 2011-2020 Natural Gas Consumption Changes Source: The National Bureau of Statistics, data of 2013, 2015 and 2020 are estimated by the author. Details will be found in the content. 2011 bcm

2012 bcm

Consumption 130.7 144.6

Annual growth%

2013 bcm

Annual growth%

2015 bcm

10.60

168

16.21

242

Annual 2020 Annual growth% bcm growth% 20

475

2.2 Natural Gas Imports Comparing the historical natural gas production and consumption data from the National Statistical Bureau, we find that prior to 2006 natural gas production was higher than consumption. However, after 2006, the situation changed and the gap between consumption and production expanded rapidly. For instance, in 2007, the supply-demand gap was 1.38 bcm and in 2012 it grew to 37.86 bcm, statistics that illustrate the continuous growth in natural gas imports. Recording of import statistics for natural gas began in 2000. Net imports were quite low until 2008. In 2009 domestic natural gas production growth declined 6.19%, resulting in a rapid acceleration in the net import of gas and an import dependency rate of 4.9%. Sustained economic development in China lead to the rapidly increasing import of natural gas during the years 2010 to 2012. In 2012, the dependency rate on imported natural gas was 26.2%. The gas price adjustment of 2013 will slow the rate of import growth but the trend for the next half-year of gas imports indicates that imports will be about 55 bcm and the import dependency rate will reach 31.5%. In Table 4, the import growth rates for 2012 and 2013 are 29.94% and 34.8%, respectively. Based on the estimates of gas consumption in 2015 as stated above, we estimate that natural gas import in 2015 will be on the order of 110 bcm. 78

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Table 4. 2005-2013 China Natural Gas Imports and Export Dependency Source: Raw data from the National Statistical Bureau, the 2013 data was projected by the author. 2005

2006

2007

2008

2009

2010

2011

2012

2013

Import / bcm

4.6

7.6

16.5

31.4

40.8

Export / bcm

2.9

2.6

3.2

2.9

Net Import / bcm

-3

-1.9

1.4

1.2

4.4

12.5

28.2

37.9

Import Dependency Rate / %

----

-3.5

2.0

1.7

4.9

11.6

22.0

26.2

31.5

Year

In 2012, China imported 39.9 bcm gas, of which 19.9 bcm came from Central Asia, and 20 bcm (14.6 Mton) came from LNG. Construction of new LNG import facilities was completed in the fall of 2012. The facilities, with designed annual absorption capacities of 18.8 Mtons, functioned well. It is estimated that another 7 LNG import facilities will be completed in China by the year of 2015. Therefore, a total of 13 LNG import facilities will have a designed capacity of 40 Mtons, equivalent to 54 bcm of gas, enabling the annual importation of 50 to 54 bcm of LNG. In addition, gas imported via pipeline will be on the order of 56 to 60 bcm to meet the consumption demands anticipated in 2015. By the end of 2014, construction of pipelines between China and Laos will be completed and the third (C) line of the Central Asia Pipeline will add more contracted gas supply from Turkmenistan.

III.Suggestions on Research for the “13th Five Year Plan for Natural Gas” China’s economy is under transformation and structural adjustment and economic reform has entered a more challenging phase. At the same time, based on historical experience, particularly the lessons of the past several years, we must commence research for the 13th Five Year Plan. Based upon points made throughout the entirety of this paper, the author has the following suggestions: 3.1 Improving Natural Gas Statistical Management For conventional oil and gas, China has already established a statistical and management system that covers both upstream and downstream, most of which follow international standards. This is a good foundation, however, there are problems in the unconventional oil and gas sector, and some basic data is missing. Research on unconventional oil and gas is very challenging but requires good data in order to draw realistic and helpful conclusions.

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3.1.1 Improved Commercial Gas Statistics and Research Because of the planned economic system, China has for a long time mixed up the concepts of production and real supply and has no commercial supply statistics available. This does not coordinate with international standards. The first step to record oil and gas statistics is to collect the total wellhead production from every producing company. Based on those figures, the cumulative proven recoverable reserves, total production, and remaining recoverable reserves potential form the general balance via a bottom up approach. Yet in China, part of the production has been divided at the wellhead to be used as energy and fuel sources within the oil and gas fields and some production is re-injected to the underground reservoir. This approach is very commonly used in the Middle East, and China’s old oil fields are starting to apply this new technology as well. Another large portion of the gas is flared into the open air at the well. A portion of pipeline gas is consumed as fuel for pipeline operations. For example, gas from the pipeline will be an energy source for compressor stations. In LNG, a similar loss occurs during the process of production, transportation, and re-gasification. The actual amount of gas that could be used commercially, net of losses in the supply chain, over the wellhead production is called the commodity rate. The commodity rate can vary under different circumstances. For example, at the beginning stages of gas exploration, the loss is huge and the commodity rate is low. According to CEDIGAZ’s statistics, the world’s total production of gas has an average commodity rate of 80%-85% in the last half of the 20th century. In 2006, the share of gas reinjection, flaring and other losses were 11%, 3.3% and 5.7% respectively. What is more, if the government considers providing subsidies to the low production gas wells (including unconventional wells at the beginning stages), the subsidies must be calculated based on the commodity amount. It is not reasonable to subsidize the gas used internally or flared at the wellhead. An accurate accounting of commodity gas is required for research into the consumption and import/export of gas in a matured market economy. We suggest that full attention be given to this issue in future five year plans. However, given China’s development status, it is a challenge to calculate a commodity rate, whereas a 90% commodity rate estimate in the 12th Five Year Plan is clearly too high. All these issues need to be studied carefully prior to development of the next five year plan and subsequent gas market reform.

3.1.2 Improving Coal Bed Methane (CBM) Statistics and Management From the information in section two we can conclude that even when fields have been registered with authorities and are granted exploration and development rights, coal bed methane exploration and development are not always fully regulated by the government. Moreover, the current law regarding the regulation of reserves requires re-calculation of reserves at a certain period of time after production starts. This process is even more important for unconventional oil and gas as their proven reserves and recoverable ratio are based on more concentrated

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production wells and single well production curves that reflects real productivity. In order to set scientific foundation for management from the start, it is necessary to generate and improve regulations for coal bed methane, as well as establishing standards and strictly enforcing a reserve management system which reflects China’s real situation. The two major types of CBM, surface extraction and vented from underground coal mines, are considerably different in their development and application. The CBM that is produced by drilling wells from the surface is almost pure methane in composition, whereas gas vented from coal mines consists of a large amount of air, some of which has a very low methane composition. International natural gas research usually measures gas in normal cubic meters (Nm3) requiring the conversion of gas with different hydrocarbon content to a single standard (If not corrected, a simple calculation of extraction amount or utilization amount of these two kinds of gas can sometimes be misleading). CBM extracted from the surface is similar to general natural gas, however, its utilization rate is currently disappointingly low. Whereas the CBM from mines is harder to utilize, the real commodity rate is a more important parameter. The conditions in coal mining areas require sufficient electricity and the only major usage of CBM is to generate electricity. Although our country has developed a full set of electricity generating equipment that is specifically designed for low caloric value of CBM, the coal mines have scarce interest in or incentives to invest in a new set of CBM electricity generation systems. Connecting with the grid and transporting electricity outside of the area is almost physically or economically impossible (as the subsidy policy cannot be effectively enforced). For quite a long period of time, when the whole coal industry is in a low coal price cycle, it will be difficult to change the low utilization of CBM, especially for medium and small scale coal mines. We should have very clear understanding of the situation and provide more suggestions. 3.1.3 Building up Shale Gas Regulatory System Shale gas development in China is still in a trial stage. As a newly defined independent mineral governed separately from oil and gas, its regulation and management requires more innovation. The first step is to complete a full set of regulations and standards on geological exploration, reserve assessment approval and development operations—none of which are easy to complete. Currently, we must concentrate on drafting the necessary documents, and after a round of practical operations, we should then form regulations that act as a working guide-including environmental monitoring and management systems-- in an attempt to comply with the national standards and industrial standards. The work has already started; the shale gas reserve regulations have been issued in draft for public review. The initial responses to the document are to have more detailed supplementary items and clauses, especially with reference to different regulations for different types of shale gas (like marine, terrestrial, and paralic coal), tight gas and coal bed gas. Some of these requirements have not been mentioned in the U.S., while some are even not referable in

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Part Two: Perspectives on China’s Natural Gas Development 下篇：中國專家觀點文章

conventional gas fields. The work outlined above has not yet been fully achieved with coal bed gas or tight gas. The national reserve reports that are mentioned above cover only a very limited scale of coal bed gas. Tight gas has been recorded as an independent unconventional gas resources in countries like the U.S. in order to identify reserves and production. In China, however, tight gas is combined with conventional gas. A new system of technical standards for horizontal drilling and hydraulic fracturing is lacking, as is also true for tight gas reserve standards. This is an impediment to sustained development for tight oil and gas. 3.2 Facing Up to the Challenges and Avoiding Setting Too High a Target If we look back at natural gas development in recent years, many researchers mention that excessive expectations were set for natural gas development, with unrealistic production target goals. Many of these targets have barely been met or required postponement for an entire five-year cycle. The author of the paper believes that when analyzing current natural gas development in China, we should not ignore the fact that China’s natural gas production growth is falling from double digits to single. The major constraints to natural gas production are: 1) Conventional gas is maturing, as old fields stabilize or decrease. Some major fields that have come into production relatively recently are declining as well. For example, Jingbian Gas Field, the largest conventional gas field in Ordos Basin had a production of 4.672 bcm in 2011, which decreased to a production of 4.398 bcm in 2012. Tianchi Gas Field, owned by PetroChina, the largest field in the Sichuan Basin, saw its production fall from 3.346 bcm in 2010 to 2.773 bcm in 2012. 2) Conventional production comes from gas fields and oilfield associated gas, the latter of which has a lower commodity rate and whose declining production has been seen in old oil fields in the east. 3) The share of unconventional tight gas has been increasing continuously, in particular, in the Ordos Basin and Sichuan Basin. 4) Other unconventional gas production (coal bed gas and shale gas) in China needs to grow in order to adapt to the special geological features in China, and form a corresponding technological system. 5) The unconventional gas production base will increase, but the overall rate of production growth may decline overtime. From the analysis above we can see that an 8% annual production growth rate in the 13th Five Year Plan would not be a low target. If institutional reform cannot be effective in the short run, and the natural gas price cannot be increased as expected, then production, imports, and consumption of natural gas will be limited as well.

3.3 Monopoly as the Critical Obstacle for Oil and Gas Development The analyses above are all limited to some objective factors regarding resources. Considering China’s situation, the most critical obstacles for oil and gas development are the social conditions, especially given the fact that economic institutions and a market economy are not yet mature in today’s China. This problem is even more obvious in the coal bed gas and shale gas sectors.

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Building a legal framework for field exploration and development are the pre-requisites of oil and gas upstream operations. According to current law, the management rights of conventional oil and gas, tight oil and gas, and coal bed gas are all entrusted to the Ministry of Land Resources, and only large, state-owned oil companies are qualified to enter this field of development. The regulations also specify that if companies do not complete the proposed work and submit reports and geological material in a timely manner, they may have their allocated fields reduced or withdrawn altogether. Yet the reality is that these rules are not seriously followed. As a result, all the available fields are monopolized by very few companies, and the exploration right transfer mechanism was largely deadlocked due to the lack of an enforceable “Field Enter Quit” system. For coal bed gas, some fields overlay with existing coal mining fields. As a new type of mineral, shale gas has been granted wide conditions for entering new fields; however, some areas open for exploration are limited to marginal fields in basins that have not yet been registered for conventional development. These areas usually have poor geological conditions and lack transportation options, thus adding more difficulties for new oil and gas companies. This occurs in areas related to mid and downstream as well. Monopolies tend to reduce oil and gas exploration. Those who have the monopoly are not interested in extracting proven reserves, let alone exploring in new fields. This is a must for production field substitution and sustained development in the oil and gas industry. Even big oil companies do not have sufficient capital and R&D investment in coal bed gas, which has stalled development during the past ten years. The state-owned oil companies would rather spend millions of dollars to acquire North American shale gas assets than increase investment in Chinese shale gas, thereby accelerating exploration and development. As stated at the beginning of this paper, oil production in China is now growing very slowly and growth in natural gas production is significantly decreasing. Whether the needed reforms in the oil and gas sector will occur is the key factor for China’s sustained development of oil and gas. It is anticipated that a breakthrough will take place in the late 12th Five Year Plan period, being applied nationwide in the middle of the 13th Five Year Plan, and thus yielding reform benefits in the 13th Five Year Plan. In addition, as the process of breaking up monopolies and implementing further reforms is not clear, it is a challenge to achieve the goal of reducing the role of state-owned companies and advancing the role of privately-owned companies in the oil and gas market. When those disadvantageous trends will change is hard to answer. Therefore, this paper does not make any projections on the supply, consumption, and importation of natural gas, as future policy will significantly impact the trajectory of natural gas development in China.

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Natural Gas Production Outlook in China Before 2020 (2020年前中國天然氣生產展望) By XU Bo (徐博) 徐博，中國石油集團公司經濟技術研究院高級經濟師。 XU Bo is a senior economist at the Economics and Technology Research Institute, China National Petroleum Corporation (CNPC). His research area focuses on the supply and demand interplay of natural gas in China and overseas markets, natural gas price formation and policy studies. He has been engaged in and presided over more than 20 research projects at national and corporation levels in China and has published over 30 academic papers. He also translated more than one million words of foreign literatures on natural gas into Chinese. XU Bo holds a Master’s degree in Economics. ABSTRACT: Since 2000, natural gas production in China has accelerated, a trend that will continue into 2020. High estimates suggest that China’s natural gas production in 2015 will reach 190.6 billion cubic meters (bcm) and in 2020 could be as high as 410 bcm. Unconventional gas will account for 24% of the total in 2015 and 51% of the total in 2020. If one were to accept a more cautious estimate, then one would expect to see China’s natural gas production reach 185 bcm in 2015 and 369 bcm in 2020. Of those amounts, unconventional gas will contribute 25% to the total in 2015 and 44% of the total in 2020. According to the national projection of natural gas consumption in China, natural gas supply is likely to surpass the demand in 2015. By adjusting foreign imports appropriately, maintaining a basic balance between supply and demand, and focusing on the development of domestic natural gas production, there will be less pressure to import expensive natural gas from overseas sources. It will also protect China’s long-term energy supply security. Keywords: Natural gas production in China, Conventional gas, Unconventional gas

I.Review of Natural Gas Production in China 2000-2012 84

Since the new millennium, natural gas production in China has accelerated. Oil and gas enterprises headed by PetroChina and Sinopec have boosted exploration and development,

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and quickly increased proven reserves and production volumes. During this period, China’s unconventional gas industry gradually started up and main pipelines and other basic infrastructure networks were initially formed. 1.1 The Resource Base Further Strengthened According to a new round of oil and gas resource evaluation, i.e. the National Oil and Gas Resource Trend Evaluation (2010), China has about 52 trillion cubic meters (tcm) of conventional natural gas resources, about 32 tcm of recoverable resources. China also has abundant coal bed methane (CBM) resources. CBM resources at depths less than 2,000 meters are estimated to be 36.8 tcm, with the recoverable resources at approximately 10.8 tcm. As of 2010, the total proven CBM geological resources are estimated to be 273.4 bcm, with a proven level of only 2.5%. Shale gas resources in China are even more abundant. According to preliminary estimates, the recoverable shale gas resource capacity is 25 tcm, comparable to the conventional natural gas resources. However, the shale gas industry is only in preliminary exploration stage. These facts demonstrate that China has an abundance of natural gas resources, with a low proven level and high development potential. 1.2 Rapid Growth in Production Volume In 1997, the Shaanxi-Beijing Pipeline #1 was put into operation, thus commencing the transportation of natural gas from distant locations to major consumers. However, the expansive development of natural gas production in China actually began in earnest at the start of the 21st century. In 2000, China only produced 27.2 bcm of natural gas, but by 2012, the production had increased to 106.7 bcm, for an average annual growth rate of 12.5% (Figure 1). According to BP statistics, China has become the seventh-largest natural gas producer in the world just behind Norway, and is likely to exceed Norway this year to become the sixth-largest natural gas producer in the world behind Canada. There are four major natural gas producing areas in China that account for 73% of the national total: the Ordos Basin, Sichuan Basin, Tarim Basin, and South China Sea. These four areas also account for 78% of the remaining technically recoverable reserves in the country.

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Figure 1. 2000 -2012 Natural Gas Production in China. Source: International Petroleum Economics

1.3 Establishing the Network of Basic Pipeline Infrastructure As of 2012, China has more than 55,000 km of major natural gas pipelines and spurs and more than 160 bcm/year of gas transport capacity. A network consisting of multiple gas pipelines creates a national gas transportation system, which connects the country from west to east, from north to south, and with imported supply. The pipelines include: the West-to-East system, the Shaanxi-Beijing system, the Zhongwu line, the Seninglan line and its twin, the Changning line, the Lanyin line, the Huaiwu line, the Jining line, the Sichuan-to-East, and the Yuji line. Meanwhile, the Southwest, Bohai Sea, Yangtze River Delta, and South-Central regions have formed a relatively complete regional natural gas pipeline network. 1.4 PetroChina: the Leader in Natural Gas Production Natural gas production from three oil and gas companies, PetroChina, Sinopec, and CNOOC accounts for over 95% of China’s total output, with PetroChina’s production consistently accounting for over 70% of the total. Although all three major Chinese oil companies have experienced increased production at different rates during the years 2000-2012, the production growth rate has been relatively stable for PetroChina, while that of Sinopec and CNOOC shows greater volatility in growth in different years (Figure 2).

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CEFC China Energy Focus Natural Gas 2013

Figure 2. From 2000-2012 Three Major Oil Companies’ Production Volumes in 100 million cubic meters (mcm) and Annual Growth Rates. Source: International Petroleum Economics

PetroChina’s production advantage mostly relies on four main gas fields: Changqing, Tarim, Southwest, and Qinghai. In 2012, the production of the four major gas fields was 290.3, 19.31, 13.15, and 6.35 bcm respectively, together accounting for more than 85% of the total. This figure increased by 24% from the year 2000. In 12 years, the four main gas fields experienced production growth at different rates: Changqing, Tarim, and Qinghai have all maintained more than 24% in average annual growth rate. Southwest had a lower growth rate, its production share in 2012 decreased by 27% from 2000, descending from the largest gas field of PetroChina to the third largest one (Figure 3). Figure 3. Changing Share of Production from CNPC’s Four Major Gas Fields between 2000 and 2012. Source: International Petroleum Economics

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1.5 An Overview: Unconventional Gas at an Initial Stage China has abundant unconventional gas resources including CBM, shale gas, and coal-togas, among other forms (China currently views tight gas as a conventional natural gas, but is working on reclassifying tight gas as an unconventional gas in order to facilitate policy support). So far only the CBM industry has reached initial commercial production stage, and only 3.5 million cubic meters of shale gas have entered into the long-distance pipelines in 2012. There are many coal-to-gas projects under development, but only the projects located in Hexigten Banner of Chifeng City by Datang International and in Yili Kazakh Autonomous Prefecture by China Kingho Group are ready for initial production. Therefore, prior to 2012, unconventional gas production came mainly from CBM resources. During the “11th Five-Year Plan” period [2006-2010], China’s CBM development might be described as starting from zero. Since then, more than 5,400 CBM wells have been drilled, creating a production capacity of 3.1 bcm. National production of CBM in 2012 was 12.5 bcm, of which 2.57 bcm were from surface extraction and 9.94 bcm were from underground gas extraction. The total volume of CBM extracted was 5.2 bcm and the utilization rate was 41.53% (Table 1). Table 1. CBM Production in China, in 100 mcm. 2005

2006

2007

2008

2009

2010

2011

2012

Underground Extraction

60.9

85.4

99.4

Surface Extraction

0.3

1.3

3.2

7.5

10.1

25.7

Total

23.3

33.3

46.2

65.5

108.4

125.1

The companies currently active in CBM exploration and development are PetroChina, China United Coal-bed Methane Corporation, and several others. Each company conducted a resource investigation of its own CBM blocks. The results are shown below in Table 2.

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Table 2. CBM Resources of Major Chinese CBM Companies (as of 2009) Source: China5e Company

Surface Area (km2)

Proven Reserve (100 mcm)

Recoverable Reserve (100 mcm)

PetroChina

526.10

894.82

447.07

China United CBM

164.20

402.18

218.38

Tiefa Coal

135.49

77.30

38.65

Yangquan Coal

94.04

191.34

75.06

Dongbao Energy

81.80

158.79

71.45

Ganglian Coal

4.19

3.61

1.80

Others

127.74

124.36

85.45

Nationwide Total

1133.56

1852.40

937.86

II.Conventional Natural Gas Production Outlook 2013 – 2020 Until 2020, conventional natural gas will remain dominant in gas production growth, mainly due to the resource base at a reserve-production ratio approximating 40, as well as the fact that China’s reserves continue augmenting. Conventional natural gas production in China is projected to exceed 150 bcm in 2015, and to exceed 200 bcm in 2020. 2.1 Proven Reserves Will Continue Growing Rapidly in the Long Term The remaining recoverable reserves of natural gas in China have maintained a rapid growth trend since 2005 with an average annual growth rate achieving 6.9%, reaching 4.2 tcm in 2011, a year-over-year increase of 7.6%. Overall, natural gas exploration in China is still in the early stages, and the proven rate of recoverable resources is less than 20%. There is an abundance of resources remaining (Table 3). Historically U.S. gas reserves recorded a high annual growth rate of 1% when the proving rate rose from 10% to 45% of the resource estimate. China is currently comparable to the United States’ early stages of rapid reserve growth in the 1930s, indicating great potential for the future growth of reserves. Reserve growth momentum will remain strong with high probability of discovering large gas fields. Onshore natural gas proven reserves in Western China remain dominant in the country, mainly concentrated in the Tarim, Ordos, and Sichuan basins, accounting for 85% of the national total, with an average annual growth rate of 7.8% since 2005. Offshore gas reserves have remained stable since 2005, but the deep natural gas potential is enormous.

CEFC China Energy Focus Natural Gas 2013

Part Two: Perspectives on China’s Natural Gas Development 下篇：中國專家觀點文章

Table 3. 2005-2011 Distribution and Change in Production Share of Remaining Recoverable Natural Gas Reserve Basins in China, in 100 mcm. Source: The Ministry of Land and Resources and annual reports from oil companies Basin Distribution

2005

Change %

2008

Change %

2010

Change %

2011

Change %

Songjiang Basin

1077

78.6

1949

-2.2

2207

5.0

2206

0.0

Bohaiwan Basin

1931

15.2

1291

-13.9

1367

11.3

1381

1.0

Ordos Basin

7991

34.3

9063

0.3

10854

6.6

11968

10.3

Sichuan Basin

5065

23.9

7514

8.3

7640

-3.2

8260

8.1

Tarim Basin

6049

17.5

7514

3.7

9952

15.0

10672

7.2

Huaigeer Basin

855

9.8

1911

162.9

1599

-8.6

1862

16.4

Caidamu Basin

2298

48.4

2024

-1.7

2383

-2.8

2415

1.3

Tu-ha Basin

343

5.2

287

4.4

313

6.1

316

1.0

Zhujiangkou Basin

959

8.9

873

-7.0

931

8.1

917

-1.5

East Sea Basin

389

34.6

426

18.7

540

10.4

551

2.0

Yinggehai Basin

412

28.8

530

8.4

630

12.9

658

4.4

Others

816

19.8

667

19.3

585

-4.1

739

26.3

Total

28185

26.5

34050

6.0

39000

5.2

41945

7.6

Using the Gompertz model, Wong-model, Gray, Hubbert, and other methodologies of forecasting, the projection of incremental proven reserves in China from 2010 to 2030 is 10.1 tcm. Natural gas reserves will continue the momentum of peak growth, with 550 bcm of average increments per year at the peak until 2025. This rapid growth of proven reserves will build a solid foundation for natural gas development in China.

2.2 Peak Production Growth of Conventional Natural Gas Will Continue Until 2045 Applying forecasting methodologies such as the Wong, Gray, and Hubbert models, it is estimated that China’s peak production of conventional natural gas will range between 240 and 280 bcm per year, and this peak production capacity will continue until 2045. The average annual increment between 2010 and 2015 is expected to be more than 10 bcm. Total conventional gas output is likely to exceed 150 bcm by 2015, and more than 200 bcm by 2020. In view of the slowdown of conventional natural gas production growth in recent years, the National Development and Reform Commission reduced the recent production growth for conventional natural gas in the “12th Five-Year Plan for Natural Gas Development” (referred to

Part Two: Perspectives on China’s Natural Gas Development 下篇：中國專家觀點文章

CEFC China Energy Focus Natural Gas 2013

as the “12th FYP” ), with a planned target of about 138.5 bcm of conventional natural gas until 2015. This article argues that with progress on complex gas reservoir development technologies in the conditions such as low permeability, high sulfur content, high pressure, volcanic rock, etc., conventional natural gas production in China should be able to achieve a higher level. The “12th FYP” also points out that the future conventional natural gas development in China is mainly concentrated in four major gas reservoir areas: Ordos Basin, Sichuan Basin, Tarim Basin, and South China Sea. By 2015, four large-scale natural gas production areas with annual production over 20 bcm each will be formed (Figure 4). Figure 4. Production Growth for Major Conventional Natural Gas Reservoirs Stated in the“12th Five-year Plan”, in 100 mcm. Source: 12th Five-Year Plan for Natural Gas Development

III.Unconventional Gas Production Outlook in China 2013-2020 According to the forecasts of the China Petroleum Economics and Technology Research Institute and the National Development and Reform Commission, natural gas consumption in China will reach 230 bcm in 2015 and 350 bcm in 2020. Obviously, conventional natural gas alone will not be able to satisfy China’s demand on such a scale. On the one hand, it is inevitable for China to increase gas imports to fill the gap; on the other hand, it also requires China to expand efforts on unconventional gas development. 3.1 Development of CBM Will be Accelerated in the Near Future In recent years, CBM extraction in China has been increasing from 2.33 bcm in 2005 to 12.5 bcm in 2012, with initial commercial operation. By 2012, 500 million cubic meters of gas entered long-haul pipelines. Although CBM development in China has encountered a series of problems and the goal 91

CEFC China Energy Focus Natural Gas 2013

Part Two: Perspectives on China’s Natural Gas Development 下篇：中國專家觀點文章

of the “11th Five-year Plan” was far from complete, compared to other unconventional gas developments, CBM is still the most realistic. First of all, there is the initial acquisition of suitable CBM development technologies for China. CBM extraction technologies in China are currently introduced from external sources and are highly dependent upon foreign collaboration. In recent years, the National Development and Reform Commission specifically set up two CBM-related national engineering research centers. The Ministry of Science and Technology also created two special projects targeting large-scale gas fields and CBM development within the 16 specially-designated major national projects. Through practical experience, PetroChina has now acquired the exploration and development technologies suitable for CBM in China. Secondly, the mining and exploration rights management system has been further rationalized during CBM development. For example, PetroChina and coal companies have formed three collaboration models in recent years, specifically targeting the problem of overlapping exploration rights for CBM and coal mining in the same reservoir area. The three models are: Qinnan – to separate gas and coal explorations, and create mutually beneficial collaboration in downstreams; Lu’an, the second model, recognizes integrated coal mining and gas extraction; and the third model, Sanjiao, creates joint development - first gas extraction followed by coal mining. Another advantage of CBM development in China lies in its diverse applications. Currently CBM is mostly utilized locally but in diverse applications on sizable scales, including chemical fuel, home heating and cooking, and power generation. Specifically in power generation, gas generation capacity in 2011 reached 1.5 gigawatts, of which the Jincheng 120-megawatt gas plant is the largest of its kind in the world. The fourth advantage of CBM is government policy support will be further extended. On September 22, the General Office of the State Council issued On the Opinions of Further Accelerating the Extraction and Utilization of Coal Bed Methane, clearly stating its intention to increase CBM exploration subsidy levels, implement market pricing, encourage the grid connection of CBM power generation, and increase the ongrid tariff of electricity in a timely manner. At present the central government subsidizes 0.2 yuan per cubic meter for Chinese companies that develop and utilize CBM. Meanwhile, local governments supplement the state subsidy by 0.1 yuan per cubic meter. According to industry sources, the new subsidy level for the CBM extraction program will increase from 0.2 yuan/m3 to 0.6 yuan/m3. According to the national “12th Five-year Plan for CBM Development and Utilization,” total proven CBM reserves will be increased by 1 tcm by 2015; above ground exploitation will reach 16 bcm while the underground extraction will reach 14 bcm. Assuming a 60% utilization rate and a 50% methane concentration, the final output from underground extraction can be expected to reach 4.2 bcm. The author estimates that CBM production could reach 50 bcm (high estimate), and at least 40 bcm (low estimate) in 2020. 92

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3.2 Large-scale Shale Gas Development in China can be Achieved by 2020 3.2.1 The Current Status of Shale Gas Exploration and Development According to the preliminary evaluation report of onshore shale gas resources released by the Ministry of Land and Resources on March 2012, China’s onshore shale gas potential and recoverable resources potential were 134.42 and 25.08 tcm (excluding Qinghai-Tibet region). These evaluation results show that China has abundant shale gas resource and great development potential. According to data valid as of February 2013, PetroChina, Sinopec, Yanchang Petroleum and Mining, and China United Coal have a combined total of 81 shale gas wells drilled, 44 fractured wells, and more than 40 wells have obtained shale gas stream. At the end of 2012, China’s shale gas industry gained 35 million cubic meters of test production. The Ministry of Land and Resources has previously organized two rounds of bidding for shale gas exploration rights, attracting widespread attention from domestic energy companies. This year, the Ministry will organize a third round of bidding for shale gas exploration rights. 3.2.2 Policies and Plans Related to Shale Gas In accordance with the targets defined in “Plan for Shale Gas Development (2011-2015)”, 600 bcm of shale gas geological resources will be confirmed by 2015, with 200 bcm in recoverable reserves. In 2015, shale gas production shall reach 6.5 bcm, and strive for an annual output of 60-100 bcm by 2020. In order to address China’s deficiencies in basic theoretical and experimental shale gas research, especially in early exploratory testing, location evaluation, and other technical issues, the national government has set up a “Key Technologies of Shale Gas Exploration and Development” research project, and established the National Energy Shale Gas Research and Development (Experimentation) Center. As shale gas is a low-grade, unconventional natural gas that requires a long development cycle and substantial investment, it is difficult to produce economic benefits in the short term. Thus, the national government decided to provide subsidies to shale gas exploration and production companies. The subsidy standard between 2012-2015 is 0.4 yuan /m3, and is subject to adjustment based on the development of the shale gas industry. Relevant national government policies also allow for local governments to provide appropriate subsidies, depending on local shale gas development and utilization. 3.2.3 Difficulties in Achieving Planned Production Targets The nationally planned shale gas production target in 2015 is 6.5 bcm, which should not be a problem in view of the production plans of China’s oil companies. PetroChina’s plan for output in 2015 is 2.6 bcm, Sinopec’s plan for output is 1.7 bcm, and Shaanxi Yanchang Petroleum Group plans for 500 million cubic meters, adding up to a total of 4.8 bcm, which will meet 74%

CEFC China Energy Focus Natural Gas 2013

Part Two: Perspectives on China’s Natural Gas Development 下篇：中國專家觀點文章

of the national plan. There is a great potential to complete the national plan if other companies can accelerate their pace of development. It is more difficult to estimate the growth in shale gas production in China during the period 2015-2020. The national plan for annual production in 2020 is 60-100 bcm, which would require drilling sixteen thousand to twenty-seven thousand wells. Although drilling wells is not a big problem, finding favorable reservoirs will require hard work and carry risks in whether significant discoveries are made. Therefore, based on the estimate of PetroChina’s internal experts, the author’s preliminary prediction is that China’s shale gas production in 2020 will be around 20 bcm; however, the author does not exclude the possibility of significant discoveries of excellent shale gas reservoirs. This could result in production reaching or even exceeding the national planned target, because China does not lack in shale gas development technology and supportive policies are already in place. 3.3 Coal-to-gas Will Soon Occupy an Important Position in the Chinese Natural Gas Market Recent coal-to-gas trend in China depends on three factors. Firstly, comparatively higher natural gas prices will make it more economically advantageous to convert coal into natural gas. Secondly, there are surpluses of other coal chemical products that forced the government to issue more restrictions. The third factor is the significant advantages of coal-to-gas in a high energy conversion rate and energy substitution effects compared to other coal chemical technologies. This is also an important reason for the government to support coal-to-gas development under current natural gas supply constraints. 3.3.1 National Policies Support Coal-to-gas Development and Businesses Are Investing The “12th Five-Year Plan for Natural Gas Development” clearly targets coal-to-gas production to be about 15-18 bcm by 2015, accounting for 8.5-10% of domestic natural gas production. This is the first time that coal-to-gas was included in the “Five-Year Plan for Natural Gas Development”. As of August 2013, the national government has approved four coal-to-gas projects with a total production of 15.1 bcm; these are roughly equal to the targets in the “12th Five-Year Plan for Natural Gas Development”. The national government also issued preliminary permits for four more projects, for a total capacity of 18 bcm/year (Table 4). Presently, China Kingho Yili project Phase I is already in operation, with the coal-to-gas entering the West-to-East pipeline. Datang Power’s Hexigten project in Inner Mongolia will start operating at the end of the year.

CEFC China Energy Focus Natural Gas 2013

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Table 4. Approved Coal-to-Gas Projects in China Approved Projects

Projects with Permits

Owner and Construction Site

Planned Production Volume by Year

Owner and Construction Site

Datang Power Hexigten

4 billion m3

China Power 60 billion m3 Investment – Hui County

Datang Power - Fuxin

4 billion m3

Datong Coal

40 billion m3

Huineng Coal - Inner Mongolia

16 billion m3

Ximong

40 billion m3

China Kingho Xinjiang

5.5 billion m3

China Guodian – Inner Mongolia Energy

40 billion m3

Planned Production Volume by Year

In fact, there are numerous coal-to-gas projects planned by companies and local governments. According to the C1Energy-China (ICIS C1)’s statistics, there are nearly 40 coal-to-gas projects under construction or planning stages with a total designed capacity up to 176 bcm/year. There are as many as 13 coal-to-gas projects expected to be in operation before 2015. The total capacity will be more than 60 bcm/year (Table 5).

CEFC China Energy Focus Natural Gas 2013

Part Two: Perspectives on China’s Natural Gas Development 下篇：中國專家觀點文章

Table 5. Coal-to-gas project to start operating before 2015. Province

Project Name

Location

Designed Production Volume 100 mcm per year

Status

Production Start (Partial Start) Year

Inner Mongolia

Datang Power

Chifeng

Ready for Production

2013

Xinjiang

Xinjiang Guanghui

Yiwu

Under Construction

2013

Xinjiang

China Kingho

Yili Kazakh Autonomous Prefecture

In Production

2013

Inner Mongolia

Huineng Coal

Ordos

Under Construction

2013

Gansu

Jiuquan Steel

Zhangye

Under Construction

2013

Liaoning

Datang Power

Fuxin

Under Construction

2013

Xinjiang

Xintian Coal-Chemical

Yili Kazakh Autonomous Prefecture

Waiting for Approval

2014

Inner Mongolia

Shenhua

Ordos

In Planning

2014

Xinjiang

Xuzhou Coal

Tacheng Area

Under Construction

2014

Xinjiang

China Power Investment

Huocheng

In Preparation

2014

Xinjiang

China Power Investment

Chabuzhaer

In Preparation

2014

Xinjiang

China Guodian

Yili Kazakh Autonomous Prefecture

100

Under Construction

2015

3.3.2 Coal-to-gas Pipeline Construction is Underway Sinopec is actively preparing for the “Xinjiang-Guangdong-Zhejiang” coal-to-gas pipeline. The project starts from the west in Yining, Xinjiang, and ends on the southern coast in Shaoguan, Guangdong. The pipeline has a total length of 8,280 km, and a design capacity of 30 bcm per year. The route overlaps PetroChina’s West-to-East Pipeline No. 2 in many areas. The total investment in this project will reach 159 billion yuan. On July 29, 2013, the National Development and Reform Commission issued Reform Office Energy (2013) Document 1844 approving preparatory work on the Xinjiang coal-to-gas long-haul pipeline project. 96

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PetroChina will also take Xinjiang coal-to-gas long-haul transportation as a major task by initiating the “West-East Line 4”, which will send coal-to-gas from Xinjiang province to eastern China markets. According to PetroChina’s plan and arrangements, West-East Line 4, ShaanxiBeijing Line 3, and the Zhongwei-Guizhou Line together constitute a long-haul pipeline network for incremental gas production in Tarim and coal-to-gas in Yili, Xinjiang. 3.3.3 Coal-to-gas Production Expected to Reach 60 bcm in 2020 Considering existing and authorized new projects, coal-to-gas production in China will exceed 20 bcm in 2015, and 60 bcm in 2020. One reason is that existing and authorized new projects will partially or completely reach their ultimate capacity. In addition, construction of the projects listed in Table 5 will be completed and new projects are expected to come on line before 2020. Not only will the two important pipelines from Xinjiang region, Xinjiang-Guangdong-Zhejiang line and West-East Line 4, go into operation, Inner Mongolia will also have multiple coal-to-gas transportation pipelines arriving in cities such as Beijing and Tianjing.

IV.Summary Through the analysis stated above, we can draw the following basic conclusions: before 2015, China national natural gas production will further increase with substantial contribution from unconventional gas. Supplemented by gas imports, a framework of natural gas supply from multiple sources will be formed, which completely breaks current supply constraints. Theoretical natural gas supply can exceed demand. Together with ninety thousand kilometers of long-haul pipelines and 22 bcm of gas storage, the flexibility and reliability of gas supply will be greatly improved. Due to greater uncertainty in production, this article attempted to analyze two scenarios of low and high gas production levels in 2015 and 2020. The high estimate is mainly calculated based on the highest production plans or forecasts for conventional and unconventional gas. The low estimate considers the most probable production capacity under various limitations. 4.1 Natural Gas Production in China in 2015 and 2020: High Estimate Under a high estimate, natural gas production in China will be 196.5 bcm and 410 bcm in 2015 and 2020 respectively, with unconventional gas accounting for 23% and 51% of the total (Table 6). Based on the National Development and Reform Commission’s consumption forecast of 230 bcm in 2015, domestic natural gas alone will satisfy 85% of consumption requirements with a shortfall of only 33.5 bcm. In 2015 the country plans to import 93.5 bcm of natural gas, which will lead to a potential oversupply of natural gas in China.

CEFC China Energy Focus Natural Gas 2013

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Table 6. A High Estimate of China’s Natural Gas Production Capacity before 2020 (bcm). 2015

2020

Notes

Conventional Gas

150

200

The Research Institute of Petroleum Exploration and Development – Lanfang estimated the production.

Coal-to-gas

Authors estimated data.

CBM

2015 data is from the national target, and 2020 data is estimated by the authors.

Shale Gas

6.5

100

2015 data is from the national target, and 2020 data is the largest value from the national target.

196.5

410

Total

4.2 Natural Gas Production in China in 2015 and 2020: Low Estimate Under the low estimate, natural gas production in China will be 185 bcm and 360 bcm in 2015 and in 2020 respectively, with unconventional gas accounting for 25% and 44% of the total (Table 7). Based on the National Development and Reform Committee’s estimate of natural gas demand of 230 bcm in 2015, domestic gas alone will satisfy 80% of the consumption projection, with a shortfall of only 45 bcm. Consequently, even under the low production estimate scenario, it is highly possible that there will be an oversupply of natural gas in China. Table 7. A Low Estimate of China’s Natural Gas Production Before 2020 (bcm). 2015

2020

Notes

138.5

200

2015 data is from national target, 2020 data was estimated by The Research Institute of Petroleum Exploration and Development– Lanfang.

Coal-to-gas

Authors estimated data.

CBM

2015 data is from the national target, 2020 data is estimated by the authors.

Shale Gas

6.5

2015 data is from the national target, 2020 data is the smallest value from the national target.

Total

185

360

Conventional Gas

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CEFC China Energy Focus Natural Gas 2013

4.3 Additional Information a. A potential oversupply of gas can occur if all the currently planned capacity comes into full operation. The oversupply referred to in this article is the potential oversupply of gas if all the currently planned capacity were in full production. Under the influence of price mechanism, supply and demand must be balanced. In other words, under limitations of “take-orpay” contracts, gas imports may not be substantially affected, but domestic production may be reduced. Natural gas production with high cost and significant negative environmental impact will be forced to curtail . b. Thanks to the efforts of China’s three major oil companies and related enterprises in recent years, future domestic gas supply will gradually improve. In particular, unconventional gas may take over a large share of domestic gas production. Due to price factors, China should reconsider the decision of introducing large-scale gas imports in the near future. This is the main reason for the statements by China’s domestic oil companies that they are reconsidering import plans and will only make prudent investments. c. The Chinese government continually emphasizes the role that domestic natural gas supply plays in protecting the security of the national gas supply. This is also the main reason why the government issues frequently new development plans for shale gas and CBM and extends additional policy support. It is believed that the leading position of domestic gas supply will not change in the future. Summarizing the views provided, the author draws several conclusions. First, natural gas production in China will continue to grow, with an even faster rate for unconventional gas. Second, the three major Chinese oil companies will occupy dominant positions in both conventional and unconventional gas production domestically. Third, the growth of domestic natural gas production will not eliminate the necessity for imported gas, but it will reduce China’s dependence on imports, turning imports into an important supplement. Lastly, the growth of domestic natural gas production provides an opportunity for a broader range of natural gas utilization. The specific production level will be flexibly adjusted by future prices, and a balance will be achieved between supply and demand based on the new prices. Thus, production should not be limited to demand forecasts mentioned previously. CHEN Yuanyuan, an intern at the Economics and Technology Research Institute, CNPC, also contributed to this article.

CEFC China Energy Focus Natural Gas 2013

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The Path to Shale Gas Development in China and the United States – A Comparative Study

(中美頁岩氣發展路徑比較研究) By ZHU Kai (朱凱) 朱凱，中國海洋石油總公司政策研究室能源經濟研究院研究員。 ZHU Kai is a researcher at the Energy Economics Institute (office for policy research) of China National Offshore Oil Corporation (CNOOC). His research area focuses on corporate strategy, energy economy and regional economy. He holds a PhD in Economics from the Université des Sciences et Technologies de Lille, France. Abstract: The history of shale gas development in the United States shows that the U.S. government has only provided very limited financial subsidies to the industry, most of which have been confined mainly to improving technology. Rather, the U.S. Shale Gas Revolution is the combined result of various factors related to the US specific system: a continued effort to revise rules and regulations to attract industry participation; an efficient division of labor and an established infrastructure which are the result of mature entrepreneurship that is made possible by the perfection of property rights, market pricing and competition. In analyzing China’s shale gas policies and practices, together with a comparison of China’s industry constraints, it can be seen that China’s competitive advantage vis-à-vis its U.S. counterparts is due exclusively to government financial support. China is clearly behind the United States in all other aspects, especially in the lack of effective system arrangements. These factors will prevent China from achieving a U.S.-type Shale Gas Revolution in the near term. This article proposes that all of China’s energy supervisory offices should commence efforts to reform the system to fully allow the market mechanism to help develop its shale gas industry. Keywords: United States, China, Shale gas development, Policy, System reform, Comparison Of all the traditional fossil energy sources, natural gas has the lowest carbon emissions. As a substitute for coal, the use of natural gas contributes significantly to the reduction of CO2 emissions. The United States has effectively reduced its reliance on imported energy by rapidly 100

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CEFC China Energy Focus Natural Gas 2013

developing unconventional natural gas and, in doing so, has helped to accelerate a new era of global natural gas. Encouraged by America’s Shale Gas Revolution, China’s energy sector has taken a keen interest in shale gas development in recent years. A series of policies has been launched to promote various investments in shale gas development. With the support of both the central and local governments, industry participants have undertaken a series of exploration and technical testing. Foreign energy companies have expressed keen interest in participating and media reports have raised expectations. China has now become the most enthusiastic developer of shale gas after the United States. Unconventional oil and gas is widely found throughout the world. Europe and China actually started to explore these resources quite early (e.g. coal-bed methane). However, to date the Shale Gas Revolution has only successfully occurred in the United States. Most Chinese energy industry participants are well aware of the many difficulties in developing shale gas in China, and are skeptical of China’s prospects at replicating America’s success. Based on a comparative study of shale gas development paths in China and the U.S., this article aims to identify the major constraints on China’s shale gas development and to propose solutions.

I.The Shale Gas Development Path in the U.S. The Shale Gas Revolution did not succeed in the United States overnight. The first commercial shale gas well was drilled as far back as 1821 near Fredonia, NY. However, extensive commercialscale operations did not take place until the tax exemption of unconventional fuels came into force in 1980. In 1981 Mitchell Energy drilled the first commercial well at Barnett Shale. For technical reasons, the U.S. could only produce 4.2 billion cubic meters (bcm) in 1989. That figure rose to 8.5 bcm in 1998, constituting only 1.6% of the nation’s natural gas production. At that time, the known reserves of shale gas were 110.4 bcm, about 2.3% of America’s total proven reserves of natural gas. In 2000, the U.S. produced 20 bcm of shale gas out of approximately 28,000 wells run by a dozen or so companies. Thanks to improved technology for shale gas reservoir evaluation, drilling and well completion, the development cost of shale gas was lowered dramatically. In the interim, the natural gas price (well-head price) had shot up from $4.88/m BTU in 2003 to $7.33 in 2005. As a result, U.S. shale gas production saw explosive growth. In 2008, the entire U.S. production reached 50.7 bcm, accounting for about 9% of the country’s total natural gas production, an annual growth rate of 12.5%. By this time there were more than 40,000 shale gas wells and 64 companies actively engaged in the industry. Today, the United States is the largest producer of natural gas in the world.

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Graph 1. 1985-2010 Trend of U.S. Natural Gas Production The production point in 1996

stagflation

The production decline point in 2001

The beginning of the shale gas revolution in 2006

In addition to the favorable geological and geographical factors in certain areas of the United States, many researchers believe that government support has contributed to the success of the American Shale Gas Revolution. This support comes mainly in two areas: (1) laws and regulations and (2) fiscal policy. Although the U.S. has passed no specific legislation for shale gas development, many policies for natural gas work equally effectively for shale gas. Table 1 lists all the relevant U.S. natural gas policies. Before the1990s, the U.S. Federal Government put an emphasis on the construction and maintenance of the market mechanism; that is, the price of natural gas was to be determined by the market rather than by preferential measures and regulations. In turn, the market price would regulate production volume. Towards the end of the 1990s, as the natural gas market began to evolve, the Federal Government began to focus on reinforcing technology improvement. As for financial support, funding was directed to technology research and development. For example, a foundation was set up to undertake research on unconventional oil and gas and to fund exploration projects. Many government units and agencies including the Department of Energy, the Energy Research and Development Administration, the U.S. Geological Survey, individual state geological surveys, along with universities and industry research bodies, initiated and implemented many shale gas projects in the eastern United States. The projects resulted in a large number of scientific research achievements, and enabled a new phase of exploration for natural gas. Over the course of the last three decades, the U.S. government has spent $6 billion to promote exploration and development of unconventional gas, $1 billion in 102

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training and research which included direct funding, loans and guarantees, training subsidies, research funding and direct investment in exploration. The Energy Policy Act of 2005 also states that in the succeeding ten years, there will be an annual funding of $45 million on research for unconventional gas. The pioneering application of key technologies in shale gas exploration (e.g. horizontal drilling, hydraulic fracturing, logging-while-drilling, geological steering, micro-seismic monitoring etc.) all originated in the United States. At present, the U.S. has mastered major technologies including gas reservoir analysis, data collection and geological characterization, drilling, fracturing, well completion and the integrated technology of production system, and has accumulated valuable practical experience. The U.S. federal government has not provided much in the way of subsidies on the production side of shale gas. Even so, 48 states in the country are taking part in shale gas development. Each state has its own gas policies and related legislation, for taxation in particular. Arkansas, for example, allows tax exemption for the first three years of shale gas exploration. Texas gives tax incentives to certain high-cost wells (including shale gas wells) -- the cost of drilling a single well could be as high as $45m in 2009 -- and provides tax exemption for half of the capital input. Nevertheless, the financial aid provided by state governments is not always adequate to offset the steep costs of shale gas development. At one time, when the price of natural gas was depressed, many industry participants withdrew from the business. It was not until 2003 that the shale gas industry took a big stride forward, due to rising natural gas prices, and sharply reduced costs thanks to technology breakthroughs. American government policy was not the direct cause enabling the Shale Gas Revolution. Rather, U.S. success reflects the effectiveness of the nation’s general system. The ultimate cause for America’s Shale Gas Revolution is an economic system which encourages market competition and entrepreneurship. In particular: 1)The sound property rights system allows all stakeholders (explorers, producers, landowners, pipeline operators, sellers and buyers) to clearly define their rights and responsibilities. Thus they are able to enter and exit business with ease. 2)The mature market mechanism in the U.S. provides stakeholders with sufficient incentive and the room for competition and cooperation to promote high productivity. It also facilitates the rise of professional services and technology companies (for example, geophysical exploration companies and drilling companies), financial institutions and government regulatory agencies. It enables each part of the production chain to enjoy low input and high output. The efficiencies shorten the work cycle and enable the efficient use of capital and a quick return on investment. Further, the market mechanism provides incentives to the entire industry chain leading to the development of necessary infrastructure such as pipeline networks. 3)Effective property rights and the market system stimulate entrepreneurship in the U.S. Many small and medium-sized companies compete in an environment where only the fittest survive. These companies become the main force behind technological innovation and commercialization

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in the industry. One could safely say that the Shale Gas Revolution in the U.S. is the combined result of various unique components of the American system. Table 1. Policies related to Natural Gas in the U.S.

Year Policy

Main Content

1938 The Natural Gas Act of 1938

Established the Federal Power Commission (FPC). It gives the FPC power to regulate the pricing of interstate natural gas piping. The public utilities commissions of individual states are also responsible for overseeing price at wellhead and gas piping price within the states.

1954 The Phillips Decision

The Supreme Court ruled that wellhead price and piping price should be subject to regulation under the Natural Gas Act, enabling the FPC to set wellhead price with Congressional authorization. The decision laid down the early supply structure of the U.S. natural gas: producers sell natural gas to the pipeline companies, which in turn sell to local distributors and ultimately to end user. Each phase is subject to supervision: rates of first two under regulation of federal or state governments, and the last overseen by state and local governments.

1977 Emergency Natural Gas Act

Residential consumers and other small volume gas users are allowed to purchase natural gas from suppliers other than the conventional utility companies. (there were over 1,000 suppliers not subject to government regulation at that time).

1978 The Natural Federal Energy Regulatory Commission (FERC) was established to Gas Policy Act review natural gas pricing system and to complete gradual deregulation of of 1978 wellhead prices. The Act releases new wells from price control effective 1 January 1985.

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1980 Crude Oil Windfall Profit Tax Act

A windfall tax of 30%-70% was put on domestic crude oil effective February 29, 1980. Incidentally tax benefit was granted to unconventional gas (including coal bed gas and shale gas) that came from wells drilled after 1979 but before 1993, and produced and sold before 2003. Subsequent laws extended the required period by three years.

1985 FERC Order No.436

The Order requires pipeline companies to open up their service in a fair way to all customers. Customers can negotiate price with gas producers directly and enter separate contract with pipeline companies. This arrangement forces pipeline companies to break the business of gas selling from gas transport. As such, market mechanism was brought into the supply business of natural gas, and give more options to local utility companies and big end users .

1989 The Natural Gas Wellhead Decontrol Act of 1989

As of January 1, 1993, all remaining natural gas price regulations were eliminated. Since then, free competition allows market to completely determine the price of natural gas at the wellhead.

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1992 FERC Order No.636

Pipeline companies were compulsorily required to make their services accessible to all customers. They could not sell gas and its transportation as one package. Customers can choose freely their gas suppliers and pipeline companies. This arrangement caused inter-state pipeline companies to restructure themselves and can be seen as a complete deregulation of natural gas industry.

1992 The Energy Policy Act of 1992

The Act compulsorily requires use of alternative fuels and lower oil consumption for transportation use. It requires at least 10% of government and private fleets to use alternative fuels (natural gas, electricity, methanol, ethanol and coal liquefaction fuel) by 2000, and 30% by 2010.

2004 The Energy Policy Act of 2004

A total of $ 45 m government money to be spent on research of unconventional gas in the next ten years

2005 The Energy Policy Act of 2005

A ten-year plan including a basket of projects. The fiscal support amounted to $90.25 billion over 2000-2005 period, $14.18 billion of which for scientific research, and $2.04 billion for fossil fuel. It also provided tax incentives to natural gas production. For oil and gas wells operated in 2006, each can get subsidies of $3 per barrel between 2006 and 2010.

2007 Energy Independence and Security Act of 2007

Aimed to increase the production of clean renewable fuels, to improve the energy efficiency of manufactured products, buildings and vehicles. It promoted research on greenhouse gas, carbon capture and storage options. It also aimed to improve energy efficiency of the Federal Government. It cancelled all subsidies to the petroleum industry and switched support to Corporate Average Fuel Economy standards.

2009 American Clean Energy and Security Act

The act has five goals: develop clean energy, increase energy efficiency, decrease greenhouse gas emission, move on to clean energy economy, and use agroforestry to cut down greenhouse gas emission.

2011 Blueprint for a Secure Energy Future

Outlines three strategies to ensure future energy supply and security: less reliance on oil and gas import; directs consumers to use more energysaving products; promotes innovative way to use more clean energy, and directs the federal government to be a role-model in this aspect.

2011 Strategic Plan 2011

Maintains vitality and competitiveness in technology and engineering to promote economic prosperity. Seeks to maintain U.S. leadership in several areas.

II.Policies and Practices of Shale Gas Development in China Over the past few years, the Chinese government has been trying hard to open the energy industry to private capital (for example, the State Council’s commonly called “36-clause on the non-public sector economy” and the “new 36-clause on private investment”, both of which were issued in 2005). Private enterprise is encouraged to participate in the development of shale gas, 105

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build natural gas pipelines and encourage gas utilization. Recently, in order to accelerate the development of natural gas and shale gas, China has included Energy and Energy Technology in the “12th Five-Year Plan”. China has also issued many policy instructions including “Guidance on the Development of Distributed Energy of Natural Gas”, “China’s Energy Policy, 2012” (White papers), “Natural Gas Utilization Policy”, the “12th Five-Year Plan for Natural Gas Development”, “Plan for Shale Gas Development (2011-2015)”, and under preparation is “The Policy of Launching the Shale Gas Industry”, and “Natural Gas Infrastructure Construction and Operation Management Regulations” among others. At the 2012 National Working Conference on Natural Gas on October 25, 2012, Mr. Liu Tienan, the former director of the National Energy Bureau, pointed out eight areas on which the bureau will focus in 2013: 1)Strengthen industry management and guidance, ensure proper connectivity of related plans, approve significant projects according to the planned order and issue the directive “Natural Gas Infrastructure Construction and Operation Management.” 2)Advocate institutional reform. 3)Enhance domestic supply security. 4)Press for vigorous development of shale gas. 5)Accelerate infrastructure construction. 6)Seek international cooperation 7)Direct efficient utilization of natural gas. 8)Further improve the pricing mechanism of natural gas; explore a new mechanism of regulating gas supply through storage. These moves help China to prepare and refine the regulation of its shale gas industry. Below are the major positive effects: 1)Shale gas development was successfully included as one of the nation’s new strategic industries. As a result, a vigorous program of exploration and development of natural gas (including shale gas) is now possible. Some development objectives are quantified to facilitate the supervision of their implementation. A supervisory mechanism is also established. 2)The entry threshold and qualification standards for participants were established. The private sector, and in particular the leading companies, are now able to participate more rapidly in the development, production, sale and transportation of shale gas. Private enterprises are also encouraged to develop shale gas jointly with state-owned enterprises. 3)A bidding system for mining rights, exit mechanism and contract management was promulgated. This will help mine owners sort out many issues during exploration, in particular ownership disputes. It will also help enhance production safety. 4)To encourage a technological breakthrough, professional training will be emphasized and a databank established with regard to the nation’s shale gas (oil) resource potential and physical distribution. These steps will help the industry develop a system of its own to include

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immediate intellectual property rights. The process is as follows: preliminary exploration work is first commissioned by the Ministry of Land and Resources, then State Council approval will be sought through the National Development and Reform Commission, after which experienced foreign companies will be brought in together with their know-how to assist in development. 5)The demarcation of shale gas exploration sites and experimental sites was provided for. This will encourage increased activity and utilization. 6)Transportation facilities will be built. First, to connect the shale gas sites with neighboring natural gas pipeline networks if they are close enough. Second, to build small LNG or CNG application facilities if the shale gas sites are distant from the pipeline networks. Third, to build shale gas pipelines if the development progress permits. 7)Strengthening shale gas developers’ management efficiency and effectiveness, which will result in improved environmental protection. 8)Formulating detailed financial support measures. These include increased funding for resource evaluations, ensuring that local governments shoulder more financing, grant duty-free import of exploration equipment (including related technology) if domestic models are not available, allow the ex-plant gas price to be regulated by the market, and give priority to the approval of land applications. In an attempt to introduce market mechanisms and break the domination of state-owned oil and gas giants, in 2011 the Ministry of Land and Resources invited tenders for shale gas exploration rights. Although the first tender in June 2011was still only open to state-owned enterprises the second tender took place in September 2012 had one third of the bidders from the private sector. However, of the nineteen companies which won in the tender, only two were private. Again, state-owned enterprises were the major players in shale gas development (Table 2). Clearly, the tender results failed to meet the original objective. At present, it is unclear if state-owned enterprises can break new ground for China’s shale gas development. The U.S. experience seems to indicate that small and middle-sized private companies should be the drivers behind the shale gas revolution. Unfortunately the Chinese SMEs were kept from fully utilizing their potential, for reasons that can be traced back to the country’s system.

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Table 2. Comparison of Two Tenders for Shale Gas Exploration in June 2011 and October 2012

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Comparison

First Tender

Second Tender

Sites

4 shale gas sites, over 2,000 sq km each and total area is 11,000 sq km

20 sites with total area of 20,002 sq km, distributed over 8 provinces: Chongqing, Guizhou, Hubei, Hunan, Jiangxi, Zhejiang, Anhui, Henan. Only sites in Hefeng and Hubei exceed area of 2,000 sq km each. 9 sites are smaller than 1,000 sq km each. The smallest is 369 sq km.

Target Tenderers

State-owned enterprises (SOE)

SOE, private companies, joint ventures controlled by China, companies of industries related to oil, coal, power, real estate, finance and geological exploration.

Entry By Invitation Qualifications only

All domestic companies or joint ventures controlled by China which are registered in China, with registered capital over ¥300m, and with permit to conduct gas exploration; or have business ventures with qualified companies.

Participants

China Petroleum, Sinopec, CNOOC, Yanchang Petroleum, China United Coal Bed Methane, Henan Coal Bed Methane

83 companies, 1/3 of which are private companies. 152 submissions.

Evaluation process

N/A

A team of experts was assembled to rank tenderers on subjects including exploration deployment, budget and safety measures.

Duties of successful tenderers

Put in minimum ¥20,000/ sq km; drill at least two wells for every 1,000 sq km

The tender is valid for 3 year. Tenderers have to spend minimum ¥30,000/ sq km on exploration each year, and also drill two wells every 500 sq km (down to target shale layer). They should operate within 6 months after obtaining exploration rights. Successful tenderers should provide a written undertaking about exploration input, work load and progress record, they need to set up companies in the sites’ administration regions and pay local tax when entering production stage..

Regulatory system

N/A

The Ministry of Land and Resources have drafted regulations to be released soon. The impact is targeted to cover each well.

Results

China Petroleum, Henan Coal Bed Methane

One site had no result. Among 19 winners, 17 were affiliated with either regional State-owned enterprises or those under direct supervision of the Central Government’s Assets Supervision and Administration Commission. Only 2 were private companies.

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III. Constraints on Shale Gas Development in China Shale gas development has a characteristic of low single-well output, low production rate, large input, long drilling-cycle, rapid output decrease, slow capital return and high technology requirements. Unlike the development of conventional oil and gas, it requires enormous capital investment during the early production period, and intensive drilling to ensure stable output. Subsidies at the current level in China are not enough to ensure sufficient return on investment. The first shale gas well, the Yang 201-H2 well, was a joint-venture operated by CNPC and Shell. Although it achieved a daily production of 430,000 m3 in early October, 2012, which was the highest record to date in China, the well was unable to maintain such productivity during actual production; in this regard the record hardly bears any significance. The single-well daily production in the U.S. major production region is between 2,800 m3 to 33,000 m3. Assuming the average single-well daily production in China is 30,000 m3, the estimated annual production would be 1,000,000 m3. Given that production would receive ¥0.4/m3 government subsidy, there will be a total annual subsidy of ¥4m. This means developers can only get ¥8 m subsidy over the course of two years, representing a mere 10% of total investment required. Since the production rate can drop off 60-70 % in the first two years, profit will become much less likely in the third year following a sharp output decline. If production is kept at 10,000 m3/day and 300,000 m3/year, the chance of making a profit becomes less certain. The profitability of an enterprise is not only the result of its own competitiveness, but is also closely related to upstream and downstream markets, the government’s industry policies, the country’s overall system and global trends. At present, China’s property rights, related policies and pricing mechanism for gas entering the pipe network give rise to a lot of risks and uncertainties. The government clearly wishes to make good use of private capital for shale gas development, and private companies are equally responsive. However, the question remains whether there is sufficient human and financial capital to sustain the development. After all, most of the Chinese companies which currently possess land exploration assets, be they 100% domestic companies or joint-ventures under Chinese control, are more or less associated with CNPC and Sinopec. Compared with these two giants, private companies or other state-owned enterprises are far less competitive. Take the example of the second-round tender of shale gas in 2012, the concerned sites have a complicated geological situation entailing high risk exploration. It is difficult to identify the spots where resources are centered. Some areas are difficult for heavy equipment (some over 30 tons) to reach, and drilling on hilltops is equally demanding. These factors reduce the price/ value of the sites. Most sites rich in resources of shale gas overlap with those controlled by CNPC and Sinopec (there are 180 sites selected with an area of 1.11 m km2, 77% of which are considered as favorable sites, but 80% of shale resources are situated within sites for conventional oil and gas currently held by oil companies). In view of this situation, the Ministry of Land and Resources issued the “Notice with regard to Reinforcing Exploration of Shale Gas

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Resources and Supervising Work Management” on November 22, 2012, and proposed measures to promote exploration of shale gas resources situated within the regions of oil and natural gas. First, priority is given to oil companies to explore the concerned shale gas. If the oil companies do not explore, the oil companies should transfer their exploration rights to other investors on the condition that shale exploration would not affect normal oil and natural gas exploration in the region. If exploration does not then take place, oil companies are required to pull out of those uncertain areas where they have not conducted sufficient exploration for oil and natural gas but the areas are considered to have shale gas resources. At present, it is yet to be seen how these measures will be executed and what their effects would be. The comparison of constraints on shale gas development of China and the United States shows the advantages and disadvantages of both (see Table 3). China only leads in the government’s preferential policy (the actual advantage is obscure due to different types of subsidies) which is commonly found in infant industry development. However, financial support alone is not sufficient to launch an emerging industry with self-development capability. It helps companies in the startup phase but tends not to be sustained. Drawing on the experience of the U.S., China cannot rely on government subsidies to realize extensive development of shale gas. China ultimately needs to set up systems favoring market competition. It should carry out a reform of the current shale gas approach (and indeed the entire oil and gas industry). It should stimulate enterprises to make profits through market competition and technology advancement, not just provide subsidies and incentives. So far, the latest policies and regulations released indicate that the Chinese government is trying to move in this direction, but actual implementation remains to be seen.

IV. Conclusion

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At present, the shale gas development in China is over-reliant on government subsidies. Although financial support is already quite significant, it is still inadequate to make up for systemic defects as far as industry participants are concerned. Therefore, current policies will not be able to fully stimulate private investments. It is understandable for the policy makers to attempt to accelerate shale gas development, increase production, enlarge energy supply diversification, and reduce carbon emissions. Nevertheless, their focus should not be just formulating preferential policy. They should instead take note of the merits of America’s Shale Gas Revolution, and release the dynamism of the market and entrepreneurship by rationalizing the regulatory system. The classification of shale gas as a separate resource entity in China has nothing to do with its physical nature. The rationale behind this classification is to keep it out of the system constraints currently imposed on the conventional fuel industry. It is hoped that shale gas can be developed on a new platform aiming at production breakthroughs with minimum detriment to the existing arrangements protecting the established interests. If that is the purpose for shale gas’s special classification, China might as well use shale gas development

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as a penetration point, make a bold attempt and explore ways for a new regulatory system and path for natural gas development. Table 3. Comparison of Constraints on Shale Gas Exploration in China and US Factors

Factors

China

Geological Environment

Shales are mainly distributed in Upper Palaeozoic and Mesozoic. Most of them are in marine facies and are in a relatively stable geological structure.

shales are rich in organic matter, found mostly in much older strata, or older paralicfacies neighbouring the marine facies . The geological structures are relatively active and shale gas accumulation patterns are complicated than those in the US.

Large flat areas with abundant supply of water (mass scale hydraulic fracturing requires 20 k to 40 k cubic meters per well).

Mostly hills, lacks water. Exploration conditions are difficult and technology required is high. Costs for exploration and environmental protection are equally high.

Sizable collection of core drilling samples. Highly concentrated oil and gas resources zone.

Insufficient exploration funding. Accumulated amount for shale gas assessment and exploration is less than 7 billion RMB (against 66 billion RMB per year for conventional oil and gas exploration), which leads to poverty of data on shale gas reserves, geological structures and the depth of bury

Possess property rights of almost all core drilling skills.

Have acquired certain degree of technology in horizontal well drilling and staged fracturing. Still in research stage, no applications technology yet.

Sites

Exploration

Technology

Degree of Conventional oil and gas Industrialization explorations have come to a very mature stage with abundant achievements in fundamental research. Shale gas discovery and applications can be dated back to 1821, and subsequently made technological breakthrough in 1990s. The US enjoys flexible engineering project structure and efficient division of labour. Both production technology and commercial operations are fully matured. Scale production has been put to effect.

production technology and commercial operations are still in an initial stage, hard to realize scale production in the short run. Cooperation between private enterprises (Including foreign companies) and state-owned entities has yet to happen.

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Infrastructure Highly developed pipeline networks that ensures Facilities all natural gas produced can be connected into pipelines, which are open to all producers. In 2006, there were 40,000 shale gas wells and the number has risen to 98,590 in 2009.

There is shortage of pipeline networks, and pipelines are not standardized. Hence coordination is required for supply, demand and transportation. China Petroleum and Sinopec controls 70% of the natural gas pipelines, and have clear say in pricing. There are 63 shale gas wells, only 0.07% of the US, and many of which are for trial purpose. Only 24 wells have shale gas flow, 14 of which have initial production of 10k cubic meters/day.

Legislation

The Federal Government has no specific legislation for unconventional oil and gas. Legislation for natural gas also applies to shale gas; however some state governments have legislation specific to shale gas.

There is no specific legislation for shale gas, but natural gas legislation may also apply to shale gas. The government is preparing policy papers for the shale gas industry.

Subsidy

In view of the benefit brought from the Federal Government’s Oil Windfall Tax, some state governments are now enacting various preferential tax laws. Fiscal support from the Federal Government is focused on research and technology development instead of subsidizing production or sales.

Subsidize developers by ¥0.4/m3. Encourage local governments to provide subsidies: free tariff for import of equipment and technology; priority in land use.

Ownership of Land and Mineral Resources

Land owners have ownership of the mineral resources and franchise income. Owners can operate production independently or transfer their operation rights via market.

All underground resources are owned by the country. There is a tender system for mining but. no management system for encouraging the established interest groups to participate in shale gas development. Site exit mechanism and contract management have yet to be improved. As a separately classified mineral, shale gas exploration is no longer subject to the franchise system of oil and gas. However, the shale gas rich areas are mostly overlapped with those owned by China Petroleum and Sinopec. These sites are unlikely to open to other companies in the near future.

Gas Price

Nation-wide price set by the natural gas hubs

Ex-factory price set by market. No nation-wide price.

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Will the “Oil and Gas Revolution” Pass China by? 1

( 油氣革命”與中國擦肩而過？) “

By Jonathan CHANIS (喬納森．強尼斯) 喬納森．強尼斯，美國哥倫比亞大學國際及公共事務（SIPA）學院兼職教授。 Jonathan CHANIS is an adjunct professor at the School of International and Public Affairs (SIPA), Columbia University. He has worked in finance for 25 years and is Managing Member of New Tide Asset Management, a proprietary vehicle focused on global and resource investing. Previously, Mr. Chanis was Managing Director at Tribeca Global Management where he traded energy and emerging market equities, and commodities and currencies. Mr. Chanis is also a member of the Council on Foreign Relations, a Member of the Board of The Energy Forum, and a Trustee of the National Committee on American Foreign Policy. He holds a Ph.D. in Political Science from the Graduate School, CUNY and a BA in Economics from Brooklyn College. The United States is undergoing a historic energy transformation. The heightened vulnerability that began in 1973 is giving way to a period of significantly less risk. The immediate cause of this transformation is improvement in petroleum and natural gas extraction methods, especially the use of hydraulic fracturing and horizontal drilling techniques. Given the technological basis of this change, many wonder if a U.S.-style oil and gas revolution can be transferred, either purposefully or surreptitiously, to China. If this revolution were to reach China, both its energy insecurity and its global greenhouse gases emissions would be significantly reduced. However, even if China acquired the U.S. technology, it is unlikely that this revolution can be replicated. The proximate cause of the U.S. energy revolution is technological, but the more important cause is better industry organization and a more agile and adaptable oil and gas business culture. Even in comparison to most other U.S. industries, oil and gas companies and managers are different. Integral to this system and culture are a greater acceptance of uncertainty, a lower tolerance for hierarchical relationships, and a higher regard for the individual over the collective. All of this encourages greater risk taking. The U.S. system also organizes its oil and gas industries through private corporations instead of state ownership. The negative impact of 1

This article, originally published June 20, 2013 on the CSIS Pacific Forum “PacNet”, is reproduced here with the written permission of the author.

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state ownership in areas such as labor and capital efficiency, operational innovation, and reserve growth is well recognized. These characteristics and the contrast with China are raised, not to trumpet US “superiority,” but simply to note that if China values efficient production of oil and gas, then a system more closely resembling that in the U.S. would produce better results. In examining the issues restraining a petroleum and natural gas revolution in China, one can divide them into physical issues and organizational/cultural issues. The physical issues include such things as geology, hydrology, and pipeline networks. For example, when considering oil production, it is clear that China does not have sufficient petroleum source rock to duplicate the U.S. experience. As is clear from many sources including the Energy Information Agency (EIA) and BP, the oil just is not there. However, when it comes to shale gas, the geology is much more favorable. While questions remain about the amount of hydrocarbon bearing material in China’s shale deposits, there certainly are enormous amount of this rock. The EIA, for example, thinks China may even have 50 percent more technically recoverable shale gas resources than the U.S. As for water, as FAO and others make clear, China is substantially water constrained, but given slow, steady progress in minimizing water use in fracturing, this constraint becomes smaller (for both countries) every year. Regarding pipelines, according to the EIA the U.S. has almost 8 times as many miles of natural gas transport capacity as China. To consume any newly produced bounty of natural gas, China would have to build out its pipeline network. This is expensive and time consuming. On the whole, the physical limitations favor the United States. But geology, hydrology, and pipeline networks are all physical problems that, to a large extent, can be overcome with known and developing physical solutions. China’s real problem concerns industry organization and business culture. The most serious organizational issue is lack of private ownership of mineral rights. Private ownership makes it easier for land to be leased or sold for development; it promotes the transfer of assets to individuals and companies interested and able to produce the resource. It is not an accident that the U.S. energy revolution is taking place primarily on privately owned land. The dominance of the big three Chinese state owned oil and gas companies (CNPC, Sinopec, and CNOOC) is another major problem. One of the primary reasons the US natural gas industry is so successful is because it is composed of thousands of independent companies. These companies are innovative and they are able to deploy nimbly hundreds of rigs and other exploration and production assets. The dominance of CNPC in the pipeline sector further constrains China’s gas development. The U.S. pipeline system is built upon “common carriers” and “open access.” Any natural gas producer that meets minimum safety and commercial standards, and who can pay for space is given access to the network. This allows exploration and production companies to invest in projects with the knowledge that the state, or a competitor, cannot unfairly keep it off the pipeline network.

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China also faces environmental challenges to fracturing, both from the vagaries of its own regulations and enforcement mechanisms, and from popular challenges to extractive operations. The US had decades to work out its regulations and the conflicts it creates. But even in the United States, these regulations still are a major source of discord. However, the federal system makes solutions to these problems easier because local jurisdiction promotes regulations tailored to local preferences and limits the ability of central authorities to intervene. China’s national approach to regulation and enforcement most likely will retard development of its shale resources. China, like many other countries, also needs natural gas royalties and taxes reform. Ironically, reform in this area might be easier since it does not necessarily threaten Communist Party or other vested interests’ control over oil and gas assets. All oil-producing countries, whether they have market- or state-driven economies, have to grapple with this issue. The point is to make the fiscal regime stable, transparent and, nondiscriminatory – especially among domestic companies. While the record of most non-Anglo-Saxon countries in this regard has not been terribly good, perhaps China’s leadership can get this right. A final area where reform is necessary and where the Chinese leadership may make progress is natural gas pricing. Historically, Chinese natural gas prices were fixed below the cost of production and well below the LNG import price. This was done primarily to subsidize domestic manufacturers. However, over the last few years there has been experimentation with market pricing mechanisms and exchange trading. If the Chinese leadership wants to promote domestic shale gas production, they will need to continue this liberalization. Chinese promotion of shale gas development is restrained primarily by the nature of their industrial organization and business culture, not by physical or technical problems. Essential reforms, such as mineral ownership privatization and breaking up the domestic oil and gas oligopoly, strike at the heart of Communist Party control and privilege. Other issues, such as natural gas price decontrol, and designing a proper tax and royalty regime, are difficult for any political system, even when it is committed to reform. And the environmental regulatory regime issue is particularly hazardous even under the best of circumstances. If China wishes to experience a U.S.-style energy revolution – and not see the gap in energy security with the United States continue to widen – another more extensive round of market-oriented reforms needs to occur in its oil and gas industries.

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Reform’s Key Role in China’s Shale Oil and Gas Development --A Commentary on Jonathan Chanis’ article “Will the ‘Oil and Gas Revolution’ Pass China by?” (改革是頁岩油氣發展的關鍵——評“‘油氣革命’與中國擦肩而過？”) By ZHANG Kang (張抗) 張抗，曾任中石化石油勘探開發研究院總工程師，退休後任諮詢委員會副主任。 ZHANG Kang is the deputy director of the Consultant Committee of the Exploration and Production Research Institute (EPRI) of Sinopec. He used to serve as the chief engineer of the Institute before his retirement. His major research works include: “the Life Cycle of Oil and Gas Fields and Tactics and Strategy to Succeed (Chinese)”, “Strategies for China’s Oil and Gas Development (Chinese)” and “The Geopolitical Aspect of Oil and Gas of China and the World (Chinese)”. He graduated from the Department of Geology, Peking University in 1963 and earned a Master’s degree from the Chinese Academy of Sciences in 1981. The U.S. Energy Information Administration (EIA) has twice conducted global shale gas reserve analysis and each time listed China in the top rankings in terms of shale gas and shale oil resources. China also has invested a great deal in shale gas research and exploration, second only to investment in these fields in the United States. The prospect of China’s shale oil/gas development has triggered profound public debate both in China and around the globe. The Hawaii-based CSIS Pacific Forum has recently published in its journal “PacNet” an article “Will the ‘Oil and Gas Revolution’ Pass China by”, written by Jonathan Chanis, who has been extensively involved in emerging market investment and commodity trading for 25 years, with a specialized focus on energy in Asia. This article intends to both introduce Chanis’s views to the Chinese audience and to comment on them.

The “Hard Constraints” are Not the Key Issue Jonathan Chanis pointed out in his article that there are two constraints on China’s oil and gas revolution – physical issues and organizational/cultural issues, which we normally refer to as “hard” and “soft” constraints. The hard constraint includes “geology, hydrology and pipeline networks.” The soft constraint, on the other hand, refers to “industry organization and business culture” which critically determines whether the oil and gas industry could function well in a 116

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market economy. The foremost among the “hard constraints” are the geological oil and gas resources. As Chanis indicates, “while questions remain about the amount of hydrocarbon bearing material in China’s shale deposits, there certainly are enormous amount of this rock. The EIA, for example, thinks China may even have 50 percent more technically recoverable shale gas resources than the U.S.” As to water resources, citing data of the Food and Agriculture Organization of the United Nations (FAO), Chanis does not find the scarcity of water as a sufficient impediment to Chinese shale development-- “as given slow, steady progress in minimizing water uses in fracturing, this constraint becomes smaller (for both the U.S. and China) every year.” As to another major constraint, Jonathan Chanis believes that China lacks sufficient pipelines, and that a monopoly on pipeline oil/gas transportation limits the potential of China’s natural gas industry. Noting the substantial growth of pipeline constructions in China, I would like to raise several points here that, in my view, were not sufficiently addressed in Jonathan Chanis’ article. Firstly, a fair market entry system to the gas pipeline industry is likely to be established in China in the coming years. Secondly, the significantly increased consumption of locally distributed Compressed Natural Gas (CNG) and Liquefied Natural Gas (LNG) make the future of downstream unconventional gas sales in China a bright one. Even some joint ventures involving private enterprises are being established, paving the way towards increased downstream production. Thirdly, the idea of a distributive energy network has exploited comparative advantages in both gas/oil energy and other energy forms (such as wind and solar power) and ensured higher quality and accessibility of energy use. Under these current conditions, the transportation and mass use of shale gas should not be an especially challenging problem. Some may believe that technology is the most challenging of the hard constraints for unconventional gas industries. Rather, I wish to point out that the preeminent difference between the U.S. oil industry and that in China lies in the market entities, which is to say, the small and medium enterprises (SMEs) in oil and gas development. I agree with Chanis’ observation that in the United States it is the SMEs which dominate shale gas/oil exploitation, in contrast to the state-own enterprises in China. The success of the American natural gas industry is due in large part to the thousands of independent companies. “These companies are innovative and they are able to deploy nimbly hundreds of rigs and other exploration and production assets.” This entrepreneurial spirit creates a higher tolerance for risk along the oil and gas production chain where the organizational culture focuses more on the individual and less on hierarchical structure. In addition, there is also a pervasive and serious misunderstanding of the technical framework of China’s shale oil/gas industries among outside industry experts. Indeed, we admit the existence of a significant technological gap between China and the U.S. in the unconventional oil and gas industries. Nevertheless, simply transplanting U.S. technologies would not work

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for China’s specific geological conditions. The application of engineering techniques in the oil and gas industry depends on the complexity and non-homogeneous nature of the geology and would vary from basin to basin and even across the different sub-sections within the same basin. Hydraulic fracturing and horizontal well drilling are at the technological core of shale oil/gas, coal bed methane, and low-permeability, tight sandstone oil and gas extractions. The United States has a long history in extracting low permeability-tight sandstone oil and gas and had gained sufficient experience to adapt those techniques for coal bed methane and shale oil/ gas extraction. China has followed a similar path and has gained extensive knowledge in low permeability, tight sandstone oil/gas extraction, achieving quite a success. Currently one quarter of all oil production and one third of gas production in China comes from the low-permeability, tight sandstone layers. Considering this remarkable achievement, it is incorrect to conclude that China does not have the technology. Rather, China is now capable of making 2500 horsepower (HP) fracturing pumps and is becoming a chief exporter of such machines. Even larger, 3000 HP fracturing pumps are also being developed. For horizontal well drilling, new records of well lengths and vertical depths are frequently surpassed too. Critical techniques such as cascade hydraulic fracturing in horizontal well and mega-scale hydraulic fracturing (pumping in over 10,000 m3 of liquid and 1,000 m3 sand at a certain time) are also in practice in China. Thus, it is fair to argue that for the shale oil and gas exploration and development technology, China has already achieved a good foundation. The technological achievements speak for themselves. Also, the development of coal-bed methane, tight gas and shale gas actually share a common technology: the drilling of horizontal wells and fracturing. In the United States, it was through the efforts and experience gained from tight sandstone gas exploration and development that enabled the wide-scale shale gas development in the U.S. today. China has also gained experience and achieved remarkable successes in its tight sandstone gas development. With the experience accrued, China has already reached an advanced level in the drilling of horizontal wells, fracturing and other accompanying technologies. Of course, China still has a long way to go in adapting its cutting-edge technologies to the different basins and making the adjustments and modifications appropriate to the different geological conditions; but thus far China has made a good start.

Key Issue is to Reform the Oil/Gas Industry Supervision

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Chanis points out that, among the soft constraints, the most serious one is the mining permit issue. Current regulations in China allow only several state-owned petroleum companies to obtain permits for oil and gas field exploration and extraction, effectively barring privately-owned and foreign-owned or cooperative enterprises from the upstream oil and gas market. While agreeing with this statement, I would like to add that the state-owned enterprises sometimes are not fulfilling their exploration commitments within the given permit period, but nevertheless have de facto permanent ownership to the best-quality gas/oil zones within the country. Therefore,

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when shale gas is listed as an alternative mining resource for mining permit bidding and opened to all qualified enterprises, the available zones offered are of relatively inferior quality. Either they are in an unpromising geological area or the zone lacks transportation infrastructure. Those constraints are currently the biggest obstacles blocking the industry’s entrance to a free market. As to the environmental concerns that challenged many in the development of shale gas, Jonathan Chanis believes that the U.S. federal governance system, with its multi-level system of supervision, is better able to resolve these problems. The regulatory system in the U.S. prevented further environmental problems. Regions that were once affected by the pollution caused by shale development but later recovered from it are now becoming advocates for shale gas and oil development. Appropriate governmental supervision and regulation, coupled with appropriate mining permit management, serves to reduce the environmental pollution caused by oil and gas extraction and contributes to the growth of the industry. Good examples are the Marcellus shale gas play in Pennsylvania and the Ordos low-permeability, tight sandstone gas field located in inner-Mongolia, China. For other reform issues such as the gas price reform and tax reimbursements, I think their implementation in China will be relatively easier than in many other emerging economies. As a foreign researcher, Jonathan Chanis expressed his sincere and candid advice to his Chinese counterparts that if China does not want to see the oil and gas revolution pass it by and wants to take measures to enhance its energy security, then it should consider making another round of extensive, thorough and in-depth market-oriented reforms.

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Prospects for Unconventional Gas Development in China

--a Summary of the 2012 Global Unconventional Gas Summit2 (中國非常規天然氣發展前景：2012全球非常規天然氣峰會總結) By Beijing Energy Club (北京能源專家俱樂部) 北京能源專家俱樂部是一個非政府的、非牟利的高層次私人論壇。 The Beijing Energy Club is a non-governmental, not-for-profit, high-level private forum for public benefit. Its purpose is to serve as a platform for the exchange of ideas among Chinese and foreign energy experts; to attract authoritative experts for in-depth discussion on energy, resources, the environment and climate issues confronting China and the world; to collect experts’ recommendations for China’s sustainable energy development; and to share the Chinese experience with the rest of the world.

I. Global Shale Gas Exploration and Development Activities are Increasing Daily Potential for Huge Global Unconventional Gas Resources: Thanks to increases in natural gas exploration and development technologies and increased economic efficiency, global unconventional and conventional proven reserves are increasing daily. Total global recoverable conventional and unconventional natural gas reserves have exceeded 400 trillion cubic meters. According to average global consumption rates, the current recoverable reserves are sufficient for 250 years.

Global Shale Gas Exploration and Development Activities are Increasing Daily: North America continues to promote increases in unconventional gas and, in 2011, shale gas surpassed 25% of America’s total gas production. China has carried out two rounds of public bidding for shale gas blocks and has introduced financial subsidies for shale gas of 0.4 Yuan/m3. The EU is currently focusing its energy on solving potential environmental impacts The article was originally published in the Beijing Energy Club’s “2012 Annual Report” in Chinese and is reproduced here with the permission of the organization. 1

Held in Beijing between November 6-8, 2012, the summit was jointly sponsored by the China Energy Research Society, the American Gas Technology Institute, the Beijing Energy Club and the China Energy Fund Committee

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caused by shale gas development, and Poland, England, Ukraine, and Romania are all actively carrying out preparations for shale gas exploration and development. Poland has already drilled more than 30 shale gas wells, and is currently intensifying the development of shale gas policy formulation and supervision. The International Energy Agency(IEA) predicts that if their seven “golden rules3” of environmental management for shale gas development are comprehensively implemented, then the added sum of unconventional gas production will surpass the production of conventional gas producing countries (specifically in the Middle East, North Africa, and Russia). By 2035, global conventional gas production could reach 5.1 trillion cubic meters, an increase of 60% over the 3.2 trillion cubic meter production in 2010.

Solid Potential for Unconventional Gas Development and Consumption in the APEC Countries: 1) The Asia-Pacific Economic Cooperation (APEC) region possesses extremely large technically recoverable unconventional gas resources, totaling 114.7 trillion cubic meters. Based on current estimates of the status of production, Asia-Pacific has more than 200 years of recoverable unconventional gas, and that data does not include recoverable Russian and Indonesian coal-bed Methane, Mexico and China’s tight gas or the shale gas located in Russia and several Central Asian countries. 2) In 2011, production of unconventional gas in the APEC region reached 558 billion cubic meters per year, amounting to around one third of APEC’s total gas production (1.831 trillion cubic meters). The future of unconventional gas production in all of APEC’s economies will experience large growth. 3) The development potential of unconventional gas in APEC is very good. Estimated production in America, Canada, and Mexico will increase from 514 billion cubic meters in 2011 to 610 billion cubic meters in 2020 and 780 billion cubic meters by 2035. Australia’s production of coal-bed methane, which is the nation’s primary source of unconventional gas, will increase from 5 billion cubic meters to 100 billion cubic meters in 2035. Russia is currently preparing to develop Kuzbass, a large basin rich in coal-bed methane resources, with the hope of producing 4 billion cubic meters by 2020 and 20 billion cubic meters by 2035. This would allow Russia to produce, at the very least, 20 billion cubic meters of unconventional gas.

Development of Unconventional Gas in China Holds Great Promise: Geological shale gas resources in China total 134 trillion cubic meters, with recoverable resources amounting to 25.04 trillion cubic meters. Initial predictions of China’s recoverable 3

The “Golden Rules” promoted by the IEA are principles that can allow governments, industry and other stakeholders to address these environmental & social impacts. They include: measure, disclosure and engage; watch where you drill; isolate wells & prevent leaks; treat water responsibly; eliminating venting, minimizing flaring and other emissions; be ready to think big; ensure a consistently high level of environmental performance. They are “Golden Rules” because their application can ensure operators have a “social license to operate”, paving the way for a golden age of gas. See more details in “Golden Rules for a Golden Age of Gas”, IEA/OECD, 2012.

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shale gas, coal-bed methane, and tight gas amount to 79.5 trillion cubic meters, which is 1.4 times that of China’s conventional gas resources. By 2015, China plans on 600 billion cubic meters of proven geological shale gas reserves, 200 billion cubic meters of recoverable reserves, and 6.5 billion cubic meters of shale gas production. Coal gas will account for 15-18 billion cubic meters in capacity, while coal-bed methane surface development production will account for around 16 billion cubic meters.

China’s Government is Actively Supporting the Development of Unconventional Gas: National regulatory authorities are vigorously applying the principles of “efficiency” and “sustainability,”diversified investment, research and development, engineering equipment, policy formulation, financial subsidies, gas price reform, and international cooperation to promote the development of unconventional gas. China also attaches great importance to environmental protection, strengthening regulation, policy guidance, and international exchange when developing and integrating conventional and unconventional gas. Currently, the shale gas exploration rights market has already been liberalized, permitting state-owned companies, privately owned companies, and Chinese-foreign joint venture enterprises access to the market.

II. Shale Gas Exploration and Development Policy, Laws, and Regulations Must be Constantly Improved The International Gas Union believes that natural gas will be an effective counter to future energy challenges, and that natural gas is the best choice to ensure energy security, reduce greenhouse gas emissions and promote sustainable development. The key measure of a policy’s effectiveness is whether it results in sustainability, supply security, and economic impact.

The Industry Determines Best Practices: Requirements for the development of unconventional resources are higher than those for the development of conventional resources. These higher requirements include new legal and regulatory standards and work practices. Industry-determined best practices include: 1) ensuring the integrity of the gas well: evaluation of bottom sealing ability, standards for well construction, integrity of well equipment, monitoring of real-time fracturing operations, realtime monitoring of production operations; 2) avoid negatively influencing the terrain, control wastewater management and processing, control gas emissions, reduce noise, manage truck traffic; 3) avoid negative public reaction through transparency and administrative innovation – carry out preliminary negotiations and communicate with communities and conduct analyses on the impact of shale gas developmental on local economies and jobs. 122

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America: Standards and Regulation Lag Behind the Pace of Development: In America, shale gas exploration and development technology quickly outpaced the necessary adjustments to regulations and business practices, speeding up work at all levels of government related to safetyand the environment. Parts of the American public has developed a skeptical attitude towards shale gas due to previous accidents and the dissemination of inaccurate information. Due to the widespread inaccurate reporting and lack of sufficient knowledge, the American public incorrectly assumed that hydraulic fracturing was the cause of several accidents,including well cementation issues, the pollution of drinking water, drilling wells in water aeration zones, and waste disposal. Consequently, American law and regulations are also being constantly improved. For example, in 2011the U.S. Environmental Protection Agency (EPA) began to assess the impact of shale gas exploration and development on water and emissions.This study, which was finished in 2012, led many states to work on improving regulations and introducing new legislation based on each circumstance. The EPA study also encouraged the industry and NGOs to constantly work hard to apply best practices, introduce appropriate regulations, monitoring and enforcement mechanisms, all of which may lead to the introduction of new federal and state legislation.

Europe: Steadily Increasing Knowledge of Potential Environmental Effects: The rapid development of shale gas has caused some to worry about the potential for negative environmental effects, especially in Europe, which has some of the strictest environmental protection requirements. For example, France, Norway, Sweden, Germany, Lithuania, and Bulgaria have already suspended shale gas development. At the end of 2010, the European Union(EU) and the Atlantic Council of the United States organized a dialogue. The dialogue’s main topic was “Establishing a pragmatic and balanced opinion for the development of unconventional gas in Europe,” the focal point was on fracturing technology and its impact on water and the environment in general. The European Commission and the European Parliament required comprehensive understanding of the environmental and social impact, complexities of development, and best solutions. The governments of several member states began to consider regulatory frameworks for unconventional resource development; however, the vast majority has still not sufficiently solved the entire problem. To this end, cooperation between America and the EU has begun to jointly deal with environmental regulation challenges. After a deeper understanding of North America’s shale gas development, Europe began setting up a regulatory framework at the EU and member state levels.

China:Positive Policy and Regulatory Conditions are Even More Important than Hard Subsidies: In China, shale gas resources are still not well defined, key technologies are still pending a breakthrough, supporting policies are not yet completeand administrative institutions are still

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waiting to be perfected. The most urgently needed change is implementation of a regulatory policy and system. There is recognition that China’s shale gas development cannot be undertaken too hastily; the basic foundation must be completed first. Development of shale gas is a process that requires sustained effortsto develop the entire society’s technology, policy formulation, regulatory framework, talent training, and data and information sharing. Regulatory policy cannot continue to be based on a broad framework level, but needs to be specific and practical. Policy must be applied not only to liberalizing private capital’s access to shale gas resources, but also to allowing full access to service technology, finance, and pipelines. At the same time, it should encourage non state-owned companies to enter the service technology field and allow local governments, NGOs, and local communities to join environmental regulatory work. Policy should refine conditions to attract foreign investments, rely on the particularities of the development of shale gas to adjust PSC (production sharing contract) terms, and be designed in such a way as to allow enterprises a reasonable profit and thus allow them to effectively manage business risks.

III. The Development of China’s Shale Gas Must Conform to Domestic Conditions The development of natural gas is a gradual process. Unconventional gas development utilizes already mature natural gas technology to refine and intensify development and then turn to technology used for large scale “unconventional resources.” China’s shale gas industry can adopt the “first take a step back then advance” strategy. In the beginning phase it should utilize precise and sound conventional technology and demonstrateits effectiveness. Once the industry possesses sufficient scale and a clear basic understanding of what will be achieved by applying improved new technology, it may then enact large-scale development, focus on construction, reduce costs, and avoid the risks of promoting the application of new advanced level technology. The development of shale gas must be targeted to its characteristics and emphasize the application of simple, economically viable, new technologies that will assist in following a low-cost development path.

Combining “Technological Innovation and Administrative Innovation”:

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Low cost development goals may be achieved through integration and focus on human resource allocation, material, investment, organization, etc. Technological innovation includes: basic research techniques, development of core technology, integrating supporting technology, and establishing technological systems. Administrative innovation includes: organizational restructuring, process reengineering, optimization and simplification, digital cost control, marketization, incentive mechanisms, etc. The combination of technological innovation and administrative innovation by China’s oil and gas industry has already made great contributions. The industry has: 1) guided the construction tackling of the Ansai low-permeability oilfield,

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which became China’s first large-scale low permeable oilfield (in 1997 exceeded 1 million tons and in 2011 reached 3 million tons of production); 2) guided the development of the Suligetight gas fields, which became China’s highest domestic producing gas field (planning on 30 billion cubic meters annual production, in 2011 reached 16 billion cubic meters); 3) created the famous Ansai oilfield model (1989-1995) and Sulige gas field model (2001-2007); 4) and has guided the rapid production growth of oil and gas in Changqing’s oil field. Currently, Changqing has become China’s number one oil and gas field and, in 2013, will be built as the western “Daqing.”

Shale Gas Development Can Follow the Sulige Tight Gas Development Model: Sulige gas field is China’s largest natural gas field with proven reserves around 3 trillion cubic meters. Sulige is one of China’s best examples of the development of unconventional gas to date. The core of the Sulige model of tight gas development is “low-cost technological systems”, “low-cost administrative systems”, and “if it can be copied, it can be transferable”. The development of shale gas similarlyrelies on science and technology, innovation mechanisms, simplified mining, and must follow the economic model of not exceeding 300 million Yuan of investment per every million cubic meters of production. America’s successful experience illustrates that the “small company decision making style” is a key approach for the development of unconventional natural gas. China, under the main framework of large companies, can attract private capital and foreign investment to create a “catfish effect2”, it can also promote large companies to use the “small company decisions making process” to develop low-grade resources to achieve comparative advantages.

Advocate for the Comprehensive Exploration and Development of Unconventional Oil and Gas, Utilize the Enthusiasm of State-Owned Enterprises, and Fully Comply with the Law on Exploration and Production Blocks: By drawing on lessons from coal-bed methane and uranium mining, the industry can actively encourage comprehensive exploration and development. Shale gas and oil are frequently found together and perhaps also in symbiosis with tight gas and oil. Tight (sandstone) or shale oil and gas may be found under conventional oil and gas reservoirs in existing fields. According to oil and gas companies, carrying out different kinds of comprehensive oil and gas exploration in compliance with laws and regulations is beneficial to a nation and its people. At the same time, targeting shale gas to act as a new mineral and a reform plan for the administration of minerals should be established. This could begin by putting every exploration and production block’s workload duty on equal footing, making inspections of conventional oil and gas blocks 2 The catfish

effect is the effect that a strong competitor has in causing the weak to better themselves.

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to ensure accordance with the law, implementing withdrawals upon expiration or make changes to liberalize block regulations, establishing the return of blocks back into the bidding process after being relinquished, using the promotion of development as a principle, and utilizing pilot projects for different stages of implementation.

IV. Technology Requirements for the Development of Shale Gas in China The 2012 Global Unconventional Gas Summit also explored the most pressing technological requirements for shale gas development in China.

Evaluation Technique for Shale Gas Resources: Resource evaluation is the key to large-scale development of shale gas, while estimated resources cannot be used to create development plans. Methodologies and standard parameters exist for researching and making predictions as to whether or not gas-bearing shale contains reserve potential or is relatively dissimilar to conventional gas. To make predictions on favorable shale reservoir distributions, the practice is to set up different types of shale gas accumulation patterns, which is the key parameter and evaluation criterion for evaluating shale gas resources. Shale gas resource evaluation emphasizes recoverability, economics, and exploration and development integration.

Favorable Shale Gas Target Evaluation Technology: An in-depth study of the geological concentration and distribution of China’s shale gas, including analysis of applicable technology and economics, which focuses on the critical factors for developing shale gas reserves and research on reservoir characteristics, is needed. When developing in difficult terrain under specific geographical conditions, the following should be used to ascertain shale gas “sweet spots” in order to provide technological means to meet the challenges: seismic acquisition, striving to make technological breakthroughs in logging methods and detailed reservoir description techniques. Additionally, to assist in optimizing development plans and measures for increased production, reservoir evaluation should include an analysis of oil and gas description, identifying favorable development and production zones, assisting in establishing development plans, carrying out analysis of various parameters, confirming favorable fracturingzones, assisting in well spacing and fracturing projects, launch development and production measurement.

Improve Reservoir StimulationTechnology and Predictive Production Technology:

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Before a single well’s production can be increased, stimulation of the shale gas reservoir must first be prepared through the development of new fracturing liquid, purification of fracturing fluid, recyclable technology, and the prevention of reservoir pollution. Research on

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the production efficiency and development optimization plans for different well networks, well separation, and types of wells should be carried out to improve shale gas development and economic efficiency.

Environmental Protection Technology: Technological requirements for shale gas development and environmental protection are relatively high. How to solve drill-bit dust and water consumption issues is a very difficult problem. Surface and underground hydrogen sulfide (H2S) pollution and other toxic gas diffusion must be prevented. In addition, there must be focus on how to manage polluted solids and liquids, their use and disposal. Initial investment into shale gas development is significant, technological barriers are high, production cycles are long, return on investment is slow, and the elements of risk are many. Therefore, it is necessary to arouse enthusiasm across the board to participate in the development of shale gas technology, shale gas exploration,and the development of the industry as a whole, while slowly introducing market mechanisms in order to realize the scientific development of shale gas and other unconventional gas in China.

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China’s Natural Gas Imports (天然氣進口縱橫談) By CHOW Chuen-ho, Larry (周全浩) 周全浩，香港能源研究中心主任，原香港浸會大學地理系教授，現為客座教授。 CHOW Chuen-ho, Larry, obtained his Ph.D. from the University of Kansas, U.S.A. He was a professor of Geography at Hong Kong Baptist University from 1976 to 2012 and a visiting professor from 2012 onwards. He established the Hong Kong Energy Studies Centre at the University in 1998 and has served as the Centre Director till now. He published quite a few papers in international journals like Energy Policy, OPEC Review, China Quarterly and Economic Bulletin for Asia and Pacific, in addition to writing a large number of book chapters, book reviews and pieces in popular magazines and newspapers. He is also a member of the international editorial board of Energy Policy and served on the editorial board of Energy Sources.

I. Introduction As the energy consumption model is highly interrelated with emission reductions, increasing the usage of natural gas has been both the global trend and a policy focus of China in recent years. Unfortunately, China’s natural endowment of energy sources may be characterized as “abundant in coal, poor in petroleum and in natural gas”, making China more dependent on coal than other countries. China’s proven reserve of coal in 2013 is calculated at 114.5 billion tons or about 13% of the world’s total. However, the country’s proven reserves of petroleum and natural gas constitute only 1% and 1.7% respectively of the world’s total. (Table 1) During the past two decades, more than 70% of China’s total domestic energy production was fueled by coal. In recent years, China’s domestic production of petroleum decreased from 19% in 1990 to less than 10% . Use of natural gas and “hydro, nuclear and wind power” have increased, now constituting 4% and 8% of total domestic production respectively in 2011 (Table 2). In terms of energy consumption, coal remains the dominant energy source in China although its proportional use decreased from 76% in 1990 to 68% in recent years. Petroleum constituted about 20% of total consumption. The shares of natural gas and “hydro, nuclear and wind power” reached 5% and 8% respectively in 2011 (Table 3). China pledged early on to the international community to reduce its CO2 emission per GDP unit by 40 to 45 percent in comparison with the emissions in 2005, so China is in urgent need 128

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of optimizing its energy structure. If, as predicted, China’s GDP maintains an average annual growth rate of 7% during the “Twelfth Five Year Plan” period, the average annual growth rate of total consumption and production of primary energy is likely to be 4.3%, the proportion of non-fossil energy in primary energy consumption is likely to increase to 11.4%, and energy consumption per unit of GDP is expected to decrease by 16%. Since natural gas is a cleaner and more advanced fossil fuel, if supplemented with government policies, China’s natural gas consumption market is likely to further expand. The government plans to increase the proportion of natural gas in the primary energy mix to 7.5% by 2015. By then, production of natural gas will reach 176 billion cubic meters, consumption will reach 230 billion cubic meters, import volume will reach 93.5 cubic meters, and the import dependence ratio will be 35%. China’s growing dependence on imported natural gas has drawn the attention of both international and Chinese observers. Table 1: Proven Reserves of Major Energy Resources of China and the World as of the End of 2012 Source: Statistical Review of World Energy 2013, BP Proven Reserves

China Proven Reserves

World Proven Reserves

China / World %

Oil (billion barrels)

17.3

1,668.9

1.04

Coal (100 million tons)

1,145.0

8609.4

13.3

3.1

187.3

1.7

Natural Gas (trillion cubic meters)

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Table 2: China’s Energy Production Composition from 1990-2011 Source: China Statistical Yearbook 2012 Year

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Production Quantity (100 million tons of coal equivalent)

Percentage of Total Energy Production (%) Raw Coal Crude Oil Natural Gas Hydro, Nuclear and Wind Power

1990

10.39

74.2

19.0

2.0

4.8

1995

12.90

75.3

16.6

1.9

6.2

2000

13.50

73.2

17.2

2.7

6.9

1005

21.62

77.6

3.0

7.4

2006

23.22

77.8

11.3

3.4

7.5

2007

24.73

77.7

10.8

3.7

7.8

2008

26.06

76.8

10.5

4.1

8.6

2009

27.46

77.3

9.9

4.1

8.7

2010

29.69

76.6

9.8

4.2

8.4

2011

31.80

77.8

9.1

4.3

8.8

1990-1999 annual average percentage

74.3

17.9

2.1

5.7

2000-2011 annual average percentage

76.2

12.5

3.4

7.8

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Table 3: China’s Energy Consumption Composition from 1990-2011 Source: China Statistical Yearbook 2012 Percentage of Total Energy Production (%) Year Consumption Quantity (100 million tons of coal equivalent) Raw Coal Crude Oil Natural Gas Hydro, Nuclear and Wind Power 1990

9.87

76.2

16.6

2.1

5.1

1995

13.12

74.6

17.5

1.8

6.1

2000

14.55

69.2

22.2

2.2

6.4

1005

23.60

70.8

19.8

2.6

6.8

2006

25.87

71.1

19.3

2.9

6.7

2007

28.05

71.1

18.8

3.3

6.8

2008

29.14

70.3

18.3

3.7

7.7

2009

30.66

70.4

17.9

3.9

7.8

2010

32.49

68.0

19.0

4.4

8.6

2011

34.80

68.4

18.6

5.0

8.0

1990-1999 annual average percentage

73.9

17.6

1.9

5.7

2000-2011 annual average percentage

69.6

20.0

3.2

7.2

II. Analysis of China’s Natural Gas Imports Although the West-East Gas Pipeline Project has alleviated the problem of a mismatch in the location of demand and supply, domestically produced natural gas still cannot fully meet the increasing local demands (especially from the coastal cities), leaving a supply-demand gap which must be filled with imported gas. China has imported natural gas since 2006 and became a net importer of gas in 2007. China’s dependence on imported natural gas has increased sharply from 2% in 2007 to 21.4% in 2011 (Table 4). It is even reported that last year nearly thirty percent of China’s natural gas consumption relied on imports.

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Table 4: China’s Natural Gas Balance Sheet from 2000-2011 Source: Derived from China Energy Statistical Yearbook 2001-2012 Year

Production

Consumption

Export

Import

Net Import

(100 million cubic meters)

Import Dependence Ratio (%)

2000

272.0

245.0

31.4

-31.4

-12.8

2001

303.3

274.3

30.4

-30.4

-11.1

2002

326.6

291.8

32.0

-32.0

-11.0

2003

350.2

339.1

18.7

-18.7

-5.5

2004

414.6

396.7

24.4

-24.4

-6.2

2005

493.2

467.6

29.7

-29.7

-6.4

2006

585.5

561.4

29.0

9.5

-19.5

-3.5

2007

692.4

705.2

26.0

40.2

14.2

2.0

2008

803.0

812.9

32.5

46.0

13.5

1.7

2009

852.7

895.2

32.1

76.3

44.2

4.9

2010

948.0

1069.4

40.3

164.7

124.4

11.6

2011

1026.9

1305.3

31.9

311.5

279.6

21.4

2.1. A Survey of China’s Natural Gas Imports China’s import of natural gas mainly takes two forms: LNG and pipeline gas, each making up half of China’s total gas imports. LNG Imports Due to the late development of China’s pipeline network, China relied on LNG import to satisfy domestic demand from 2006 to 2009 with import volume reaching 20 billion cubic meters in 2012 (Table 5). The Dapengwan terminal in Guangdong province (put into operation in 2006) was China’s first LNG terminal project marking the beginning of LNG imports. Since then, a series of projects have been put into operation such as the phase two expansion project of Dapengwan, and new terminals in Fujian (2009), Shanghai (2009), Dalian (2011), Jiangsu (2011) and Ningbo (2012). Currently, China’s capacity to receive imported LNG has reached 40 million tons per annum and 8 more new terminals are under construction or planed. Based on its main coastal terminals, it is predicted that China’s receiving capacity will double (Table 6) by the end of the “Twelfth Five Year Plan” period.

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Table 5: China’s LNG and Pipeline Gas Import Volume (billion cubic meters) Source: Derived from Statistical Review of World Energy 2013, BP 2006

2007

2008

2009

2010

2011

2012

Total Import

1.0

3.9

4.4

8.4

17.0

37.2

41.4

LNG

1.0

3.9

4.4

8.4

13.4

22.9

19.9

100

Pipeline

0.0

3.6

14.3

21.5

The sources of China’s LNG are now being increasingly diversified, primarily thanks to the three major state-owned oil companies’ active engagement with international natural gas suppliers to secure LNG contracts. In 2006, Australia was still China’s only source of imported gas. But by 2012, imports from Australia accounted for only 24% of the total, with 34% coming from Qatar, 17% from Indonesia, 13% from Malaysia and the rest from Middle East and Africa (Table 7). The International Energy Agency has analyzed the contracts signed by these three oil majors and estimates that the signed contracts with durations from 20 to 30 years (Table 8) will bring China 43 billion cubic meters of natural gas per year after 2014.

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Table 6: China’s LNG Import Terminals in Operation, under Construction, and Planned Source: Derived from Energy Bluebook 2013 and the press releases from the major three Chinese oil companies (CNOOC, CNPC and SINOPEC). Project

Operation Scale (10k tons / year) (Scheduled) Time

Location

Operator

In Operation Dapengwan, Shenzhen

370+470

2006

CNOOC

Fujian LNG

Putian, Fujian

260+260

2009

CNOOC

Shanghai LNG

Yangshangang, Shanghai

303+300

2009

CNOOC

Dalian LNG

Dalianwan, Liaoning

300+480

2011

PETROCHINA

Jiangsu LNG

TaiyangdaoRudong, Jiangsu

350+300

2011

PETROCHINA

Ningbo LNG

Beilunwan Ningbo, Zhejiang

300+300

2012

CNOOC

Guangdong LNG

Planned/Under Construction PingpaishanGaolangang, Zhuhai

350+350

(2013)

CNOOC

Shandong LNG

DongjiakouJiaonan, Qingdao

300+200 / 300

(2013)

SINOPEC

Tangshan LNG

Caofeidian, Tangshan

350+300

(2013)

PETROCHINA

Hainan LNG

HeiyangangYangpu, Hainan

200+300

(2014)

CNOOC

Yuexi LNG

Donghaidao Zhanjiang, Guangdong

300

(2014)

CNOOC

Beihai LNG

Beihai, Guangxi

300+900

(2014)

SINOPEC

Yuedong LNG

Jieyang, Guangdong

200

(2015)

CNOOC

Tianjin Floating LNG

NanjiangGangqu, Tianjin

220+380

No data

CNOOC

Zhuhai LNG

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Table 7: Sources of China’s LNG Import (billion cubic meters) Source: Derived from Statistical Review of World Energy 2013, BP

Total Import Volume Qatar % Australia % Indonesia % Malaysia % Yemen % Russia % Other Soviet Republics % Egypt % Nigeria % Trinidad and Tobago % Oman % Algeria % United States % Equatorial Guinea %

2006 1.00

2007 3.87

2008 4.19

1.00 100

3.30 85

3.61 86

0.01 0

2009 8.36 0.55 7 4.75 57 0.72 9 0.88 11

0.25 3

0.08 2

0.07 2 0.42 11

0.25 6 0.24 6

0.08 1 0.08 1 0.80 10 0.09 1

2010 13.43

5.21 39 2.45 18 1.68 13 0.70 5 0.51 4

0.08 1 0.17 1 0.70 5 1.61 12

2011 21.80 3.20 15 5.00 23 2.70 12 2.10 10 1.10 5

2012 19.90 6.80 34 4.80 24 3.30 17 2.50 13 0.80 4

0.30 1 0.20 1 1.00 5 5.00 23

0.50 3 0.40 2 0.20 1 0.10 1 0.10 1

0.17 4 0.16 4

0.08 1

2.00 9 0.20 1

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Table 8: China LNG Import Contracts Source: “Chinese Oil SOEs Overseas Investment Evaluation Report”, EIA. Volume (billion cubic meters/year)

Valid Period

NWS, Australia

4.5

2006-2030

Tangguh, Indonesia

3.5

2008-2032

Tiga, Malaysia

4.1

2009-2033

Qatargas

2.7

2009-2033

TOTAL

1.4

2010-2024

Qatargas

4.1

2013-unknown

Qatargas

2.7

No data

Queensland Curtis Natural Gas, Australia

5.0

2014-2033

(In Negotiation)

(20 years)

Supplier CNOOC

North Phase, Iran

PETROCHINA Qatargas

2.7

H1 2010s

Qatargas (IV)

4.1

2012-2035

Gorgon Natural Gas Project, Shell, Australia

2.7

2014-2033

Gorgon Natural Gas Project, ExxonMobil, Australia

3.1

2014-2033

2.7

2014-2034

SINOPEC Papua New Guinea Natural Gas Project

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Pipeline Gas Imports Pipeline gas is the second form of import. China started importing natural gas via pipeline in 2010. Import volume reached 14.3 billion cubic meters in 2011, coming solely from Central Asia. This is China’s first cross-border pipeline project, extending 2,000 kilometers in length. Starting in Turkmenistan, the pipeline passes through Kazakhstan and Uzbekistan, extends to Khorgos in Xinjiang and then joins the pipeline network of the West-East Gas Pipeline Project before it ultimately reaches terminals in Shanghai and Guangdong. Bordering China, the Central Asia region is endowed with abundant natural gas resources, making it the ideal choice for China to launch cross-border pipeline cooperation projects. Since the above-mentioned three countries all belong to the former Soviet Union bloc, they still rely

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CEFC China Energy Focus Natural Gas 2013

on pipeline networks built during the Soviet era to reach their markets even after the dissolution of the Soviet Union, making them susceptible to the potential Russian manipulation. Hence, based on their self-interest, they view positively the construction of gas pipelines in cooperation with China in order to diversify their gas exports. At the same time, China is also seeking to diversify its sources of gas imports to stabilize the natural gas supply. This mutually beneficial relationship facilitates opportunities for cooperation. Russia, which has he biggest reserves of natural gas in the world, is also located in the Central Asia region, making it another desirable cooperation partner for China. During the course of the past ten years, China and Russia have negotiated gas pipeline plans but failed to reach an agreement on gas price. It was not until September of 2013 that the two nations signed a 30-year gas supply contract. Gazprom will supply China with an average of 38 billion cubic meters of gas per year starting from 2018, with a possible increase to 60 billion cubic meters, via the eastern route of the “Strength of Siberia” pipeline. In addition to the Central Asia region, China is also imports gas via pipeline from Myanmar. The Sino-Myanmar gas pipeline has been under construction since 2010. Commencing in Kyaukpyu City, Myanmar, the pipeline enters China through Ruili in Yunnan and then proceeds to Guangxi via Guizhou, a total 2,500 kilometers in length. In operation since July 31st 2013, the pipeline is temporarily supplying gas for six cities in Guizhou Province and is projected to be finished in 2015 with a design supply capacity of 12 billion cubic meters per year. China is also negotiating with Pakistan to extend the “Iran-Pakistan” gas pipeline to China’s western regions. Measuring 2,700 kilometers in length, the “Iran-Pakistan” pipeline will start from the port of Chabahar in South Pars Iran, passing along the Makran coastal area in the Arabian Sea and end in Nawabshah in Pakistan. With natural gas coming from the South Pars gas field in Iran, its designed supply capacity is 21.5 million cubic meters per day (7.8 billion cubic meters per year). As the biggest gas field in the world, the reserve of South Pars gas field is estimated to reach 51 trillion cubic meters. The project has been delayed due to insufficient funding but in March 2013 China provided Pakistan with 500 million dollars in loans to initiate the project. The pipeline is planned for completion in 2015 and will supplying natural gas to Pakistan. If materialized, the China-Pakistan pipeline project is believed to enhance the security of China’s gas supply. 2.2. Pro and Cons of LNG and Pipeline Gas Both LNG and pipeline import cooperation projects can facilitate a mutually beneficial relationships between China and the exporting country. The exporting country expects to expand its overseas markets and accumulate foreign exchange reserves. Once their market is expanded with more gas exports, they will have more say in pricing in the international markets. Besides securing natural gas supply through trade contracts, China can also facilitate a closer economic and diplomatic relationship with the exporting countries, thus simultaneously achieving two

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objectives. Following is a comparison of the two forms of import in terms of transportation cost, security of supply and transportation safety. First, transportation cost: as pointed out by some scholars, if the distance is over 4,000 kilometers, it is more economical to import LNG. Pipelines have long construction period and are usually more costly in terms of maintenance and management. But once natural gas is liquefied, its volume is compressed six hundred times, thus greatly saving the space and cost of storage as well as transportation. However, LNG suffers from spoilage during the transportation process: Since LNG is compressed before transportation, part of the compressed gas will “escape” during transport. Hence, spoilage rate rises with the increasing transportation distance. Second, the security of gas supply: pipeline gas belongs in the category of “door to door” transportation, thus unless the pipeline plan is cooperatively developed by multiple countries, the source is relatively exclusive and not easily expanded to adjacent countries via branch lines. In comparative terms, the sources of LNG are diversified and not restricted by region and distance due to sea transportation. The importing country can also choose its own supplier with relatively high flexibility. But the shortcoming of LNG is the big variation of gas quality (such as the heating value and sulfur content) based on its origins. If the variations become too significant, they will cause significant inconvenience for the user. The user’s burden is increased if power plants have to modify their equipment such as boilers if they begin using a new source of LNG with different characteristics. Thirdly, transportation safety, is a risk both for LNG and pipeline gas imports. If the regions through which the pipelines pass becomes politically unstable, gas pipelines may become easy targets for attacks. With the exclusiveness of gas supply source for each pipeline, once the pipeline is damaged, the supply of natural gas is affected. Safety hazards also exist for LNG import via sea transportation. That’s because more than 80% of China’s imported goods go through the Malacca Strait, which connects the Indian Ocean, the South China Sea and the Pacific. The Strait has very narrow waterways with the narrowest one measuring only 2.8 kilometers across, making it easy for collision accidents to occur. Moreover, the Strait is regarded as the lifeline of international trade and was once labeled as the target for pirate and terrorist attacks. In addition, political conflict in a third country could lead to insurgencies or maritime embargoes, thus impeding or cutting off LNG shipments. 2.3. China’s Strategic Considerations for Natural Gas Imports When importing natural gas, China should also consider the two strategic factors of supply source stability and importing price. While China can seek to diversify its imports by cultivating its political and economic relations with the major gas exporters, it remains less capable of influencing the import prices.

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Stability of Gas Supply Source The gas supplier’s proven reserves, production output, and reserve/production ratio are of primary concern. Qatar, Iran, and Russia are among the top ten countries possessing gas reserves and their reserve/production ratios have historically remained stable, thus making them highly reliable. Although Indonesia and Malaysia’s gas reserves are not among the top ten, they are nevertheless have become among the top gas producing countries in recent years. At present, Qatar is China’s biggest LNG supplier. At the same time, China is negotiating pipeline cooperation plans with Iran and Russia and has also increased its LNG imports from Indonesia and Malaysia. In addition to signing long-term contracts with gas production countries, China is also joining efforts to develop offshore gas fields, with a view toward obtaining “equity gas” to increase the stability of the nation’s gas supply. Admittedly, the stability of gas supply will be damaged if the producing country signs more trade agreements with foreign countries than it is able to deliver due to making inaccurate estimates of production capability. For example, China imports pipeline gas from Turkmenistan. However, it is reported that Turkmenistan has signed multiple export agreements with other foreign countries, raising the concern of whether it will have sufficient gas reserves to supply China in the future. To be sure, gas pipelines are costly both to construct and maintain but both the seller and the buyer are eager to keep the gas flowing so as to maintain the operation of the pipeline as agreed. As for the China-Myanmar pipeline, its designed supply capacity is 12 billion cubic meters per year, but Myanmar currently only has the capacity of supplying 4 billion cubic meters of gas per year to China. Fortunately, Hyundai from South Korea has constructed an LNG terminal in Kyaukpyu in order to re-gasifying LNG for export to China via the pipeline. Since the source of gas can be supplemented with LNG, the China-Myanmar route it is believed to greatly increase the stability of China’s gas supply. In addition, the development of the exporting country’s diplomatic relations can directly affect gas supply. Take the China-Myanmar pipeline as an example. This project was proposed as early as 2005, when China signed multiple agreements with the Myanmar military government. But at the end of 2010, Myanmar saw the establishment of a democratically-elected government. In an effort to balance its dependence on China, the new government halted many Chinese projects (such as the dam project) and domestic criticism of China has been on the rise. In this atmosphere, the Sino-Myanmar pipeline project fell behind schedule and was not officially commissioned until 2013. The pipeline is protected by government armed forces along its entire route but, in view of the occurrence of armed conflicts between Myanmar ethnic militias and the government armed forces, many scholars are still concerned that the pipeline may become a target for the Myanmar opposition forces. Geopolitics has also drawn China closer to some gas exporting countries. For instance, among China’s natural gas cooperation partners, Iran is regarded as the part of the axis of evil by the West, and its nuclear project has become the focus of the international concern. Another

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example is Pakistan, which has been criticized for allegedly harboring Islamist insurgent groups such as the Haqqani network and Lashkar-e-Taiba and, in the past, Pakistan was subject to sanctions over the development of its nuclear weapons capability. Both Iran and Pakistan are keen on cooperating with non-western countries, especially with rapidly developing China, which is both a major energy importer and a country with vast foreign exchange reserves. These conditions have facilitated mutually beneficial cooperative relationships. Furthermore, all three countries lie at strategic geographical positions, conducive to increase the security of China’s energy imports. For example, Iran borders the Strait of Hormuz, which handles 20% of the world’s energy transportation every year. As for the port of Gwadar in Pakistan, it is east of the Gulf of Oman and the Strait of Hormuz, and north of the Indian Ocean, and of high geopolitical value. China obtained the management right of the port this year with significant implications. There are plans to ultimately expand rail and highway connections between China and Pakistan making it possible for Iranian oil and gas to enter China via land transportation, avoiding the volatility of sea transportation.

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Import Price Considerations China is an Asian nation and, like other oil and gas importing countries in Asia its purchasing power is weaker in comparison with western countries. Asia remains one of the most expensive regions for natural gas import and must pay what is known as the “Asian Premium”. Data has shown that until July 2013, the average LNG price is 13-14 USD per Million Metric British Thermal Units (MMBtu) for Asia, but only USD 10 per MMBtu for Europe and less than USD 4 per MMBtu for the US, with the price differential ranging from 2 to 6 times. South Korea, Japan and China pay the highest price in the world for imported LNG. Since Japan and South Korea do not have cross border pipelines, importing LNG is their only option. Hence their LNG CIF (cost, insurance and freight) price is even higher than China’s. Therefore, importing natural gas via both land and sea transportation can increase China’s clout in price negotiations and should be regarded as a wise strategy. There are “stories” explaining the reasons for “Asian Premium” including: firstly, Asia’s natural gas is a seller’s market with demand greater than supply. China, Japan, South Korea and Taiwan are increasingly dependent on natural gas. With the exception of China, the other three don’t have domestically produced natural gas and all must rely on imports. When demand is greater than supply, pricing power is enhanced. Secondly, Asia is geographically distant from natural gas exporting countries, especially the Middle East and West Africa, hence bearing a higher transportation cost than western countries. Qatar and Australia are both major LNG exporters in the world. Qatar is far from East Asia, raising the cost for transportation; Australia is relatively closer, but the base price for its LNG is more expensive than that of Qatar’s, resulting in a tradeoff effect for both countries’ LNG, making East Asian countries pay a high CIF price.

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CEFC China Energy Focus Natural Gas 2013

Thirdly, Asia does not have a spot trading center or a forward market for LNG. This region’s spot price is pegged to the oil price, and has risen rapidly in tandem with oil price hikes in recent years. In the past ten years, China’s major suppliers (Qatar, Australia and Indonesia) have used this as an excuse to demand price rises. For example, in 2004, CNOOC signed a trade agreement with Indonesia, pledging to import 2.6 million tons of LNG per year to Putian, Fujian Province for 25 years, under the promise of long-term price stability. However, Indonesia later demanded a price rise explaining it had insufficient resources, and CNOOC had to raise the price by 40 percent in 2006. In July 2013, Indonesia has again demanded a more than 70% price rise to about 7 USD per MMBtu. Other supply sources ater followed Indonesia and demanded price rises from China. Qatar announced this year that they will raise the CIF price for China’s LNG by 100 to 700 USD per ton, making it the most expensive LNG supplier for China. Australia is the first country to export LNG to China; both parties originally signed a long-term “take or pay” agreement in 2002. In violation of its contract, Australia has repeatedly cut its export to China in recent years seeking a price rise. China and Russia also have failed to reach an agreement for the price of importing gas via the pipeline thus delaying the commissioning of the pipeline project from November 2013 to the first quarter of 2014. Considering the pricing conflict between Russia and Ukraine in 2006, China should learn a lesson from that incident. At that time, Russia insisted on readjusting the price according to market price, but Ukraine hoped to maintain the old, lower price. Many European countries depended on Russia as gas source but had to rely on transmission via pipelines through the Ukraine. Russia knew that if Ukraine cut the gas, the other party would have to give in. Negotiations eventually broke down between both parties and the action to cut the gas has had profound influence on other European countries. Eventually, the EU had to step in to mediate in order to get Russia and Ukraine to compromise and resume gas supply. Therefore, diversification of import sources can raise the pricing power of the importing country. Asian countries have traditionally been passive in the face of the “Premium” issue. In recent years mainland scholars have come up with an idea that since Asia is a large-scale energy importing region, if it can be interconnected, and a regional energy trading center can be established, then the fragmented voice in pricing can be integrated, thus increasing our leverage when negotiating gas prices with energy exporting countries and alleviating the “Asian Premium” problem. Within this framework, Asian countries can negotiate a reference price reflecting Asia’s demand and supply situation, and establish a cooperative energy reserve system, protecting the interest of all parties and avoiding intra-regional vicious competition. However, with the complicated political situation in Asia, and differences among the countries, make this easier said than done.

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III. Two Factors Influencing the Future Development of China’s Natural Gas Market Undoubtedly, China will continue to increase the import and use of natural gas in the future. At the same time, the development of the natural gas industry and its related services will further accelerate in China. Director of the Center of Oil and Natural Gas Strategy, Pan Jiping in the Ministry of Land and Resources forecasts that by the year 2020 China’s volume of imported natural gas will reach 150 billion cubic meters, making up 40% of total natural gas consumption. The two following issues are highly critical for the future development of China’s natural gas market: first, how does domestic price reform influence domestic consumption and second what are the implications for China of the international development of shale gas?

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3.1. Domestic Gas Price Reform China’s domestic price for natural gas has long been criticized for its under evaluation and lack of accord with international institutions, making natural gas producers and importers faced with severe business loss. A reasonable gas price can effectively reflect the level of scarcity of resources and the demand/supply situation in the market. On the one hand, it can stimulate production and can incentivize users to conserve energy and increase efficiency. In the past ten years, the price of imported natural gas has increased 70 percent while that of domestic price has remained stagnant. According to the Xinhua News Agency, ex-plant price for China’s domestically produced natural gas is 1.5 Yuan per cubic meter lower than the CIF price of Central Asian natural gas. This is neither beneficial for increasing natural gas import, nor for incentivizing production and development of China’s domestic gas. In addition, an undervalued domestic natural gas price has also led to temporary “gas shortages” during peak periods. Winter is the peak period for China’s use of natural gas due to the increased demand for heat generation. Chinese oil and gas companies are supposed to store gas in reserve during the off-season in order to cope with the peak period in winter. But it is reported that Chinese oil and gas companies choose to export natural gas during the offseason in order to make money, leaving insufficient reserves to cope with peak demand during winter, resulting in “gas shortages”. The industrial sector is the biggest user of gas, once “gas shortages” occur, industrial users would be forced to halt production in order to limit their gas use. The Chinese government understands the importance of adjusting the price of gas and has issued a price reform plan; it has also raised the price of non-residential gas in July this year and has adopted the market net return approach in order to adjust the domestic natural gas price. So far, China’s gas price reform is still going through an exploratory stage with a long road lying ahead. While the government is pushing for price reform, it should also observe the societal reaction and evaluate the endurance capacity of the market to avoid excessive influence on people’s welfare. While China is pushing for increased use of natural gas hoping to improve air

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quality, if the price increase is too steep creating a burden for Chinese consumers, some users will relapse and switch back to coal and oil products. This is in violation with the intention of environmental protection. On the other hand, an undervalued natural gas price would drive up demand rapidly in the short run, leaving gas supply lagging behind. This creates “gas shortages” and affects people’s welfare. In order to effectively adjust the domestic demand/supply situation, the government must find a balance between the two extremes. 3.2. International Development of Shale Gas The U.S. has made breakthroughs in shale gas extraction technologies in recent years, with a twenty fold increase from 2006 to 2010 and creating the “shale gas revolution”. This development has dramatically reduced the U.S. dependence on foreign energy and might transform the U.S. from an energy net importer to an energy net exporter, with profound implications for future international supply and gas price. In fact, with the sharp increase of shale gas production in the U.S., the international natural gas market has become a buyer’s market with supply greater than demand. In the United States, some coastal LNG importing terminals have been converted into exporting terminals. According to an IEA estimate, the U.S. could overtake Russia in 2015 as the biggest producer of natural gas. The U.S. government has even predicted that its domestic gas reserve can satisfy domestic demand for a hundred years. In 2011, the EIA pointed out that China holds the biggest reserve of shale gas in the world, with a total reserve of 100 trillion cubic meters and extractable reserve of 36 trillion cubic meters. The Chinese Ministry of Land and Resources has announced in 2012 that according to a preliminary survey, China’s onshore potential reserve of shale gas is 134.42 trillion cubic meters with an extractable reserve of 25.08 trillion cubic meters. The government hopes to conclude an investigation and evaluation of domestic shale gas potential in order to obtain a preliminary understanding of shale gas quantity and its geographic distribution. Production has gradually expanded and is scheduled to reach an annual output of 6.5 billion cubic meters in 2015. In order to further develop its prospecting and extraction technologies, China has also signed a memorandum of shale gas technologies with the U.S. However, China has a complicated geological structure with resources buried deep under earth. China’s overall geological condition is less favorable than that of the U.S., making extraction and development difficult. American. developed technologies also do not necessarily meet the extraction conditions in China. Plus, shale gas projects are traditionally investment intensive ones. Considering China’s geological conditions, extraction in China will inevitably be more costly. If it costs more than import, the government needs to reconsider whether it’s worth the high level of investment. It is said that the U.S. can export its surplus gas to Asian and European countries, benefiting China in the process. Looking back on the development of the U.S. shale gas industry, several points need to be noted. First, it is reported that single well output of some shale gas fields in the

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U.S. has fallen quite rapidly, raising concerns among scholars of whether the U.S. can maintain its rapid growth rate as predicted. Second, the environmental implication of shale gas extraction remains unclear, some potential problems are believed to surface in the following years. Third, the U.S. has traditionally enjoyed a relatively low price for natural gas; the price is further reduced after the mass production of shale gas due to excessive supply, driving some producers to give up further extraction. Fourth, some Americans are opposed to shale gas export. They believe once export is expanded in the future, it will drive up domestic gas price and increase the cost of gas. Others have argued that there is a conspiracy behind the celebration of shale gas by the U.S. and other Western countries. The “shale gas revolution” is certainly good news for the economy in the west. For example, with the rapid increase of U.S. shale gas production, the U.S. energy self-sufficiency has risen considerably. This helps to free the U.S. from chronic dependence on Middle East oil and gas and it also reduces the U.S. budget deficit. This news has caught the attention of investors, who are more willing to increase their holdings of dollars and U.S. securities, further benefiting the U.S. economy. In addition, shale gas extraction and prospecting companies can utilize this opportunity to export their technologies. Companies with shale gas related services can also benefit from an increase the value of their shares on the stock market. Shale gas became an available resource as early as the 1970s. However, due to cost issues, it never experienced mass development until the “shale gas revolution” in recent years. With uncertainties lying ahead, China should move forward with caution and prudence.

IV. Conclusion

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With the worsening problem of global warming, increasing the usage of natural gas to reduce greenhouse gas emissions has become a worldwide priority. Of the three fossil fuels, natural gas is the cleanest and the lowest in carbon content, making it a source of high quality energy. In order to raise living standards, western countries have switched to high quality energy in the post WWII era thanks to economic development. This process is called “energy transition”. Third world countries are now following that same trajectory by gradually optimizing their fuel mix, reducing the usage of coal and oil and increasing the usage of electricity and natural gas. China is currently undergoing this process. Natural gas is likely to play an increasingly important role in China’s future energy consumption. In order to stimulate the steady growth of urban natural gas usage, it is important to increase construction of pipelines. China is currently expanding the Central Asia pipeline and the Sino-Myanmar pipeline and is also negotiating the Sino-Russian pipeline and the ChinaPakistan-Iran pipeline in order to achieve diversification of import portfolio and secure gas supply. These gas sources enter from the northwest and have to rely on West-East Gas Pipeline network to reach their final destinations on the east. Besides, LNG has to be re-gasified before

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it can be transported via pipelines to its markets. Admittedly, the government will continue building intra-city networks. With the growth of coverage of downstream networks, urban usage of natural gas will expand. At the same time, cities are speeding up their gas modification projects, switching from artificial gas and oil gas to natural gas. Due to the differences in their heating values and other properties, resident users have to first convert to special natural gas equipment. Moreover, rationally adjusting the price of natural gas is conducive to the development of a domestic natural gas market (no matter upstream, midstream or downstream). On the one hand, a rational gas price can incentivize upstream industries in the development and production of natural gas, helping to enhance domestic supply; on the other hand, it can effectively raise downstream consumption, avoiding wastage due to an undervalued price. In order to raise the competitiveness of natural gas in the energy market, the government needs to formulate rigorous and effective environmental protection regulations, urging users to switch to natural gas.

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A Socio-economic Introduction to Natural Gas Extraction in China: Actors, Networks and Institutions (中國天然氣開發的社會經濟角度介紹：行為主體，網路及制度) By LEUNG Chun-kai, Guy (梁俊佳) 梁俊佳，香港中文大學全球政治經濟學碩士課程講師。 LEUNG Chun-kai is a lecturer of a graduate program at the Chinese University of Hong Kong and a research associate at the European Centre for Energy and Resource Security at King’s College London. He is also a visiting scholar at the Centre for Energy and Environmental Policy Research of Beijing Institute of Technology and currently a doctoral researcher at the Department of Geography, Durham University. Leung reviews manuscripts for a dozen of international academic journals and has published 15 papers, of which “China’s Energy Security: Perception and Reality” was awarded as the “Top 25 Articles” of the Energy Policy in 2012.

I.Introduction

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China is undergoing a transition to a lower carbon, cleaner economy. Gasification of the country’s energy structure, together with efforts to beef up the infrastructure for renewable energy and improve national energy efficiency performance, represent a significant component of this latest energy transition. In the past, natural gas was largely a localized fuel in China. China started producing natural gas in 1949, but for a long time the Sichuan Basin was the only major gas-producing region. China did not have a “national” gas industry until the construction of the West–East Gas Pipeline in late 2004, which brought gas from the Tarim Basin of Northwest China’s Xinjiang Autonomous Region to East China’s Shanghai. The national gas market in China has developed only recently: the share of gas in China’s primary fuel mix amounts to around 5%, which is significantly lower than the global average of 24%. The desire for gasification is reflected by the national plan to raise the relative share of gas in China’s primary fuel mix to 10% by 2020. In 2012 the International Energy Agency predicted that the size of the Chinese gas market, now roughly the combined size of German and British markets, will match that of the European Union by 2035. By any standard, China’s gasification represents one of the

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most remarkable energy transitions in the 21st century. Some observers estimate that a total of 250 billion cubic meters (bcm) are needed in 2020 to realize 10% of primary energy consumption. The amount of gas required can be supplied by domestic and foreign sources. Despite the fact that China has produced gas at a growth rate of 12% year on year on average during 2000-2012, which is already four times the rate of 19802000, demand has still outpaced domestic supplies in recent years. China started importing gas in 2006 and became a net importer of gas in 2007, when only 2% of its gas use was being imported. The 2013 import dependency of gas (or the percentage of net gas imports over national gas consumption) will reach 32%, a trend that alarms Chinese strategists, especially when contrasted with the United States becoming a net gas exporter by 2020, thanks to the shale gas boom. Besides the rising import dependency and the geo-political vulnerability it implies, the cost of gas imports also vexes Chinese leaders. Unlike oil, the natural gas industry is far from globally integrated and pricing mechanisms in North America, Europe, and Asia are different from one another. China’s sources of gas imports, either pipeline gas from Central Asia or liquefied natural gas (LNG) from the Asia-Pacific region, are significantly more expensive than the gas in Europe and North America. Gas is a standardized commodity, meaning that the dearer imported gas and the cheaper local gas are no different materially and functionally. The increasing proportion of imported gas in China’s gas pipelines means that the current regulated gas pricing (de facto a form of subsidy) is becoming more costly and less effective. It could also mean that national oil companies (NOCs), especially the largest gas producer and importer CNPC/PetroChina, would become less motivated to secure overseas gas for imports and engage in the exploration and production (E&P) activities, because the higher average cost of gas cannot be passed on to consumers proportionately. Domestic gas is cheaper and more easily negotiated. While the need for gas imports is unlikely to be reduced completely, Chinese leaders would like to reduce the growth rate of gas imports and, at the same time, fulfill the volume required for the national gasification strategy by ramping up domestic gas production. This short article aims to investigate the institutional context of and organizational connections among China’s gas production actors. It introduces an analytic framework called global production networks (GPN) for the state and firms and examines how different actors (both firm and non-firm actors such as governments) are functionally and geographically integrated. This introductory article is written for non-technical policymakers and readers. It is focused on the broad socio-technical picture of the industry rather than delivering a purely technical account.

II.Energy: A Socio-economic Relation China is fortunate to have nurtured and attracted a great workforce of energy economists, engineers, and scientists to work on its energy issues. Their innovations, discoveries, and theories continue to appreciably benefit the development of China’s energy industry and economy. At the same time, given the sheer complexity of the subject and the increasingly deep connections

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between Chinese and global energy markets, political leaders, entrepreneurs, and non-technical investors now require more social science analyses to help put matters into perspective. At the time of writing this article in Durham, I had a chance to talk to a previous employee of Atomic Energy of Canada Limited (AECL) and, from him, I learned that this nuclear firm is now hiring social scientists to undertake strategic planning. Dr. Philip Andrews-Speed, a China energy expert, explicitly stated in 2012 that any energy transition, such as that required by a move to a low-carbon economy, is essentially a socio-technical transition, which requires comprehensive changes in political, economic, and social systems and the networks and institutions that govern the energy sector and the actors involved. Failing to take a wider socio-economic view, governments cannot move beyond narrow, short-term, economic considerations and deliver the technical, industrial, institutional and human innovations required. Contemporary energy geographers Gavin Bridge and Philippe Le Billon, in their book Oil, state unequivocally that oil and gas are always political. The politics of oil and gas is the struggle to define who wins and who loses as the product moves from underground reserves to the point of consumption, as oil and gas is claimed in different ways by national governments and other interests. The gasification of China’s energy structure is, indeed, more than an expansion in the share of gas in the country’s fuel mix on paper, or some tangible material changes in infrastructure, but is also a set of institutional transitions that actually involve both the state and firms from upstream to downstream in a more nuanced way. The development of natural gas, as a commodity, can be broadly seen as a social relation and this “commodification of nature” is identified and studied by, for example, Karl Marx, Karl Polanyi, James O’Connor and David Harvey. Professor Gavin Bridge believes that any hydrocarbon commodity chains are embedded with both natural and social production (Figure 1) and each stage (from exploration to carbon capture) involves interaction between governments and four types of energy companies, including: 1.Vertically integrated companies (ranging from PetroChina to ExxonMobil); 2.Independent producers which are focused on upstream activities with very limited involvement downstream (e.g. Apache and Devon Energy); 3.Independent transporters, refiners, and distributors with no or very limited upstream assets (e.g. Valero in the U.S., Petroplus in Europe and Beijing Gas in China); and 4.Oil field service (OFS) companies, which do not own any oil and gas reserves or produce oil and gas on their own account; rather they provide drilling, interpretation and logistical services to producers (e.g. Schlumberger, Baker Hughes, Diamond Offshore, and Anton Oil). Hence, in recent years, while scholars agree that it is sometimes helpful to think of the production of oil and gas as a linear “supply chain”, they are convinced that it is more accurate to visualize the oil and gas production as “networks” that capture complicated inter-firm, intrafirm and extra-firm connections on different scales (from global to local). This is the basic idea of GPN, which is an analytical approach developed by social scientists for examining

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the political economy of globalization, including that of energy. It builds on the global value chains (GVC) and global commodity chains (GCC) approaches, which are common in business and management studies nowadays. On the contrary, GPN is different in that it rejects the idea that turning resources such as natural gas into commodities is a linear process, and that such processes are isolated from institutional contexts. These institutional contexts are the key to understanding, for example, why the U.S. shale gas revolution is hardly replicable in China and elsewhere. The idea that “the world is flat”, famously proposed by Thomas L. Friedman, is flatly untrue in the natural gas world. Turning GPN into a tool to understand global gas industry is now a major research project funded by UK Energy Research Centre (UKERC), which is essentially the UK national energy research laboratory. Figure 1: Hydrocarbon Commodity Chains Source: Journal of Economic Geography.

III.Beyond Geology: Social Conditions of Gas Production Estimating a country’s gas resources and reserves is both an art and science. Even though the physical/geological endowment of gas (which is technically called originally gas-in-place, or OGIP) is objectively present, given limitation of technology, knowledge, and cost, no estimates on OGIP are final and conclusively made; instead we keep revising/correcting our estimates as our geological knowledge advances. According to a national survey published in 2005, China’s prospective gas resources amounted to 56 trillion cubic meters (tcm) and 35 tcm geologically. Recoverable resources were estimated at 22 tcm, which is 70% higher than the previous study conducted in 1994. Chinese classification of energy resources is not strictly compatible to the international ones, such as the SPE (the Society of Petroleum Engineers), the AAPG (American Association of Petroleum Geologists), and thus, it is not always clear what is meant by “recoverable resources”, but we can assume that it roughly means the part of gas resources that is technologically recoverable but not necessarily economically extractable. Indeed, it is the “deliverability” of natural gas rather than its “availability” that is central to

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the geopolitical economy of gas. The industry traditionally classifies the part of gas that is both technologically and economically recoverable as “reserves” (strictly speaking, therefore, “resources” and “reserves” are not interchangeable, and the latter is only a small subset of the former). In 2012, China’s Ministry of Land and Resources (MLR) announced its largest-ever increase in gas reserves. The MLR’s estimates for reserve increases in gas are, closer to those of the U.S. Energy Information Administration (EIA), about 500.8 billion cubic meters (bcm), of which onshore fields accounted for 91% of this increase and offshore fields made up 9%. The biggest contributors to the growth in reserves are the Jingbian gas-field (in Shaanxi) and the Chengdu gas field. In 2012, China’s proven gas reserves (“proven” means that we are 90% sure that the gas can be produced commercially) amounted to 3.1 tcm, which is twice the size reported in 2005, but it accounts for only 1.7 per cent of the global total. What is frustrating Chinese energy leaders is that the increase in proven gas reserves has been slower than that in gas consumption and, as a result, the reserve/production (R/P) ratio of gas dropped alarmingly from 100 years in 1993 to 29 years in 2012. On paper, it means that if we assume China no longer finds any new gas reserves and gas demand remains unchanged, China will stop producing gas (commercially) in 29 years. Scholars even assert that China’s gas production will hit a peak by 2020. However, such a linear extrapolation, which is common in mass media, does not take into account that “reserve” is a dynamic, socialized concept that is subject to transitions in political economy, including changes in pricing, technology, and industrial policies (such as tax rate and market access) that adjust proportion of “reserves” in the total of recoverable “resources”. The “peak gas” narrative also fails to take into account the potential for unconventional natural gas in China. China has the potential to be a very large gas producer because it has abundant unconventional gas, such as tight gas, shale gas and coal bed methane (CBM). According to a special report of The Economist, in 2011 China had around 4 tcm of recoverable conventional natural gas remaining, but it had 48 tcm of recoverable unconventional gas (Figure 2). In total, China’s recoverable natural gas resources rank third globally, after Russia and the U.S. (Figure 3). Nevertheless, since resource availability does not imply its deliverability, China produced only 107.2 bcm of natural gas in 2012, ranking as the world’s seventh highest, while the U.S. ranked first (681.4 bcm) and Russia second (592.3 bcm).

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Figure 2: Global Recoverable Natural Gas Resources Source: The Economist, 2012

Figure 3: Top 15 Countries by Their Recoverable Gas Resources Source: The Economist, 2012

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There are several important social factors in determining whether, and how quickly, gas resources can be developed (Figure 4). Once developers are certain that the resource size of a given region is large enough to reach production economies of scale, they must overcome all the physical, social, or environmental constraints to gain access to the resources. Obtaining resource access is a challenging task for firms that have no immediate connections with the state. In most countries around the world, it is mainly governments that own mineral resources. Even in the Western societies where private landowners or communities can own the surface rights, subsurface resources belong to the state. The commonly quoted story of U.S. shale gas constitutes an exceptional case of “vertical sovereignty”: in the United States, mineral rights, except those on federal lands, do not belong to the government but to individual land owners. To put it more colorfully, the landowners in the U.S. not only own the surface but in principle, also everything underground to the core of the Earth. In socialist states such as China, legally speaking, all land and their underground mineral resources belong to the central government or the state. In December 1950, the State Council promulgated the “Regulation on the Mining Industry in the People’s Republic of China”, which specified that the country’s mineral resources, including oil and gas, were state assets and should be managed by the central government. The Ministry of Land and Resources (MLR) oversees the surveying, planning, management, protection and sustainable use of China’s natural resources, including natural gas. Figure 4: Factors Determining the Deliverability of Natural Gas Production Source: International Energy Agency

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The different institutional arrangements in the United States and China mean that gas developers need to secure resource access in different ways, and would need to come up with different corporate strategies to acquire development rights. In the U.S., since a landowner clearly possesses the mineral rights, the financial benefit to the landowner is an incentive for development. Private firms basically only need to come to agreement with individual landlords and, if the landlords agree to lease their lands, the firms can, in principle, start exploring and exploiting the gas. In the United States, access constraints come mainly from the local community on environmental grounds as some residents are worried about the potential for water and land contamination during shale gas production. A lot of interesting politics, struggles and negotiations pervade the process of mineral rights acquisition, and different interests are using a variety of ways to promote their agendas and argue against others (see the influential documentaries Gasland series and FrackNation). In China, local protests about gas production are not yet common, but Chinese producers are cautious about the potential “resource curse” consequences commonly found in developing countries (that gas production only benefits the NOCs and the central government via taxation and royalties, but it does not benefit economically and socially the local commodity and governments while exploiting regional resources and environment). For example, our interview with the CNPC Advisory Center suggests that CNPC is implementing the campaign of “gasifying southern Xinjiang” (qihua Nanjiang) in order to improve the quality of life and ameliorate the energy poverty problem in that region. In most countries around the world, including China, it is the government that centrally determines who can be granted resource access. But China might be different from some other countries in that China’s oil and gas sector is dominated by national oil companies (NOCs), partly for historical reasons and partly due to the fact that government leaders see the energy industry as highly strategic and they are thus less willing to open up the upstream sector to foreign participation. International oil companies (IOCs) and domestic private producers find it extremely difficult to obtain access to gas resources for development unless they can find a way to form joint-ventures with NOCs, because most of the conventional and unconventional gas mineral rights have already been granted to Chinese NOCs. We will return to this point later, but it is worth mentioning that NOCs are quite common and now control approximately 90 percent of the world’s oil and gas reserves and 75 percent of production and they exist not only in developing countries but also in developed countries, such as Norway’s Statoil. Another factor in gas development is the availability of appropriate extraction technology, including processes, equipment, and personnel. A key element in the success of the North American shale gas boom has been combining cost-effective horizontal drilling, a technology developed over the last 30 years, with hydraulic fracturing (or “fracking”), which has been practiced since the 1940s. Besides technology, an appropriate, well-defined and supportive regulatory and fiscal framework needs to be present. Overall, the gas sector enjoys unprecedented political support in China since the original proposal for the West-East Gas Pipeline. In analyzing the

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expedited approval of the large West-East Gas Pipeline, academicians believe that the reason the pipeline received almost universal support and won unambiguous endorsement should be attributed to more than the benefits of energy supplies, energy efficiency and cleaner air. As a variety of industries in locations the pipeline traverses fits into China’s “Western Development Campaign”, which aims to narrow the development gap between eastern and western China. Ten years on, the political environment is even more supportive of the industry. Table 1 summarizes recent government policies to support natural gas. However, the regulatory framework on mineral rights (such as the conflicts between central and local interests in the case of CBM) and regulation of gas pricing still leave much to be desired. CNPC/PetroChina, which accounts for about 70% of the country’s gas production, lost 41.9 billion Yuan on gas imports in 2012, stemming from regulated wholesale prices being below import and distribution costs. Losses increased to 14.5 billion Yuan in the first quarter of 2013 from 11.9 billion Yuan in the previous quarter on the rising cost of imports, since CNPC has multiple contractual commitments (“take-or-pay”) to buy given volume of gas every year. Some analysts claim that the growth rate of China’s gas outputs slowed to 5% in 2012, vis-à-vis 11.8% on average during 2007-2011, due to the fact that rising imports have taken the market share of domestic output and funding constraints have led to weaker domestic reserves. Gas experts in China do not agree on what role NOCs should play in the nascent gas industry and on the actual effects of gas imports on domestic production, but regulatory and institutional challenges do have significant implications for China’s natural gas production. Table 1: Recent Government Policies1 to Support Natural Gas Industry in China

Finally, market access is also critical in deciding whether or not producers would explore and develop a region where gas is present. In other words, unless producers are certain or reassured that the gas can be sold to the market, they will not produce any - the industry calls it “stranded gas” - or at least not produce gas as a commodity - the gas produced from oil production activities (called “associated gas”) might be flared, or injected back to the oil reservoir. Chinese gas experts, therefore, generally agree that China’s gas production did not become a national phenomenon until the construction of the West–East Gas Pipeline. MOF for Ministry of Finance; NDRC for National Development and Reform Commission; NEA for National Energy Administration; MLR for Ministry of Land and Resources. 1

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The problem of regional discrepancy between gas supply and demand calls for a solution that expands distribution infrastructure. By the end of 2015, construction will be complete on Chinese natural gas pipelines with a total transport capacity of 150 bcm per year (these include the West-East Pipeline III, Xinjiang-Guangdong-Zhejiang Pipeline, Shaanxi-Beijing Pipeline, etc). Natural gas tanks with a total storage capacity of 22 bcm will be built and able to store 10% of China’s planned natural gas requirement in 2015. Moreover, and this often seems strange to outsiders, China is running a remarkable business of inland mini-LNG plants. Since interprovincial gas pipelines remain dispersed and scattered in China, mini-LNG plants find a way to fill up this gap by liquefying the gas without access to pipelines and transporting it to customers across the country via truck or rail. According to a recent General Electric report, mini LNG logistics now accounts for 1 percent of the world’s total gas transportation.

IV.Topology: China’s Gas Extraction Firms China’s primary natural gas-producing regions are Sichuan Province in the southwest (Sichuan Basin); Xinjiang and Qinghai Provinces in the northwest (Tarim, Junggar, and Qaidam Basins); and Shanxi Province in the north (Ordos Basin). China has explored several offshore natural gas fields located in the Bohai Basin (Yellow Sea) and the Panyu complex of the Pearl River Delta Basin (South China Sea) and is exploring more technically challenging areas, such as deepwater and unconventional resources, in collaborative ventures with foreign companies. There have been limited opportunities in China for private or international gas companies. As mentioned, all gas resources are centrally owned and distributed by the national government, and non-state companies have limited access to gas reserves unless they find a way to work with the Chinese NOCs if they want to obtain “equity gas” from production. Such “resource nationalism” is internationally common and thus not confined to China. In 2012, China produced 108 bcm of gas, of which CNPC/PetroChina produced 79.9 bcm, Sinopec 16.7 bcm, CNOOC 11.3 bcm and Yanchang (founded in 1905, now a firm that is directly attached to Shaanxi People’s Provincial Government) 0.3 bcm. The official statistics seem to mask the volume of gas production by IOCs, probably because the IOCs produce gas as NOC’s joint venture companies, and Chinese NOCs must hold the majority participating interest in a production-sharing contract (PSC). According to a report of the Business Monitor International, Shell China is the largest non-NOC gas producer in China, with outputs in 2009 amounting to 2.6 bcm. The other IOCs, including Chevron, Statoil Orient and ConocoPhillips China produced less than 0.1 bcm. IOCs involved in offshore exploration and production (E&P) work in China include: ConocoPhillips, Shell, Chevron, BP, Husky, Anadarko, and Eni, among others. Unconventional gas provides a better opportunity for IOCs to participate in onshore gas production, as Chinese NOCs often have to rely on the expertise and technology of IOCs. An interview with Shell China by the author in June 2013 resulted in several interesting findings. First, Shell was invited by the central government to participate in E&P in Changbei gas field

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in 2003 because the government wanted to ensure sufficient supplies of gas to reduce Beijing’s coal use by substituting gas before the 2008 Olympics. Changbei gas field is a tight gas reservoir. Although Chinese NOCs had the technology to exploit it, their technology was not advanced enough to produce gas as quickly as needed. Shell has a proven track record in this area and was invited to form a joint venture with CNPC, in which Shell controls 49%. In the end, Shell delivered what it promised. The senior Shell staff interviewed shared that this is a landmark victory for Shell because the central government will remember the contribution of Shell, and both sides have established trust and connections, which could result in more E&P opportunities in the future. In fact, Shell and PetroChina signed an agreement to jointly develop tight gas deposits in China’s Sichuan Province in March 2010. Under a 30-year PSC, the companies will first appraise and then potentially develop tight gas reservoirs across 4,000 sq km of the Jinqui block. Although details of the agreement were not included in Shell’s press release, Reuters quoted an unnamed source as saying that Shell would be making the “total investment” and would take a stake of more than 50% in the project, which is unprecedented. In other words, a “network-rich” IOC has a better chance to obtain resource access from the state or NOCs. Second, gas production in China is not an attractive business for IOCs. In August 2012, Shell announced plans to invest US$1 billion per year into developing China’s shale gas resources, yet the participation in shale gas activities is currently “money burning” to them, according to my interview. However, having a stake in China’s upstream gas sector helps IOCs better monitor and evaluate China’s oil and gas development on the frontline from upstream to downstream via corporate networking and direct collection of market information. Also, although China’s unconventional gas industry is still in its nascent stage, a forward-looking IOC would want to establish deep and rich networks with the central government and NOCs before the industry takes off. Third, Chinese NOCs are keen to get overseas business in return for allowing international competitors into their home territory. For example, PetroChina and Shell completed a joint take-over of Australian coal seam developer Arrow Energy in 2010. The “strategic coupling” between regional assets and global production networks of gas carries significant implications for regional development. To participate in China’s gas production, however, does not necessarily involve acquisition of resource assets. There is a gap in academic energy research: the role of oilfield service (OFS) companies in China is seriously overlooked. According to Spears and Associates, the overall oilfield services market for China is RMB92.2 billion, mainly dominated by the three majors and their subsidiaries with 85% of the total market share. Despite their small market share, some independent domestic OFS, such as Anton Oil, have a niche in high-end and critical services, as technology becomes increasingly specialized for complicated reservoirs. There is also considerable room for international OFS, such as Schlumberger, Halliburton, and Baker Hughes, which now together hold a small 5% market share in China but there is room for expansion. Schlumberger has been working closely with Chinese NOCs for decades and does not pursue

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acquisition of national oil and gas reserves. This business model, according to our interview with an international OFS which wishes to remain anonymous, might be more welcomed by Chinese government, as the government is “resource nationalism”-minded or strategic-minded and less willing to allow foreigners to exploit national resources. In other words, international OFS companies could gain easier entry into the Chinese market than IOCs. Moreover, international OFS can help Chinese NOCs and non-experienced players plug a technical and knowledge gap in exploration and production. Although they will be rivals to the NOCs’ own OFS subsidiaries, in the short-term their skills are needed if the NOCs need to tap shale gas resources as quickly as possible. These international OFS firms have tailored their solutions to problems peculiar to China. For example, GE Oil & Gas, the OFS arm of the U.S. conglomerate General Electric, is looking into ways of reducing the amount of water needed for E&P - targeting the issue of China’s water scarcity. Baker Hughes has already teamed up with Sinopec and PetroChina to drill some of the country’s first shale gas appraisal wells in early 2012. Halliburton is also working on shale gas wells in Sichuan and Chongqing. The OFS companies are especially needed after the results of China’s Second Shale Gas auction, whose list of winners is dominated by inexperienced, non-traditional players. Another way for international OFS to get into Chinese business is through capital investment in domestic Chinese OFS. For example, Schlumberger, the world’s largest oilfield services company (in terms of market capitalization), acquired a 20.1% stake in Anton Oil in July 2012. Baker Hughes has signed a cooperation agreement with Honghua Group to develop unconventional natural gas in China. However, some argued that the Chinese government still has, to a certain extent, a Cold War mentality and does not completely trust international OFS for the fear that they might obtain “state secrets” of geological data. Andrew Kennedy from Australian National University has recently published a paper on the reason of this Chinese “techno-nationalism”. This, once again, brings us back to the significance of institutions on gas production, as “institutions”, according to Andrews-Speed, mean not just institutional environment (e.g. political system and legal system) but also embedded institutions (norms, values and ideas) and institutions that govern transactions (e.g. policies, bureaus and production networks). Indeed, institutional constraints on gas production are pronounced and evident. Both Chinese and international gas experts are now convinced that MLR’s shale gas production target (6.5 bcm by 2015 and 60-100 bcm by 2020) will not be achieved due to institutional constraints. Our interview with MLR confirms this observation. Many physical problems are facing China’s shale gas production, including more complicated and fractured geology, water scarcity, and seismic risks, making production more costly and technologically challenging. Institutional constraints, however, appear to be even more significant. As previously mentioned, the U.S. shale gas revolution is increasingly believed not replicable in China (and elsewhere) because of the different institutional arrangements regarding mineral rights. Experts trust that the

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institutional monopoly of NOCs in mineral rights and pipelines is the key reason that would prevent the U.S. experience, such as competition among domestic oil and gas producers (large and small), from happening in China. The lack of abundant and publicly available geological data in China also means that both domestic and foreign investors have to start from scratch and have no opportunity to make a quick profit. This is particularly unfavorable for small or medium-size independents. The Chinese NOC sources we interviewed openly agreed with these arguments, but they believe that the most fundamental institutional constraint, at present, is regulated gas pricing. The monopoly of NOCs, they believe, does not necessarily prevent a shale gas boom in China; if the level of gas prices justifies production, the NOCs will have an incentive to produce.

V.Conclusion This article has provided a socio-economic introduction to the dynamics of China’s natural gas production. It has shown that the commodification of gas, or other forms of energy, or natural resources in general, involves a very broad social (economic, political and institutional) relationship. The article has also shown that a “network” is a better metaphor than a “chain” in terms of natural gas industry, because gas production actually involves an universe of company and non-company actors (ranging from NOC, IOCs, OFSs to governments) collaborating and negotiating with each other on different levels and in different places. It is also because gas production is not a linear, one-way process, but upstream, mid-stream and downstream are in fact affecting each other. Simply put, one cannot accurately understand China’s natural gas production without comprehensive knowledge of the non-E&P components of the production network, especially the role of the state, monopoly of NOCs, pricing mechanisms, structures of regional and global gas industry, among others.

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New Changes in the LNG Market: Will U.S. Export of LNG Influence the LNG Market Price in Asia? (LNG市場新變化：美國LNG出口是否會對亞洲LNG市場價格產生影響) By ZHANG Meng (張萌) 張萌，現任第一財經戰略研究院能源資源研究部，研究員，主任。 ZHANG Meng is a researcher and head of the energy division of the Research Institute of China Business News (CBN). His research area focuses on Asia’s natural gas market, especially China’s natural market. He also co-authored the book (Chinese): “The Upcoming New Structure of the World’s Oil & Gas Patterns”. He earned a Juris Master (J.M.) degree from China University of Petroleum. Thanks to the rapid development of shale gas, natural gas in the United States today has a comparative price advantage over that of other, more expensive markets. Shale gas is redrawing the picture of the U.S. natural gas market with the U.S. becoming an LNG exporter. The gap between the natural gas price in the U.S. and the oil-linked imported gas price in Asia has greatly increased Asian countries’ interest in potentially importing gas from the United States. In January 2012, two Asian buyers, GAIL from India and KOGAS from Korea, announced that they would start importing LNG at Henry Hub price beginning in 2017 in the amount of 7 million tons (Mt) per year. (Henry Hub is a distribution hub on the natural gas pipeline system in Louisiana and lends its name to the pricing point for natural gas futures contracts and over the counter swaps in the U.S.). LNG, which will be based on Henry Hub pricing, has also attracted the interest of the world’s largest LNG importer, Japan. Last April, two Japanese companies, Mitsui and Mitsubishi announced that they had commenced negotiations with Sempra, a California-based energy company, to manufacture LNG and export it to Japan. Agreement was expected to be reached by the end of 2013. Upon completion of the LNG manufacturing facility, Mitsui and Mitsubishi will each have an annual import of 4 Mt LNG. The current long-term contract price for LNG to Japan is indexed against Japanese oil import 159

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price plus a 1-2 dollars constant. This is the so-called “Japanese Crude Cocktail,” or JCC. Generally speaking, when the international oil price is $100/bbl, the gas import price in Japan will be $13-15/mmbtu. Since Japan’s imports account for one third of world total LNG imports, Japan’s long-term contract price is also the LNG price band in the APEC region. That is to say, compared with $9-10/mmbtu in Europe and $2.5/mmbtu in North America, importers in APEC have to pay more for the same amount of gas. Following the earthquake in eastern Japan and the Fukushima nuclear accident of 2011, Japan’s demand for LNG has increased. Currently, Japan has shut down most of its nuclear power plants. Therefore, it has to import more LNG to make up for the lost power generation capability. According to the statistics of Japan’s Ministry of Finance in April, Japan’s LNG imports during the fiscal year of 2011/2012 were 83.2 Mt., an increase of 18 % compared to the previous fiscal year. In January 2012, the amount of LNG imported rose to 8.15 Mt., a growth of 13.7% from December 2011 and an increase of 28.2% from the previous January. It is expected that Japan’s LNG imports will exceed 90 Mt in fiscal year 2012. Not only will Japan increase its LNG imports, but China’s LNG demand will also grow dramatically. China currently has 7 LNG import projects under construction and the country’s total import capacity is expected to reach 20 Mt by 2016. China is projected to expand its share of LNG imports in the APEC region from 8% to 20% by 2020.

Rising external LNG demand provided the U.S. with a potentially broad market for LNG exports. Will the LNG price mechanism in Asia be influenced by the United States’ entrance into the LNG export market? If U.S. LNG enters the Asian market, what will be the potential impact on the current high price of LNG in Asia?

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Changes in the U.S. LNG Market Infrastructure investment for LNG imports and exports takes a relatively long period of 3-5 years. For example, most of the LNG import capacity in the U.S. from 2009 to 2012 was based on the market expectation in 2005. Therefore, a practical method to investigate U.S. LNG market changes is to reexamine the U.S. Energy Information Agency’s (EIA) recent projections. The EIA projected in its 2005 Annual Energy Outlook (AEO 2005) that the US would need to import 70 bcm of LNG in 2010, which would account for 23% of the world’s LNG market in 2010,making the U.S. the second largest LNG import market after Japan. In order to prepare for the planned import of LNG, the U.S, significantly developed its receiving and re-gasification capacity, increasing it seven fold between 2002 and 2010.

However, with the steady increase in U.S. natural gas production, the expectations illustrated above have changed significantly. In 2008, the EIA projected that the U.S. would only need to import 34 bcm of natural gas by 2010. In its 2011 Energy Outlook, the EIA further reduced LNG import expectations. Since 2012, the EIA has begun to project that the U.S. would become an LNG exporter in 2016. A number of LNG export projects is planned in the U.S. One of the first to come on line is Cheniere Energy’s Sabine Pass project in Louisiana with 17 Mt/year capacity. Phase 1 & 2 of the project will export 7 Mt of LNG to European customers in 2015 while Phase 3 & 4 of the project will export the same amount of LNG to Asia starting in 2017. The reason why the U.S. is switching from being an LNG importer to an LNG exporter lies in its growing unconventional natural gas production. By 2011, natural gas production in the United States exceeded its previous record high level of 1973, reaching 651.3 bcm. Some analysts believe that total U.S. shale gas production will decrease soon and result in a “Shale Bubble” due to the fact that shale gas production per well rapidly decelerates. However, current developments in the industry cast doubt on this argument. In the United States today, many shale gas producers have relinquished pure gas production as the price of natural gas is so low. Instead, they have focused their drilling capacity on a higher

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value-added product—shale oil (oil that lies in common geological layers as shale gas) and NGLs (natural gas liquids, a deuterium substance in shale gas, including ethane for chemical industrial utilization). During the production of these higher value-added products, shale gas (mainly CH4) is extracted as a by-product. Given its developed pipeline network and stringent environmental regulations in the U.S., gas venting is rare, and gas has to be sold in the market. As the low gas price does not significantly impact the shale oil producers’ revenues, production leads to a decline in natural gas prices. For example, in the Bakken field in North Dakota, revenue from natural gas only accounts for 10 percent of a producer’s total revenue with more revenue being generated from oil and NGLs. These producers do not care as much about the production of natural gas, which is considered a by-product. Increased NGL production ensures the companies’ profits. Meanwhile, if the demand for natural gas increases, the gas price will go up; if oil prices decreases, gas production will decrease correspondingly, which will consequentially reduce the production of natural gas. In this way, the natural gas price could also go up. However, once gas prices move up, some previously unprofitable projects would presumably resume production. Considering the ample reserves of shale gas in the U.S., gas price will remain at a low equilibrium level for a long time. Low natural gas prices also provide U.S. LNG exports with advantages on raw material costs. Take the LNG from Sabine Pass, Louisiana as an example: Purchasers pay 115% of the Henry Hub wellhead price plus $2.25-$3/mmbtu for liquefaction and $2-$6/mmbtu for transport cost. Considering that Henry Hub price was as low as $2.5/mmbtu in 2012, the U.S. LNG export price could range between $7-$12/mmbtu. Even if the Henry Hub price climbs to $5/mmbtu, U.S. LNG exports will still be profitable. Besides the cheaper gas, Sabine Pass also has lower capital costs; the project was retrofitted from an existing LNG import project, therefore the only newly installed construction was the liquefaction facility. No additional investment was needed in pipeline and storage tank construction. Cheniere Energy can purchase natural gas on the market and liquefy it before exporting. On the supply side, the United States’ natural gas production ensures enough gas for LNG exports, but there is some concern that LNG exports will increase the price of gas in the United States. Some people believe that increased gas prices would ruin the U.S. domestic cost advantage in the chemical and power industry, thus diminishing America’s economic competitiveness. Energy research institutes have reported on the potential impact of LNG exports on domestic gas prices. The EIA commissioned study projected that the price of natural gas in the United States would grow by 3%-9% and the price of electricity by 1%-3%, under a scenario in which LNG exports reach the level of 60 bcm to 120 bcm per year. Currently, the total capacity of the four authorized U.S. export projects for non-FTA corntries has been expanded to around 6.6 bcf/d, (approximately 51.6 million tons per annum). By the year 2020, the U.S. LNG supply is expected to exceed 130 bcm/year (100 Mt/year). Nevertheless,

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Part Two: Perspectives on China’s Natural Gas Development 下篇：中國專家觀點文章

opposition from American domestic interest groups remain one of the major uncertainties concerning large scale expansion of U.S. LNG export capacity. List of US LNG Export Terminals

Company

Capacity

Sabine Pass Liquefaction, LLC

2.2 billion cubic Approved feet per day (bcf/d)

Approved

Freeport LNG Expansion, L.P. and FLNG Liquefaction, LLC

1.4 bcf/d

Approved

Lake Charles Exports, LLC

2.0 bcf/d

Approved

Dominion Cove Point LNG, 1.0 bcf/d LP

Approved

Total NON-FTA Export Approved

FTA Export Application

Non-FTA Application

6.6 Bcf/d

Competition from Australia When we talk about new LNG supplies in Asia/Pacific, the United States in not the only player drawing our attention. Australia also has a major role. Currently, Australia is the world’s 6th largest LNG exporter, after Qatar, Indonesia, Malaysia, Nigeria, and Angola. With 6 natural gas liquefaction plants and more than 19.8 Mt/year of LNG export capacity, Australia is constructing 14 more liquefaction plants and a Floating LNG Production Platform (FLNG). In the next 5 years, these projects will equip Australia with 65.5 Mt more LNG export capacity a year, making Australia the largest LNG exporter with a total export capacity of 85.3 Mt/year. Australia is also considering the feasibility of adding another 50 Mt/year capacity, including 11 more liquefaction plants and 2 more FLNG. If all of these capacities are realized, Australia’s yearly LNG export capacity will achieve 136 Mt, nearly 7 times larger than the current level. However, LNG projects call for huge investments. On the LNG export end, liquefaction and related infrastructure are needed, while special LNG carriers are required for shipment. On the import end, a re-gasification facility is needed to gasify LNG before injecting it into pipeline networks. These are all capital-intensive projects. For example, at the Gorgon LNG project in Western Australia, expected to come on stream in 2015 with 15 Mt/year capacity, total construction costs will be 40 billion USD. Currently, in Australia, some of the projects’ production costs are already at the level of $12/mmbtu. In order to sustain their profits and accommodate the high cost of Australian LNG, suppliers will continue with an oil-price linked pricing mechanism for LNG. Otherwise these suppliers 163

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would be forced to halt LNG development, which is not acceptable to LNG buyers in Asia. If these ongoing projects fail to supply enough LNG to the market, LNG supply stability could be greatly threatened.

Conclusion Taking both demand from Asia and expected supply from the United States and Australia into consideration, if 15-20 Mt of LNG from North America flows to the Asian market by 2017, it will still only constitute 6%-9% of the Asian total annual LNG demand of 230 Mt. By that time, Australia will be the largest LNG supplier to the Asian market. However, given the fact that LNG development and upstream infrastructure in Australia are both very expensive, Australian LNG export projects will not yield any profits under the North American gas pricing scheme. Buyers from Asia are more concerned about supply stability than price, which allows importing countries in Asia to pay a higher price on secure supplies. Meanwhile, since spot market pricing is highly volatile some Asian countries have doubts about adopting it. To conclude, the anticipated contribution from North America’s LNG export to the APEC market will be too small to affect the high price of LNG in the Asian market. However, increased global supply will reduce the advantages from some marginal LNG suppliers, such as Russia. Although LNG trade will not abandon the oil-linked pricing scheme, we could possibly anticipate the occurrence of a combined pricing mechanism of both oil-index based and Henry Hub based price. This is definitely good news for LNG importers in the APEC area, including China.

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Natural Gas Pricing Mechanism Evolution in China (中國天然氣價格形成機制的演變) By LIU Yijun (劉毅軍) 劉毅軍，中國石油大學（北京）教授，中國油氣產業發展研究中心副主任。 LIU Yijun is a professor at China University of Petroleum (Beijing) and the deputy director of China Oil and Gas Industry Development Research Center. His research focuses on the economics and risks of the natural gas industry chain and has published over 50 academic papers in China. He also published several books themed on natural gas, including the “Research of the Gas Industry Chain and Downstream Market Risks (Chinese)” and “Research of the Price Factors of Natural Gas and the Industry Chain (Chinese)”. He holds a PhD from China University of Mining and Technology. The commercial launch of the West-East Gas Pipeline I (WEGP I) at the end of 2004 marked the beginning of the rapid development phase of China’s natural gas industry. This transformative phase, which is expected to last for another ten years, involves the ongoing construction of gas pipeline networks, a greatly expanded level of resource extraction, market maturity, and the acquisition of foreign experience. As the structure of China’s natural gas industry changes, the mechanisms by which natural gas pricing is determined will as well. This article aims to explain and clarify the natural gas pricing mechanism evolution in China.

I.Historical Context of the Formation of China’s Natural Gas Pricing Mechanism China’s natural gas industry has developed in several different stages. The government has adjusted the institutional arrangement of the industry, including that of natural gas pricing mechanism, over time: During the early stage (1956-1997), the government regulated the natural gas industry by controlling the wellhead prices in an attempt to expose producers and their decision-making to market signals. A dual-track (state-set and market priced) pricing mechanism was introduced in 1987; a sectorial differential pricing system was adopted in 1992, which was an important marketization measure at the time. A trial pipeline gas pricing method, which charged the gas transportation via old pipelines by distance, had been explored since 1997.

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During the rapid transitional stage of the natural gas industry (1997-2004), a key government regulation was to apply pipeline transmission pricing instead of ex-plant pricing. This started by regulating the transmission fees of Shan-Jing Pipeline I and implementing the “new pipeline, new price; different pipeline, different price” policy. Local governments directly regulated the pipeline distribution end-use prices but not the prices of city gas. During the rapid development stage (2004 to present), government regulation was extended to formulating the structure of the natural gas industry. With the launch of West-East Gas Pipeline I, ex-plant prices were all converted to government-guided prices, and their base levels and range of adjustment, especially the upward adjustment, required national approval. The government attempted to establish a type of pricing mechanism that is linked to alternative energy prices and to simplify the categorization of gas prices. It also tried to explore a reform of the current “two-part pricing system” but that failed due to certain constrains. At the same time, some local governments set up distribution prices that were in sync with upstream and mid-stream prices.

II.Recent Trends in the Formation of China’s Natural Gas Pricing Mechanisms In recent years the formation of China’s natural gas pricing system has mainly involved the establishment of “optimal starting prices” at the ex-factory stage and at the provincial citygates, progressive changes in pricing reform.

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2.1. Pricing reform by establishing “optimal starting prices” at the ex-plant stage On December 23, 2005, the National Development and Reform Commission (NDRC) carried out a natural gas pricing reform and explicitly announced that its near-term goal would be to further systemize pricing regulation, to gradually increase price levels to make them more compatible with the price of alternative energies, and to set up a dynamic pricing mechanism linked to prices of alternative energies. In the long run, together with the establishment of a competitive market structure, ex-plant prices of gas will be set by market competition. The NDRC also decided to replace the ex-plant prices with government-guided prices and to increase the base levels of the ex-plant prices. The NDRC proposed that natural gas ex-plant prices should be adjusted annually with reference to five-year average moving prices of crude oil, liquefied petroleum gas (LPG), and coal with the respective weights of 40%, 20% and 40%, and an adjustment not exceeding 8% for the following year. In fact, such a proposed arrangement was first mentioned in the “Notice of National Development and Reform Commission on the Issues of West-East Gas Pipeline Gas Pricing Issues” on September 28, 2003. These arrangements were just advocated it more explicitly this time. This was a key reform of China’s gas pricing mechanism. It began with the gradual increase in

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the ex-plant gas prices by setting up “optimal starting prices” and rationalizing the relationship between alternative energy prices in order to create a pricing system that is ultimately linked to alternative energy prices. Compared to today, establishing “optimal starting prices” was relatively easier at that time when international oil prices were below USD70 per barrel. Among the energy alternatives to gas, coal is the energy type most abundant in China; therefore coal was included in the pricing formula. The NDRC reform was, however, launched suddenly and rapidly in late December 2005. This had to do with the fact that China’s natural gas industry had entered into a rapid development phase, that there was a severe “gas shortage” in the winter between late 2004 and early 2005, and the government was anxious to avoid a possible recurrence of such a shortage in late 2005. Essentially, the reform served to provide incentive to gas producers, which has since become the norm. The reform simplified the categorization of gas prices because the original way of categorizing different gas users in different regions no longer adequately captured the complex reality of gas pricing and variation among regions. This reform ultimately increased gas prices. Specifically, it required that planned gas production from major gas fields be sold at a tier-I price while the other production was sold at a tier-II price. The tier-II price had an ex-plant price with a benchmark price level of RMB 980 per 1000 cubic meter with an adjustment not exceeding RMB50 per 1000 cubic meter, while the tier-I price had a benchmark price level of RMB770 per 1000 cubic meter. The reform also linked up the tier-II price with alternative energy prices and planned to gradually adjust over a three year period the level of the tier-I price to match that of the tier-II price. One can see that the system at that time was markedly different from the system today, which differentiates existing gas supply pricing (also known as stock gas pricing in China) from incremental gas pricing. With the implementation of the December 2005 reform it was expected that gas prices would rise. Local governments, therefore, started exploring the synchronization of up-, mid- and downstream gas prices, which are most sensitive to residential gas users. 2.2. Insist on establishing an “optimal starting price” at ex-plant stage Since 2008, natural gas pricing reform has drawn widespread concern. A variety of proposed versions of reform have sprung up. A particular variation that was proposed by major gas producing oil companies to establish an “optimal starting price” at the provincial city-gate level prevailed. The key to this proposed reform was that each province set up a unified citygate price based on the weighted average prices of stock gas (the 2009 supply volume) and incremental gas (the newly added gas use since 2010) in the province. Stock gas price is then set according to the weighted average of ex-plant prices of gas-fields and pipeline transmission fees. The ex-plant prices of different gas-fields across the country also took into account, on a weighted basis, the RMB0.4 subsidy for the gas used as city gas and for chemical fertilizer (the

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national average ex-plant price amounted to RMB1.17/ cubic meter). Incremental gas prices, on the other hand, were set based on the weighted average of the national average ex-plant price (RMB1.17/ cubic meter) and taxed gas import costs, plus pipeline operation cost. The proposed reform requested that the national average ex-plant price (RMB1.17/ cubic meter) be adjusted according to the variation in international oil prices, and domestic ex-plant prices of LPG, gasoline and diesel prices, with each being weighted at 25%. The key changes we find in the proposed reform are that it bundled gas production and transmission; incremental gas adopted nationally unified ex-plant prices; it linked up explant prices of domestic gas with alternative energy prices in a controlled manner; it adopted a complicated weighted formula to calculate prices for stock gas, incremental gas, imported gas and various pipeline transmission that only a few specialists could understand. Users for incremental gas in Eastern China represented vested interests, whereas residents in Western China bore a greater burden due to land gas imports; each province had its own unified maximum city-gate price. The reason for this reform was to subsidize city gas users and chemical fertilizer producers at RMB0.4/cubic meter, and since November 10, 2007 the NDRC has slightly increased the explant price of the gas used by industry. As a result, all onshore gas-fields (including those linked to West-East Gas Pipeline, Chungmuro line, Shaanxi-Beijing gas transmission systems, etc.) that supply gas to industry users (including gas power generators, non-fertilizer manufacturing and independent heating firms) have seen their prices raised by RMB400 per 1000 cubic meters, but there were no adjustments for gas provided for chemical fertilizer producers and city gas users. The subsidy was to ameliorate the unreasonable sectoral differential prices, also known as cross-subsidization. In this reform, NDRC also left off the regulation of the liquefied natural gas (LNG) ex-plant prices, which would be set through bilateral contracts. It has led to a rapid development of in-land LNG plants. It also meant that the prices of imported LNG, as long as it is not re-gasified and loaded into pipelines, are unregulated. The reform also rationalized the relative price relationship between transport-use natural gas and gasoline, which accelerated the construction of natural gas filling stations. However, after about a year of heated debate and waiting, NDRC announced new pricing reform on May 31, 2010. The essence was to increase the ex-plant prices of domestic onshore natural gas by RMB230 per 1000 cubic meters. At the same time, it abolished the two-tier pricing in effect since 2005. This reform was part of the broader reform of industry structure, moving the industry forward in market competition. At this time, the ex-plant base price formed a relative price relationship with alternative energies and was no longer set by a “cost-plus” method. Coincidentally, the price increase this time followed another “gas shortage” in the winter between late 2009 and early 2010. Before that, the NDRC had been looking for the right timing, such as low CPI growth rate and steady economic growth. The new challenges came in late 2009 when the share of more expensive gas imports climbed following the launch of the

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Central Asia-China Gas Pipeline and continuous expansion of the West-East Gas Pipeline II. The global financial crisis, which depressed international oil prices to below US$60 per barrel, created good timing for the establishment of an “optimal starting price”. The price increase this time was large in range. Ex-plant prices for onshore domestic gas were increased from RMB925 per 1000 cubic meters to RMB1155, by 24.9% (or RMB230). Before that, on June 26, 2009 the NDRC approved that the ex-plant price for gas transmitted from Sichuan to eastern China could be set at RMB1.28 per cubic meter (value-added tax included), and that no differential pricing was adopted. The May 2010 price raise announcement again signaled clearly that the “cost-plus” pricing method was abolished. The NRDC also announced that it would explore carrying out a differential gas pricing policy. In cities where seasonal and peak-valley variations of gas are large, seasonal differential pricing, peak-valley differential pricing and interruptible supply pricing should be adopted. This made some regions start exploring differential pricing. For example, Shenyang City, Liaoning Province, from November 1, 2010 onwards, experienced tight gas supply in the winter and it thus raised the gas prices for industrial and commercial users by 20% as a temporary measure. The signal and implementation of price increases from 2006 have motivated local governments to develop a gas distribution system that synchronizes with the up- and downstream. NDRC even published a document in July 2010 to encourage this trend. 2.3. Establishment of provincial city-gate “optimal starting price” in pilot regions In January 2011, the main gas-producing oil companies hinted to the public that a “netback” pricing method would be adopted. At the end of 2011, the NDRC made Guangdong and Guangxi pilot regions for gas pricing reform, adopting the “netback” method that linked gas prices to alternative fuels (fuel oil and LPG) to determine the maximum city-gate prices in a province, region, or city. It tried to set up an “optimal starting price” for a province, region or city. The pilot scheme has four key elements: First, it replaces the current “cost-plus” method with the “netback” method and sets up a gas pricing mechanism that is pegged to alternative energies. Second, the city-gate price in a province, region or city takes into account the physical flow of gas resources and transmission costs. Third, it creates a dynamic mechanism for the formation of city-gate prices. Prices will be adjusted every year (and later every half year or quarter) based on the changes in prices for alternative energies. Fourth, it allows ex-plant prices for shale gas, coal bed methane, and coal-based synthetic gas to be set by the market. The key changes in natural gas pricing reform since 2005 can be summarized as following: Gas prices are set by provincial city-gate stage instead of ex-plant stage. Ex-plant prices are still government-guided prices; the Shanghai market (the central market) is chosen to be a price reference. A mechanism that links up central city-gate prices and alternative energies prices is created; Alternative energies now include only fuel oil and LPG, with respective weights of 60% and 40%; the reform clarifies the pricing formula for central city-gate prices; the city-gate

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prices for Guangdong and Guangxi are based on the central city-gate price while considering their actual socio-economic development levels, physical flow of gas and transmission cost. In the cases of Guangdong and Guangxi, when the governments determine provincial citygate prices, they are in fact bundling ex-plant prices and long-distance pipeline transmission costs. This arrangement essentially reinforces the institutional monopoly and runs counter to the realization of market competition. Unconventional gas producers that do not own pipeline assets may find it difficult to send their gas via pipeline for sale; this means producers may have to sell their gas at the ex-plant stage and are thus controlled and monopolized by pipeline owners. This stifles entrepreneurship and duplicates pipeline construction. Local governments will also reinforce their control and intervention over the pipelines in their region in the name of protecting downstream users, thus creating a new monopoly. Oil companies, on the other hand, will strengthen their vertical integration of up-, mid- and downstream, creating a situation which discriminates even more against the user. As for regional pipeline networks, during the construction of West-East Gas Pipeline I, the provincial branch pipe network became a new pricing monopoly in many areas, especially in Jiangsu. In November 2003, the Jiangsu government decided to estimate and manage independently the branch network of the West-East Pipeline in its administrative area. The case of Guangdong province is even more representative of a provincial government controlling the pipeline network under its administrative jurisdiction. On November 24, 2011, the “Scheme on the Mode of Natural Gas Trunk and Branch Pipe Network Construction and Operation in Guangdong” was issued, stating that the provincial government would be in charge of the planning, construction, and operation of the gas pipe network in the area, also known as “one province, one network”. Guangdong Natural Gas Pipeline Company are now responsible for the construction and operation, thus other entities cannot construct any pipelines and get them connected directly to downstream buyers (city gas companies and end-users). On July 2, 2012, the prices city gas companies pay to receive West-East Gas Pipeline II gas from the provincial pipeline network company was temporarily set at RMB3.003/cubic meter (tax included). Of that amount, the source of gas itself accounts for RMB2.740 while transmission cost accounts for RMB0.263 (but those for power plants and industrial-commercial users are RMB0.278 and RMB0.290 respectively, tax-included). On December 3, 2012, “Guangdong Provincial Price Bureau on the Pipeline Gas Price Management Approach (Trial)” was issued to regulate and strengthen price management. Since 2011, to solve the problems associated with increasing residential use gas prices, a pricing ladder in the residential sector has been explored by the government, a process that has accelerated since 2012. Considering the rationalization of the pricing relationship between vehicle-use natural gas and gasoline, the provincial measures to synchronize up-, mid- and downstream, and differential pricing on downstream, one can see that the government has adopted the end-use-side approach to reform pricing mechanisms. The role of local governments

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is becoming visibly important in the gas price reform.

III.Latest Development in China’s Gas Pricing Reform In response to the rapid growth in demand for natural gas, China began importing LNG in 2006. By the end of 2009, China started importing natural gas via pipeline. Import dependency rose to 27% in 2012 and is expected to surpass 30% in 2013, with no sign of reduction. At the same time, due to the lower prices of domestic gas, maintaining China’s natural supply-demand balance becomes difficult. According to the annual report of CNPC, for example, imports from Central Asia and LNG sources grew dramatically in 2012, resulting in mounting financial losses, amounting to 41.9 billion RMB. Therefore, the greatest challenge for China’s natural gas industry is to ensure long-term supply sufficiency. Despite the fact that the “gas shortage” in the winter between late 2012 and early 2013 was not severe, gas supply was unexpectedly tight after May 2013. The NDRC unusually issued a “Notice of National Development and Reform Commission on Further Improvement in Natural Gas Supply” on June 13, 2013, and “Notice of National Development and Reform Commission on Adjusting Natural Gas Prices” on June 28. The latter notice consisted of several key points: First, it applies the type of pilot pricing system in Guangdong and Guangxi to the whole country. Second, it differentiates prices for stock gas from prices for incremental gas. Prices for incremental gas are based on the pricing method used in Guangdong and Guangxi and were adjusted to a level equivalent to the 85% of alternative energy prices in the second half of 2012, regardless of consumption purpose. Stock gas prices were increased somewhat. Prices for the gas used for producing chemical fertilizer cannot be increased by more than RMB250 per 1000 cubic meters. Prices for stock gas are planned to be adjusted to a reasonable level by the end of 12th Five-year Plan period. Third, ex-plant prices for shale gas, coal bed methane and coal-based synthetic gas and LNG source prices are unregulated and are set by bilateral deals. Fourth, residential gas prices are unadjusted. It seems that the Notice on June 28 called for an adjustment in gas prices, but, in fact, it involves a major change in the gas pricing mechanism. There are three positive changes: First, it is estimated that prices for stock gas will be raised by RMB0.19, which eases the financial losses resulting from overland pipeline gas imports. A preliminary account is that if the increased stock gas prices will all be absorbed by users, prices for the natural gas before entering into pipelines will be increased by 16-25%. Second, the dramatic increase in incremental gas prices will improve the capacity to maintain gas supplies by getting the incentive right and differentiating stock gas from incremental gas. It slightly increases the stock gas prices as a basis, on which it increases the prices for incremental gas by RMB0.88 (or RMB0.58 in the cases of Guangdong and Guangxi, as their stock gas prices are already higher; places like Hainan, Chongqing, Sichuan, prices are up RMB0.86). In Shanghai, the CIF price for LNG (de facto imported incremental gas) is around RMB2.25, which takes into account the import tax,

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across the board pipelines earnings, and foreign upstream investment earnings etc., improving the import incentive. Third, it controls the impact of price rise on users by putting in a 0.85 discount coefficient in order to maintain a steady demand growth. The adjustment, on average, increased gas price from RMB1.69 to RMB1.95. We can understand the price adjustment this way: Stock gas price is equal to the “optimal starting price” for domestic onshore gas and pipeline imported gas (although it is probably not optimal enough), while the incremental gas price essentially means a nation-wide attempt to establish an “optimal starting price” that is linked to the chosen alternative energy prices, without having it tested fully in Guangdong and Guangxi. The pricing reform of June 28 also has two negative effects: First, it created a new “dualtrack” pricing system, the negative effects of which China is quite familiar. Second, while the ultimate goal of gas pricing mechanism reform is to separate production and transmission and to have enough quantity of gas producers and suppliers; this reform, however, seems to ensure that China will embrace a system in which production and transmission are bundled, running counter to the global trend. It is also not clear how to distribute the dividend stemming from rationalizing the price relation between gas and alternative energy. Probably due to this reason, this Notice is called a notice on “gas price adjustment” instead of a notice on “gas pricing mechanism reform.” To tackle the problem of the bundled production and transmission of gas, the “Management Method on the Construction and Operation of Natural Gas Infrastructure” in preparation will contain an “independence” clause that should enable natural gas infrastructure operating companies to establish a robust and sound financial system if they also run sales or other gas businesses. The system will independently audit the business operation of natural gas infrastructure, ensuring the reported costs and revenues are real and accurate. The “infrastructure service price” clause establishes that the pipeline transmission fee, gas storage fee, gasification fee, and liquefaction fee are set by the relevant departments of government. At the same time, the government department that is in charge of pricing is coming up with a way now to regulate the government’s pricing of infrastructure service and to establish a reasonable pricing standard. It targets Xinjiang’s outward-bound pipeline of coal-based synthetic gas as a pilot to explore a way to separate gas transmission, distribution service and gas supplies. Moreover, regions with regional pipe networks such as Sichuan are now creating a weighted evaluation on stock gas and incremental gas, abolishing the dual-track system above provincial city-gate. At the same time, on December 17, 2010, the Shanghai Oil Exchange launched LNG and LPG spot trading. This is the first electronic platform of gas marketization in China. With this platform, spot trading helps to meet the peak LNG needs in the summer and winter. On August 13, 2013, the platform launched LNG trading for domestic pipeline transportation with the receiver being Guangzhou, Guangdong. The settlement period is four months. Spot trading via natural gas exchange might be developed into (another) new pricing mechanism.

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Prospects for Natural Gas Development and Energy Transformation in China (展望中國未來天然氣發展及能源轉型) By CHEN Weidong (陳衛東) 陳衛東，現任中國海油能源經濟研究院首席能源研究員，教授級高級經濟師。 CHEN Weidong is a senior economist and the chief energy analyst of the Energy Economic Research Institute, China National Offshore Oil Corporation (CNOOC). He also served as the executive vice-president and chief strategic officer of China Oilfield Services Limited (COSL). He has over 31 years experiences with China’s oil and gas industries and has received multiple awards. He is also an Honorary Researcher at the Chinese Academy of Social Sciences.

I. New Definition of “Energy Security” In recent years, the concept of “energy security” has been in the spotlight in both China and overseas. However, the idea of energy security is perceived differently in various countries. The 2013 World Economic Forum (WEF) in Davos published an analysis of the efficiency of energy development using an “Energy Architecture Performance Index” (EAPI). EAPI includes three types of indicators: economic growth and development, energy access and security, and environmental sustainability. The WEF report synthesized and ranked the performance of 105 countries. It is interesting to note that all of the highest ranked countries are resource-importing countries, except for Norway, which sustains itself in terms of energy supply. Also, all resourceexporting countries fell below the medium level in the EAPI ranking. Energy supply security is only one of the primary foci in the WEF report. A self-sustaining energy supply does not necessarily imply a high-efficiency energy supply structure. The concept of energy security has two attributes - it should not only meet the demand for economic development but also ensure environmental sustainability. The quality of energy supplies, including affordability, sustainability, and quantities of supply are emphasized. China is fairly rich in coal resources and, over the past three decades of rapid economic expansion, the country has heavily relied on coal as an energy supply. However, the use of coal has produced severe air pollution and the negative public health consequences associated with the pollution have been significant. A sufficient energy supply that comes at the cost of the nation’s public health would by no means imply “energy security.” 173

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Based on the EAPI assessment scheme set forth in the WEF report, this essay will argue that the future of China’s energy supply must be centered on the issue of environmental sustainability. Reducing coal consumption and significantly increasing the share of natural gas in the country’s primary energy supply would be China’s most reasonable choice and would be critical to achieving a successful shift in the overall energy structure.

II. The Challenge of a Less-Coal-More-Gas Proposal: Overview of Supply and Consumption Sustainability 2.1. Supply Side Sustainability The price of natural gas in China has for a long time been below the market equilibrium level, thus making the supply side unsustainable for major natural gas importers and causing gas processors to incur ever-increasing losses. On the other hand, coal is China’s most abundant energy resource and the price of electricity generated by coal-fired plants is treated as a benchmark for the overall electricity supply price. Hence, the biggest obstacle to a shift in the energy supply structure is the significant price gap that exists between coal and gas. On the demand side, China’s natural gas supply and demand were balanced in 2005, at an amount of 50 billion m3. However, in subsequent years, consumption has increased to 150 billion m3, but production only rose to 100 billion m3, leaving a huge gap of 50 billion m3 that must be imported. Imported gas now accounts for nearly 30% of total national gas consumption. Current projections predict that by 2020 consumption could reach 300 billion m3, since 2005 it has increased 5 times. So securing a quantitatively sustainable supply of gas is truly becoming an issue of concern.

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2.2. Consumption Side Sustainability Many non-market factors currently impact the natural gas pricing scheme in China. Natural gas currently only accounts for 5% of the primary energy supply, of which 40% is for household use, and only 17% is used for electricity generation and peak-load adjustment (in contrast to the fact that 78% of coal resources are used for electricity generation). The on-grid price of electricity generated by natural gas is about one times higher than that of coal, and the gap between the actual costs is even more substantial. The relatively low portion of natural gas in China’s gross energy supply is caused not only by the limited availability of natural gas resources due to delayed exploitation, but also by the irrational pricing structure. China has higher gasoline and diesel prices as compared to those in the United States. However, the retail electricity price is roughly at the same level as that of the U.S. (approximately USD 102 per MWh in China, and USD 98.6 per MWh in the U.S.), but the natural gas price is roughly four to five times higher in China than in the United States. This high cost has made Chinese power plants unable to sustain generation under the current electricity pricing mechanism. The low natural gas price in the U.S. has paved the way

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for natural gas to gradually replace coal as an energy source, without adding any additional cost to be borne by society. China will need to eliminate the big disparity between the price of natural gas and the retail price of electricity in order to encourage natural gas consumption and eventually substitute coal for the cleaner energy resource of natural gas. China also needs to realize that, although natural gas price currently seems too high, the problem actually lies in the exceptionally low price of electricity. However, as electricity plays a key role in ensuring the normal functioning of industry and society, raising the price of electricity would require careful thought by the national authorities. Hence the dilemma: Should China raise the retail price of electricity or are there other alternatives to consider given the current electricity-pricing scheme? According to economics theory, a free market creates a reasonable price. The mass substitution of coal with natural gas that took place in the United States was the result of a considerable increase in the production of natural gas, rising demand for clean fuel, and declining cost. In the case of Japan and Korea, Japanese Crude Cocktail (JCC) index for LNG pricing is associated with petroleum price. (The price of LNG equals roughly 80% of the price of petroleum with the same calorific value.) Therefore, increasing the use of natural gas will not bring significant extra cost. Without government intervention and under a free market scheme, energy industry and consumers would seek a better balance that benefits society as a whole. The transportation industry has demonstrated excellent potential for increasing natural gas usage. However, natural gas in transportation substitutes for petroleum not coal. Nevertheless it reduces GHG (greenhouse gas) emissions. LNG normally would have a comparative advantage in cost competitiveness over diesel, but the mass substitution of diesel with LNG requires new infrastructure, e.g. gas pumping stations, as well as research and commercialization of LNGspecific engines. These would require considerable time to develop, making it hard to mitigate China’s unbearable air pollution in the near term. On a separate note, if we include GHG emissions as part of energy cost and factor the negative impact of burning coal in the electricity price, the gap between the price of electricity generated by coal and by natural gas could be alleviated. It is all reflected in people’s willingness-to-pay: when people place a higher priority on the environment, the negative impact of burning coal could have a higher cost. Subsequently, the price barrier for natural gas could become lower, too. Ultimately, public awareness of environmental concerns truly matters in resolving the current electricity pricing dilemma, as the public opts for cleaner energies despite cost increases.

III. Necessary Measures to Promote Future Energy Transformation 3.1. Utilizing American Experience in Developing Unconventional Gas The shale gas revolution has allowed America to become the largest producer of natural gas in the world. This has allowed the U.S. to successfully escape declining oil and gas production, and perhaps evolve from a natural gas importer to a natural gas exporter, thus transforming the

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global energy landscape. Due to the development of shale gas, America’s natural gas prices are the cheapest among three global economic regions: North America, Europe, and Asia Pacific. U.S. gas is priced at only 1 RMB per cubic meter, the cheapest level reaching 0.7 RMB per cubic meter dropping below the average production cost of shale gas. Inexpensive natural gas (1/5 to 1/6 the cost of petrol prices of the same period), as well as the rapid growth in production of natural gas, has greatly strengthened the competitiveness of American industry and manufacturing. This has rapidly lowered U.S. greenhouse gas emissions and, in 2012, it was predicted by some that emission levels would return to 1995 averages. Compared with conventional oil and gas, shale gas is from “low-grade ore.” The key to developing low-grade ore is reducing production costs, which often leads to small and mediumsized companies having an advantage when developing shale gas. Conventional extraction rates in America are extremely high, due to a very rational division of America’s petroleum industry. When oil field development enters the later stage, production output decreases and production costs rise, usually causing large companies to opt out, while medium to small companies will continue to maintain production. When production output decreases to a certain point, medium and small companies will also cease production. However, even smaller companies, or individuals, may continue to maintain production before ultimately abandoning an oil well. China and the United States are at different stages of development. With regards to conventional natural gas, China is currently facing a sustained growth stage, while American output of conventional natural gas has already been on decline for several years. However, unconventional oil and gas in America is experiencing an energy revolution that is seeing explosive increases in production. America has abundant shale gas resources and highly efficient applied technology, but the key to continued sustainability is the price of natural gas. According to predictions made by Chinese and American experts and professional institutions, China’s shale gas resources are abundant and China’s exploration and development technology is currently in the process of maturation. The organizational structure of China and America’s petroleum industries are extremely different, however. If the technological innovations of state oil companies are weak, the capacity to learn and mobilize resources is certainly present, allowing for the ability to “focus resources to manage projects.” If we take the ability to import oil and natural gas into account, up to the present, the state-run monopoly of the petroleum industry has been able to support the strong demands for oil and gas resulting from national economic development. From the perspective of technology, one third of China’s domestically-produced natural gas comes from tight gas. Since 2009, Sinopec and PetroChina have already achieved great progress in shale gas drilling and fracturing technologies. Tight gas is considered unconventional natural gas in America, suggesting China’s unconventional natural gas exploratory and development technology is not far behind. Unconventional natural gas includes coal-bed methane, which will continue to represent a larger and larger proportion of the supply of China’s domestic natural gas.

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3.2. Respect the Power of the Energy Market A basic law of market economics is “market price discovery.” Currently China’s natural gas pricing system is still not market based. Before the 1970s, the American government interfered with natural gas prices and, for a long period of time, the U.S. government suppressed the development of the natural gas sector. It was only after price controls were eliminated in the early 1980s that the resulting shale gas revolution occurred. America’s advantage exists in its abundant competitive freedom and advanced technology, with capital markets that serves to commercialize that technology. When technological breakthroughs are achieved and market demand exist, a rapid pace of industrialization and marketization will then emerge. The organizational structure of China’s petroleum industry and its historical and cultural framework are very different from that of the United States. The pattern of America’s shale gas revolution would be difficult to copy in China; however, this does not mean that shale gas and oil cannot be become a reality. China’s petroleum industry has a history of longer than 50 years, and China’s three major state-owned petroleum companies have been engaged in overseas markets for 20 years. Urgent demand for energy transformation will accelerate the speed of reform of the petroleum industry system in China; while domestic energy resources are always the most competitive and controllable resources and will be developed ultimately. China’s petroleum industry does not possess a uniform organizational structure, and, at an institutional planning level, medium and small-sized petroleum companies are completely ruled out from upstream production and are given no space to exist. There is data that illustrates that the extraction rate of proven oil reserves in America reaches 50% on average of original oil in place, while in China it still does not reach 30%, under relatively similar crude oil prices and production costs. The difference in extraction rates reveals the gap, which exist between the Chinese and American petroleum industries. However, even without any reform or adjustment to organizational structure, the current three major state-owned petroleum companies can certainly develop shale gas under their current capacity, setting aside development costs. However, the key for the long-term health of the industry is production cost, scale, and the question of continued sustainability and pricing. Since its creation the American petroleum sector has never been nationalized, while China’s petroleum industry was established based on certain ideals, the shadow of which can be seen in the molding of its reform and reconstruction. However, this type of molding was not done “removed from the outside”, because a country or region’s development experience results from certain constraints based on its “reliance on historically patterns.” The contributions of China’s petroleum industry more than 60 years after the establishment of “New China” and its continued contributions towards economic development have been very great both in large material and non-material contributions. 3.3. From “Ensuring Supply” to “Improving Energy Quality”

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Today, China’s development has once again reached a turning point and transformation of the energy structure is urgently needed. It has become common knowledge that the current rate of environmental degradation cannot continue under present conditions and needs immediate action to mitigate increasingly serious environmental pollution. The government and energy companies are under increasing pressure to address the causes of environmental pollution. In the past China’s energy industry faced constant pressure to “ensure supply”, but it can now be said that going forward, the energy industry’s greatest challenge is transforming the energy structure and improving energy quality. There are two significant issues that must be simultaneously solved to increase the available supply of natural gas and encourage its use as an energy source. These issues are not the same as those faced in the past with regard to coal, oil, and electric power. Currently the greatest issue is supply of natural gas. Under the dual challenge of dealing with “improving energy supply capacity and environmental sustainability,” the most realistic and inevitable option is to increase natural gas consumption. Nevertheless, this must be done while at the same time facing the challenges caused by natural resource distribution in China of “abundant coal, little oil, and insufficient gas.”

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3.4. An Objective Look at Expanding Imports Due to the increase in the scale of oil consumption and changes in domestic supply over the past 20 years, China has mainly relied on the international petroleum trade to solve its rapid growth in demand. With time, the relationship between supply and demand of natural gas will also repeat this process. This has been determined due to China’s natural energy resources and its current stage of development. Drawing on experiences related to ensuring China’s supply of oil, increasing natural gas supply will also follow two paths: promoting domestic production and increasing imports. At present, it is unlikely that China will soon witness the widespread growth of unconventional oil and gas. Therefore, the main path to ensuring natural gas supply, at the very least before 2020, is to increase natural gas imports. For the next 3 to 5 years, increasing LNG imports is more realistic than importing gas via pipeline. As natural gas and alternative energy supplies gradually become more abundant and begin to replace oil as an energy source, the oil and gas trade’s voice and initiative authority will shift and become more favorable to the buyer. China is one of the largest purchasers of energy globally and its call on global petroleum and natural gas supplies has never been as important as it is today, a trend that is likely to continue in the future. China does not have to be over anxious about being a major purchaser, as the seller should be even more concerned over uncertainty and risk, especially large sellers of single surplus products, who have even greater reason to be concerned. Japan does not have any natural gas resources and through the international market purchases

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more than 60% of global LNG. Since Japan has consistently utilized the world’s most expensive prices in order to lock down LNG supplies, even if all of Japan’s nuclear power plants were shut down the country’s electric power supply would not be greatly affected. China’s access to natural gas resources is affected by price factors, not insufficient supplies of resources. Successfully utilizing the market to acquire energy resources, while simultaneously achieving security of supply, hinges on knowledge of international trade and operating modes. When only considering price, under a pure market system, imported or domestic production will reach an equilibrium point. Price will dictate supply and demand, and there is no need to deliberately control anything. It is expected that before 2020, the growth in China’s natural gas imports will surpass the growth of domestic production output, causing increased dependency on imports. 3.5. Government Decision Making is Essential Making energy adjustments to reduce the consumption of coal and increase that of natural gas cannot be an economic process by the government of “letting nature take its course.” The adjustment of natural gas prices is nothing like the almost completed reform of the petroleum pricing system, as it not only involves the price of natural gas itself and the cost of pipeline transportation etc., but also entails a series of associated coal and electricity price reform issues, which involve every aspect of society and will have far reaching effects. Thus, politicians must play a valuable role in policy direction and determination, the most critical being the central government’s guidance via the issuance of comprehensive policy plans. Without strong policy and political leadership and guidance, it will be difficult to achieve predicted outcomes -- even the initiation of necessary energy structural adjustment would be difficult. The core issue at the center of all policy is reforming the pricing system. Implementing change from China’s current energy pricing system to a market system cannot be done overnight, nor can different interest groups be allowed to take society hostage in order to serve their own interests. The central government must clearly indicate direction and objectives when reforming the pricing system and this requires ample willingness to bear responsibility and the daring to promote reform.

IV. Summary It cannot be denied that China’s current upstream production, mid-stream pipeline transportation, and downstream pricing structure do not benefit natural gas, especially unconventional gas development. The most important reason for this is that it does not benefit the rapid large-scale importation of social and foreign capital into the petroleum industry. To change that equation would involve the transformation of many basic institutions and greater value placed by society on environmental protection. Additionally, before shale gas production at scale can be achieved, it requires a lengthy period of time to reorganize social divisions of labor and incorporate large capital inflows.

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Differing from the currently more mature stage of oil development in China, domestic natural gas, including pipeline construction, still revolves around large-scale investment and rapid increases in growth. One of the most realistic options for increasing domestic supply of natural gas, while maintaining current production initiatives and current production investment, is to encourage greater investment in unconventional oil and gas and pipeline construction. To further promote natural gas consumption, policymakers should create an environment that encourages more “marginal or fringe experiments” at the market end, allowing for increased inflows of investment to the domestic natural gas industry by private Chinese capital and foreign investors1. Fast or slow, the ratio of natural gas consumption in China is certain to increase. However, if there is no clear great leap forward in the development stage, then we cannot anticipate a clear effect on the environment of “reducing coal while increasing gas”, and there will be no significant reduction of emissions. It will also be difficult to achieve even the most basic change in China’s serious air pollution situation and the current “environmental un-sustainability” could become even more acute. In China, the process of replacing coal with natural gas will not occur naturally, due to the fundamental obstacle of a distorted energy price system. In order to eliminate this obstacle, political determination and ownership will be the most important factor in initiating reform of the energy pricing system, while providing guidance and assurance through fresh, progressive, market-oriented policy measures. At the very least, we anticipate that in the years leading up to 2020, the rate of natural gas imports will increase. Simultaneously, government policy will encourage greater investment in basic infrastructure (pipelines and LNG transportation and re-gasification), expand import licensing, encourage diverse import competition, obtain long-term contracts for resources, and improve the efficiency of operations. In the past, China’s petroleum industry structure has undergone effective market reform, but currently it has fallen behind economic development requirements. A new round of even greater petroleum industry reforms should be initiated, otherwise the new oil and gas revolution will pass China by and an important opportunity to transform the energy sector will be lost. Even though reforming the energy system will not immediately lead to large increases in domestic gas production, it will provide sustainable conditions for development of China’s energy sector by laying a solid foundation for the long term. To paraphrase an old saying, when speaking of natural gas development in China – “the prospects are very bright, but there are twists and turns in the path ahead.”

Ronald Coase, a recipient of the Nobel Prize for economics, believes that China’s success in economic reform benefited from the simultaneous promotion of the two wheels of “central government promotion” and “marginal or fringe experiment”.

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