The u s experiences report en

The U.S. Experiences in Coal-based Synthetic Natural Gas and Lessons for China

Chi-Jen Yang

3/F, Julong Office Building, Block7, Julong Garden, 68 Xinzhong Street, Dongcheng District, Beijing, China. 100027 Tel: (86)10 65546931 Fax: (86)10 65546932 www.greenpeace.cn Greenpeace is an independent global campaigning organisation that acts to change attitudes and behaviour, to protect and conserve the environment and to promote peace.

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作者：杨启仁

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The U.S. Experiences in Coal-based Synthetic Natural Gas and Lessons for China

Biography Dr. Chi-Jen Yang is a research scientist at Duke University. As an renowned expert on energy and environmental policy, he has been widely quoted by mainstream American and international media. His recent article titled China’s Synthetic Natural Gas Revolution has been published in Nature Climate Change. He received his Ph.D. in Public Affairs from Princeton University, an MS in Technology and Policy and an MS in Civil and Environmental Engineering from MIT, and a BS in Chemistry and an MS in Environmental Engineering from National Taiwan University.

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The U.S. Experiences in Coal-based Synthetic Natural Gas and Lessons for China

Contents 1. A Brief History of Coal-Based Synthetic Fuels

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3. Pollution and Pollution Control at Great Plains Synfuels

Development of Coal-Based Liquid in South Africa

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Development of Coal-Based Synthetic Fuels in the United States

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Air Pollution 23

Development of Coal-Based Synthetic Fuels in Other Countries

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Waste Water 24 Solid Waste 26 Capture and Storage of Carbon Dioxide

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Consumption of Water Resources 30

2. Bankruptcy, Restructuring and Financial Analysis of the Great Plains Synfuels Plant

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Financial Analysis 17 Misjudgments of Natural Gas Price and Long-Term Energy Supply and Demand 19

4. Lessons from Great Plains Synfuels and Warnings for China 32 Determination on the Maturity of Technology

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The Dilemma of ‘Too Big to Fail’

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Concern over Sunk Cost and Technological Lock-in

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The Importance of Transparent Information in Demonstration Projects

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Long-term Energy Prices Difficult to Predict, Resource 35 Endowments Are Changeable Energy Infrastructure Must Be Planned with Long-Term Vision

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References 39

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The U.S. Experiences in Coal-based Synthetic Natural Gas and Lessons for China

1. A Brief History of Coal-Based Synthetic Fuels 1

The modern coal-based synthetic fuels technology originated in Germany.

As early as the 1930s, Germany had developed the Lurgi technique for coal gasification. Because Germany lacked oil and gas, Hitler fully supported large-scale manufacturing of coal-based liquid fuels to fuel the mechanized 2 warfare of Nazi Germany’s invasion. During Japan’s invasion of China, it also researched techniques for manufacturing coal-based fuels in Japan and in the occupied northeast China. While the Japanese experiments had 3 some limited success, they failed in achieving scaled production.

Research and development of coal-based synthetic liquid and gas in western countries is categorized mainly under the title of “synthetic fuels”, which [1] includes coal-based liquid and gas, and the extraction of shale oil. Outside of China, there are only three examples of scaled production of coalbased liquid and gas – coal-based liquid in Nazi Germany, coal-based liquid in South Africa and coal-based SNG at the Great Plains Synfuels project in the United States. There are many commonalities between the technologies for coal-based liquid and gas, making it difficult to discuss them separately. South Africa developed its coal-to-liquid technology based on the technology in Nazi Germany, and the Great Plains Synfuels Plant adopted the Lurgi gasifier from South Africa. Therefore, these three projects all developed along the same line.

In recent years, the smog problem in eastern Chinese cities has been worsening.

The public is increasingly demanding a cleaner environment and better protection of their health. In 2013, the Chinese government suddenly accelerated the approval of many coal-based synthetic natural gas (‘SNG’) projects under the pretext of solving the smog problem in China’s eastern cities. The government is also openly encouraging investments in SNG. However, coal-based SNG is a premature technology with extremely rare application worldwide. The application of SNG technology comes with serious environmental impacts, including high water consumption, high carbon dioxide emission, wastewater, solid waste, and air pollution, as well as the upstream environmental damages for mining coal. The two demonstration projects, Qinghua and Datang were shut down due to serious malfunctions after only a few months into operation. There were even casualties in the Datang project.

In their promotion of this technology, China’s coal-based SNG supporters often refer to the experience of the U.S. Great Plains Synfuels Plant. However, there is wide misunderstanding of the history of the Great Plains Synfuels Plant by both Chinese industry experts and Chinese media. We hope that through a detailed review of the development of this project as well as the relevant U.S. policies, we will be able to provide a useful reference for those charged with supervising the current development of China’s coal-based SNG industry.

[1]

The term ‘coal-based gas’ and ‘coal-to-gas’ in this report refers to synthetic natural gas and not ‘manufactured gas’ (also known

as town gas or coal gas). Western countries have long stopped using manufactured gas because it produces high levels of carbon

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monoxide that can cause death. This method of manufacturing was not considered even during the oil crisis of the 1970s.

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The U.S. Experiences in Coal-based Synthetic Natural Gas and Lessons for China

Development of Coal-Based Liquid in South Africa Since before the Second World War, the South African company Anglovaal had attempted to introduce coal-toliquid technology from the Germany company Ruhrchemie and had signed an licensing agreement with the Lurgi Company. However, the technology transfer was suspended with the outbreak of the Second World War. After the war, the patents originally held by Ruhrchemie for coal-based oil were mostly confiscated or seized by the United States and the United Kingdom, which forced Anglovaal to turn to the South African government for assistance. South Africa enacted a law in 1947 to drive the development of coal-to-liquid. In September 1950, the South African government founded the state-owned company Sasol to head the development of coalto-liquid. From that point forward, research and development of coal-toliquid technologies was completely 4 taken over by the government.

Sasol simultaneously introduced technologies from the United States and Germany, i.e. the ARGE fixed bed reactor developed jointly by Ruhrchemie and Lurgi after the war and the fluidized bed reactor developed by the American company

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Kellogg. Technicians in South Africa believed that the German technology was proven to be reliable in scaled production. The American technology, meanwhile, was superior in laboratory testing, but lacked experience in scaled production. Each technology has its own pros and cons.

During the introduction of the Kellogg fluidized bed reactor, Sasol came across many technical problems. The gasifier’s temperature was difficult to control, and overheating was a recurring problem. The poisoning of catalyst frequently led to deactivation.

Kellogg failed to resolve these problems even after repeated trials and eventually lost its partnership with Sasol. However, even after Kellogg’s departure, Sasol did not give up the unsuccessful fluidized bed technology and continued with its own research to improve it, and eventually developed it into the Synthol processes to which Sasol owned full rights. Sasol’s first coal-to-liquid plant began production in 1955, using both the Lurgi and Synthol processes. In the beginning, numerous technical problems persisted, but the South African government maintained its support despite the costs. Sasol continued R&D for improvements of its first coal-to-liquid plant for 20 years. It was not until 1976 that Sasol gathered enough experience and confidence to begin construction of a second plant. Similarly, Sasol built its third plant in 1982, only after the second

plant had successfully operated for many years. Besides the South African government’s unwavering long-term support, the cautious strategy without rush investment was an important key to Sasol’s success. Additionally, the environmental requirements in South Africa, a developing country, were not as strict as that in the United States and Europe, allowing this highly polluting industry to be more acceptable by the society.

South African government’s strong support for coal-to-liquid was rooted in the country’s unique history. At the time, South Africa was sanctioned by many countries for its apartheid policy.

The sanction made it difficult to buy crude oil on international markets.

South Africa lacks oil resources while has rich coal reserves. The unique history led to the South African development of its unique coal-

to-liquid industry. In addition to its staunch support for Sasol for several decades regardless of the costs, the government also interfered directly in markets to ensure the sale of coalto-liquid products. The South African government and all South African oil companies entered into an agreement, where the oil companies must shut down part of their refining capacities and purchase 91% of Sasol’s output 5 to feed the South African market. In the 1970s, in addition to subsidizing Sasol’s operational costs with a gasoline tax, the South African government also subsidized the price of coal-based liquids. Under the political and economic system of the time, the South African government was able to strictly control the entire oil sector and ensured the survival of coal-to-liquid production despite its lack of commercial competitiveness.

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The U.S. Experiences in Coal-based Synthetic Natural Gas and Lessons for China

Development of CoalBased Synthetic Fuels in the United States Inspired by Nazi Germany, the United States experimented with coal-based synthetic fuels on a small scale after the Second World War. Between 1944 and 1952, led by the Bureau of Mines under the Department of the Interior, the U.S. government began a series of research and development projects focusing on coal-based fuels. During this period, the program on coalbased fuels was entangled in conflicts between government departments.

The Bureau of Mines represented the interests of the coal industry. In order to obtain more funding, they estimated a low price for coal-toliquid, suggesting that the cost of coalbased gasoline was lower than the price of regular gasoline. The National Petroleum Council, on the other hand, spoke for the interests of the petroleum industry and insisted that coal-based liquid was not competitive, and that such funding would be a waste of money. In 1951, the Bureau of Mines projected the price of coalbased gasoline at 11 cents per gallon, while the National Petroleum Council estimated its cost at 41 cents per gallon (the cost of regular gasoline at the time was 12 cents per gallon).

In 1953, after U.S. President Dwight Eisenhower took office, he adopted

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a relatively conservative fiscal policy and because of the disagreement over the feasibility of coal-based fuels, the synthetic liquid fuels program was 6 abolished.

Between the 1950s and the early 1970s, the real (inflation-adjusted) price of crude oil on the international market steadily declined. Many industries shifted their energy source from coal to oil, creating a depression in the coal industry. The depression prompted many congressmen from coal producing states to bring proposals to revitalize the coal industry.

Through their efforts, the Bureau of Mines established the Office of Coal Research in 1960 to carry out research on coal conversion. Research on coal conversion during this time was 7 tainted by pork-barrel politics. The main goal of the congressmen was to allocate as much money as possible from the federal government to create employment and boost the economy in their districts. They cared little whether coal conversion technology would actually be successful. This resulted in a great deal of politically directed projects with little regard to technical rationales. The main debates in Congress surrounding coal research projects were about the size of subsidies and the location of projects. Each representative hoped that they would get a bigger slice of the pie and that the projects would

be located in their districts. Economic and technical considerations were not important. While there were few technical achievements of significance, the Office of Coal Research’s budget continued to rise. From 1962 to 1973, its budget grew by over 40 times.

All the pilot projects were constantly delayed and over-budget. The goal of congressmen was to expand government spending to create jobs, and commercial viability of the technology was irrelevant. In 1973 alone, when the oil crisis hit, the budget of the Office of Coal Research 8 tripled.

The H-coal project, which began in 1973, was a classic example of technological research warped by 9 political interference. Initial research of the H-coal project used coal from Illinois and Wyoming, so the demonstration plant was designed based on the properties of coal from those regions. However, the governor of Kentucky fought to have the factory built in his home state and agreed to provide nearly $8 million in donations and subsidies. The federal government ultimately agreed to locate the factory in Kentucky. Anyone who has a basic knowledge of coal conversion technologies knows that coal conversion processes have strict requirements on the stability of coal quality in feedstock. An arbitrary change in the type of coal is a big

mistake. However, with politicians directing the course of the project, the U.S. government had to make concessions on the location of the plant. In 1974, the federal government restructured its energy institutions.

The Office of Coal Research, which had originally been under the Department of the Interior, was now placed under the Energy Research and Development Administration. In 1976, this Administration invested $143 million in the construction of the H-coal demonstration plant in Catlettsburg, Kentucky, but after years of investment and research, the H-coal project was ultimately shut down in 1982. The reason was that companies involved in the project began to back out, because they couldn’t see a commercial future in the technology.

The well-known American think tank, the Rand Corporation, produced a report on the American experiment with research into coal-based liquid and gas, finding that nearly all projects follow the same pattern – initially, cost estimates are very low, but as the project develops, from initial feasibility study, to preliminary designs, to budgeting, to definitive designs, to actual construction and into operation, changes and add-on equipment gradually cause the cost to go up.

On average, the cost of a project, form the initial feasibility study to final implementation, tends to increase

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The U.S. Experiences in Coal-based Synthetic Natural Gas and Lessons for China

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Expecyed Price?

$12 $10 $8

Great Plains Synfuels Bankrupt

$6

Great Plains Synfuels Started construction

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U.S. Price of Natural Gas Price Delivered to Residential Consumers

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Figure 1 – Price predictions and actual U.S. natural gas prices before and after the construction of Great Plains Synfuels

Price of Imported Oil ( US$/Barrel )

$90 $80

Expected High

$70

Expected Medium

$60

Expected Low

$50

Actua Price

$40 $30 $20

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The Great Plains Gasification Associates (GPGA), formed by five pipeline companies, began construction of the plant in 1980. In order to support the development of oil-replacement technology like coalbased SNG, the U.S. government provided loan guarantees for 75% of construction and startup costs (the final amount of guaranteed loans totaled $1.54 billion). The GPGA put in

$14 Current US$ / MMBTU

From the 1940s to the present day, in the decades of research and development into coal-based synthetic fuels in the United States, there has been only one coal-based synthetic fuels plant – the Great Plains Synfuels – that has achieved commercial operation. Feasibility studies for the plant began in 1973 and originally planned to create a facility capable of producing 250 million cubic feet (about 7.08 million cubic meters) of coal-based SNG per day. By the end of 1975, estimations showed that required capital investment would be too great and in order to contain risk, the designed capacity was reduced by half to 125 million cubic feet (about 3.54 million cubic meters) of SNG per 11 day.

equity investment of $493 million. The total cost of construction of the Great Plains Synfuels Plant was around $2.03 billion.

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US$ ( Const 1980 $ )

between two and four times. This is why projects go from being assessed economically feasible in the early stages, to being proven unfeasible later in the course of the project.

Figure 2 – Comparison of long-term price predictions 12,13 and actual trends by the U.S. Department of Energy in 1980.

The plant was completed at the end of 1983 and began commercial operation on July 28, 1984. Before the construction, the Great Plains plant had signed 25-year contracts with four natural gas pipeline companies in which the companies agreed to purchase SNG at a price higher than the market price of regular natural gas.

The actual price would be determined according to a formula in the agreement. The purchase agreement set a base price of $6.75 per MMBTU on January 1, 1981, to be adjusted using the formula based on the producer’s price index and the price of No. 2 fuel oil; with the stipulation that for the first five years, the purchase price could not be higher than the market price of No. 2 fuel oil.

At the time, most Americans believed that the United States was rich in coal, poor in oil and had scarce natural gas resources. With increasing dependence on foreign oil and gradually depleting natural gas reserves, Americans believed that the prices of oil and gas would continue to increase over the long-term. Figure 1 compares the actual price of natural gas before and after the construction of the Great Plains Synfuels plant with the projected

price when the plant was built. The idea that the United States was rich in coal, poor in oil and running out of natural gas, was widely held at the time and was not just a misconception by a minority of investors. Figure 2 compares predictions on the long-term projected price of oil made by the U.S. Department of Energy in 1980 with the actual historical price. Official U.S. government predictions also reflected the belief of long-term ever increasing price.

In planning of the Great Plains Synfuels project, the GPGA, like most people in the U.S. energy sector at the time, believed that the price of natural gas could only go up, not down. They predicted that by the time they finished the project, the price of natural gas would have reached $9-$10 per MMBTUs. After the project was completed, the price of natural gas not only failed to increase as predicted, but it actually went down. The Great Plains Synfuels project would be unprofitable even with the favorable pricing formula in the SNG purchase 14 agreements. What’s more, even the pipeline companies would lose money under the agreed pricing model.

They tried to pass over the price of high-cost SNG to the consumer, but consumer groups took them to court, ending with the final settlement that both parties would share the losses.

The pipeline companies had to abide

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The U.S. Experiences in Coal-based Synthetic Natural Gas and Lessons for China

by the purchase agreement and buy SNG at above market prices, but there was disagreement on how much they had to buy, which also led to litigation between pipeline companies and the Great Plains Synfuels until a settlement in 1994.

After the Great Plains project started commercial operation, the GPGA reevaluated pricing levels and estimated that the plant would lose $1.3 billion in the first ten years.

The GPGA initially sought more subsidies from the government, but the government was unwilling to keep throwing money into this fiscal black hole. Without further government aid, on August 1, 1985, the GPGA filed for bankruptcy. As the guarantor for GPGA loan, the U.S. government had to pay for the defaulted loan. The Great Plains Synfuels project ended in a lose-lose outcome for all involved. The original investor, GPGA, went bankrupt and the Department of Energy had to pay for its defaulted loan. The pipeline companies lost money on purchasing the high-priced SNG. Even the consumers suffered from higher natural gas prices.

The Great Plains project created a massive loss and bankruptcy, and also entangled the government in heavy losses. This served as a lesson for countries around the world looking to develop coal-based SNG. With the exception of China, no other

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country has attempted to scale the production of coal-based SNG, but many countries have researched its development. Here I will briefly discuss their experiences.

Development of CoalBased Synthetic Fuels in Other Countries The oil crises in 1973 and 1979 caused many countries to look into developing coal-based liquid and gas to replace petroleum. The Program for NonNuclear Energy Research in then West Germany emphasized coal liquefaction as a key to the future of energy in Germany. According to Japan’s Sunshine Project, synthetic fuels were expected to play an important role in Japan. Other countries including New Zealand, Australia, the United Kingdom and Canada, all carried out extensive research into coal-based liquid and gas in the 1980s. However, they all ended in the experimental stage and never achieved commercial production. The following are major factors in the failure to develop coal-based liquid and gas 15 in western countries: 1. A pluralistic democracy: political competition that represents diverse interest groups throughout society makes it difficult for governments to maintain long-term commitment to

synthetic fuels as in the case of South Africa.

2. Fiscal difficulties: the oil crises of the 1970s resulted in a global depression, which caused fiscal difficulties for governments. The development of coal-based SNG required long-term financial losses. Most governments did not wish to undertake such losses in tough financial times.

3. Premature technologies: while coalbased liquid and gas are not new technologies, they lack large-scale production experience and all countries have experienced many technical difficulties in the development.

4. Changes in the global energy market: from the early 1980s to late 1990s, global oil prices had shown a steady decline, negating the motivation for countries to develop coal-based liquid and gas.

5. Increased emphasis on environmental protection: since the 1970s, western countries have developed an increased environmental awareness. The high pollution from coal-based liquid and gas makes them unacceptable to the society. If governments subsidize such highly polluting technologies, they cannot maintain public support.

In reviewing the coal-based liquid and gas experiences around the world, most have ended in failure with only a few examples of success. Those succeeded in scaled production (coalbased liquid in Nazi Germany, coalbased liquid in South Africa and the Great Plains SNG project in the United States) were the results of unique historical contexts. There has never been an example of coal-based liquid and gas being truly commercially profitable in a free market.

Chapter Highlights: 1. In the history of coal-based liquid and gas development, most attempts have failed and there have been only a few special cases of success.

2. The keys to South Africa’s success in producing coal-based liquid lie in the government’s long-term support, extended and cautious research and gradual improvement, refraining from rush investment, and lax environmental requirements.

3. For a long period of time, the U.S. government supported the research and development of coal-based synthetic fuels because of its wealth of coal resources and scarcity of oil and gas.

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2. Bankruptcy, Restructuring and Financial Analysis of the Great Plains Synfuels Plant

The U.S. Experiences in Coal-based Synthetic Natural Gas and Lessons for China

After GPGA went bankrupt, there was no private company willing to take over the plant. Because of its huge size, if the plant stopped production, there would be devastating impacts on employment and the overall economy in North Dakota.

This prompted the governor of North Dakota and congressional representatives to push the federal government to step in. In addition, the Department of Energy was the guarantor of the $1.54 billion defaulted loan and had no choice but to deal with the problem. With interest, the Department of Energy paid $1.64 billion in 16 loan payments. On June 30, 1986, the U.S. Department of Energy acquired Great Plains Synfuels for a nominal $1 billion (deducting from the amounts already paid on loans).

Used with permission from The Wall Street Journal, WSJ.com. Copyright 2014 Dow Jones & Company, Inc. All rights reserved.

Figure 3 – Wall Street Journal article about the Great Plains Synfuels’ financial failure on 17 May 21, 1985.

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After the Department of Energy (DOE) acquired ownership of Great Plains Synfuels, it did not intend to run it as a state-owned company. On October 31, 1988, DOE sold the plant to the Basin Electric Power Cooperative (BEPC).

The following are the major elements of the agreement:

2. The DOE shall pay a total of $120 million in cash for operation and renovation of the Great Plains Synfuels plant, including:

1. BEPC shall pay $85 million in cash to the DOE.

(2) $75 million to be used as a cash reserve fund (loan)

(1) $30 million to be used for an environmental protection fund to reduce sulfur emissions (loan)

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The U.S. Experiences in Coal-based Synthetic Natural Gas and Lessons for China

(1) From October 1988 through December 1989, 100% of profit from the sale of synthetic natural gas shall be paid to the Department of Energy.

(2) From January 1990 through December 1994, all profit shall be retained by BEPC. (3) From January 1995 through December 2004, 100% of profit from the sale of synthetic natural gas shall be paid to the Department of Energy.

(4) From January 2005 through December 2009, 60% of profit from the sale of synthetic natural gas shall be paid to the Department of Energy.

To encourage the development of synthetic fuels as an alternative to petroleum, at the time, the U.S.

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In August 1988, when the U.S. DOE officially transferred the ownership of Great Plains Synfuels to BEPC, it evaluated the value of the agreement at about $600 million, but in October of the same year, the General Accounting Office (GAO) analyzed the DOE estimates and found several 18 mistakes:

were $391 million. Ignoring interest and inflation over this 20-year period, total losses to the DOE were over $1 billion.

After BEPC took over Great Plains Synfuels, the poor profitability of coalbased SNG forced the company to concentrate on developing byproducts to increase income. Over two decades, the number of byproducts at Great Plains Synfuels gradually increased, including ammonium sulfate, anhydrous ammonia, carbon dioxide (used for enhanced oil recovery), crude cresylic acid, krypton/xenon gas, liquid nitrogen, naphtha, phenol and tar.

(1) The production tax credits that BEPC had been required to give up (estimated at the time to be $300 million) should not be included as payment to the government.

(2) The funds that had been loaned to Great Plains Synfuels by the DOE should not be counted as payment when returned in the future.

(3) The $15 million in operating capital given by the DOE should be deducted from its revenue.

The GAO re-estimated the total value of the agreement at $200 million. In 1988, the GAO estimated that total 20year revenue sharing would amount to $100-200 million. At the end of profit sharing in 2010, total actual payments

$400 $200 $0 -$200

The percentage of total revenue from byproducts increased from 2% in 1989 to 58% in 2013. The co-production of various byproducts is a crucial factor to the profitability of Great Plains Synfuels.

Financial Analysis Figure 4 shows investment and returns of the Great Plains Synfuels project.

Calculation of interest saved due to bankruptcy was conservatively based on 10-year U.S. Treasury bond

GPGA equity investment Basin Electric purchase payment

1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

3.The 20-year revenue sharing agreement (November 1988 through December 2009) applicable only when the sales of SNG at Great Plains Synfuels do become profitable, payment must be made to the DOE according to the agreed percentage.

If there is no profit, no payment must be made. BEPC may retain all profits of byproducts without any payment to the DOE. Specific profit sharing percentages and timetables are included below:

government offered a number of production tax credits. However, as the U.S. government had taken on the vast majority of the losses in the transfer agreement for the Great Plains facility, it required that BEPC give up these tax credits.

Million US$ ( current $ )

(3) $15 million to be used as working capital (payment)

-$400 -$600 -$800 -$1000 -$1200 -$1400 -$1600 -$1800

U.S. DOE payment for defauted loan

Figure 4 – Capital input and return of the Great Plains Synfuels Project.

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The U.S. Experiences in Coal-based Synthetic Natural Gas and Lessons for China

rates, which are usually much lower than commercial loan rates. Figure 4 obviously shows that, without the early bankruptcy, the Great Plains Synfuels’ income would have never been enough to even pay the interest on its loans and the compounded debt would have grown like a snowball.

Because the Great Plains Synfuels plant has been operating for over 20 years, to compare current and historical data, I must adjust for inflation. In addition to the calculation based on the original costs of construction, I also compare a recent estimate by the National Energy Technology Laboratory of the U.S. DOE to account for changes in technology over the past 20 years.

When the construction of the Great Plains Synfuels plant began in 1980, original investor GPGA provided $493 million in equity and borrowed $1.54 billion from the Federal Financing Bank (guaranteed by the DOE), bringing total initial investment to $2.03 billion. For simplicity, I do not include the expenses incurred during the bankruptcy and restructuring of the plant. I also ignore all the additional investments by BEPC in the over 20 years. The adjustment for inflation is based on GDP deflator, which shows that one dollar in 1980 was equivalent to $2.45 in 2010. The total construction costs of the original Great Plains Synfuels plant in 2010 dollar would be

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around $5 billion.

At a rate of 2.8%, which is the average rate for 10-year U.S. government bonds for the past five years, annual interest payments on $5 billion would amount to around $140 million. Because GPGA and the U.S. government absorbed the majority of the debt during bankruptcy and restructuring, the current owner is not responsible for interest on the original costs of the plant. Since BEPC took over Great Plains Synfuels, there have been profits and losses in the past 20 year. The most profitable year was 2008, with $128 million in profit.

Despite interest rates having dropped far below 1980 levels, revenue generated by the Great Plains Synfuels plant would still be insufficient to pay the interest on the costs of building the original facility. Even the $85 million payment in 1988 for ownership of the facility was not recovered until 2007, 21 after 20 years of operation. This shows that the key to Great Plains Synfuels’ profitability lies fundamentally in bankruptcy and government bailout.

If the government had not assumed the debt, the construction costs of the original plant would never have been recovered.

In 2011, the National Energy Technology Laboratory estimated the costs of building new coal-based 22 SNG plants . One of the scenarios was for SNG from lignite in North

Dakota. Building a plant using the latest technology capable of producing 1.5 billion cubic meters of coal-based SNG per year would cost around $4.2 billion with a production cost of $21/ MMBTU. For comparison, the prices of conventional natural are in the range of $2.5-$8/MMBTU. Therefore, it would be nearly impossible for coal-based SNG to be profitable and extremely likely to produce massive losses.

Summarizing the overall experience of the United States in building and operating the Great Plains Synfuels plant, several factors have contributed to the profitability of the current owner: 1. Not taking on construction costs, over 95% of which were absorbed by the bankruptcy of GPGA and the U.S. government bailout.

2. High sale prices: SNG was sold at higher than market prices for natural gas. This was determined in the long-term gas purchase agreements between Great Plains Synfuels and natural gas pipeline companies.

3. Diversified operations, which include cost sharing for coal mining, coal-fired power and SNG, and also in developing multiple byproducts to increase revenue. Currently, SNG only accounts for less than half of the total revenue.

Misjudgments of Natural Gas Price and Long-Term Energy Supply and Demand Between 1954 and 1985, the U.S. Federal Government controlled the wellhead price of natural gas that was shipped interstate. The initial intent of the controls was to protect consumers and prevent natural gas producers and pipeline operators from using their monopoly power to fix prices.

Because the United States is a federal system, regulations of natural gas produced and sold within the same state remains in the jurisdiction of the state governments and the federal government cannot interfere. This resulted in multiple pricing systems throughout the country from the 1950s to the 1980s.

Natural gas price controls lowered the price of natural gas, but administratively depressed price stimulated consumption, suppressed production and deterred investment in the exploration. Over the thirty years of natural gas price controls, economists observed an interesting phenomenon, which is that in all areas that placed controls on the price saw shortages, while there was no shortage in states 23 without price controls. Many scholars called for the government to eliminate price controls and return production

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The U.S. Experiences in Coal-based Synthetic Natural Gas and Lessons for China

and sale of natural gas to the market.

But price decontrol was a difficult political task. Long-term price controls created many interest groups that benefited from the controls.

Constrained by the interest groups, the government could only made small, gradual reforms. Starting in the mid1960s, the U.S. Federal Government began to distinguish between new and old natural gas contracts, setting different prices based on whether the contract was new or old as well as by location. As time passed, the procedures for setting the price of natural gas became increasingly complex and in addition to long and tedious administrative procedures, interest groups also lobbied and regularly questioned them in court.

In the 1970s after the energy crisis, the shortage of natural gas in the United States became increasingly serious

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and the calls for elimination of price controls gradually became louder.

Finally, the U.S. passed the Natural Gas Policy Act of 1978 and phased out price controls in 3 phases (1979, 1985 and 1987), finally achieving full marketization of natural gas in 1987.

After the U.S. natural gas price decontrol, the price not only did not rise, it actually went down. Natural gas resources, which people had assumed to have dried up, continued to increase along with renewed investment in exploration. Market competition also drove rapid development of new natural gas drilling techniques and now the United States leads the world in the extraction of both coal-bed methane and shale gas. Starting in 2009, the United States surpassed Russia to become the world’s largest producer of natural gas.

Many people have already forgotten that the United States was once a country with scarcity of natural gas.

Chapter Highlights: 1. The Great Plains SNG project was a major failure from a financial perspective.

2. After its bankruptcy, the U.S. government had to bailout the Great Plains Synfuels and assumed over $1 billion in losses.

3. The reason why the Great Plains Synfuels is able to produce a small profit now is mainly because the initial investor’s bankruptcy and the government bailout absorbed over 95% of upfront capital costs.

4. After the United States abolished price controls on natural gas, free market competition drove the discovery of new natural gas deposits and the rapid development of drilling technology, transforming its natural gas resource from scarce to abundant.

21 21

The U.S. Experiences in Coal-based Synthetic Natural Gas and Lessons for China

3. Pollution and Pollution Control at Great Plains Synfuels

Air Pollution

Pollutants of coal-based SNG include air emissions, wastewater and solid waste.

In its initial stage of operation, the Great Plains Synfuels encountered frequent malfunctions at some of its pollution control facilities. After repeated trials without success, the plant decided to remove them. Some pollution control measures were added later. Those added and removed are listed in Table 1.

Measure Startup Flare

Added/Removed

Year

Added

1984

Liquid Waste Incinerator

Removed

1993

Sulfur Recovery Unit

Removed

1994

Added

1997

Flue Gas Desulfurization Unit Wet Electrostatic Precipitator

Added

2001

Cooling Tower Dirty Water Segregation System

Added

2013

Table 1 – Pollution control facilities added or removed at Great Plains Synfuels

Table 2 shows the emissions from the Great Plains Synfuels plant in 24 2011. Pollutants with the highest volumes are ammonia, sulfur dioxide, nitrogen oxides, carbon monoxide and methanol.

Annual Emisions

Unit

SO2

4,579

Metric Tons

NOx

3,194

Metric Tons

NH3

5,445

Metric Tons

CO

1,526

Metric Tons

PM10

321

Metric Tons

PM2.5

594

Metric Tons

VOC

580

Metric Tons

Methanol

1.106

Metric Tons

p-Xylene

998

kg

Toluene

4,717

kg

Phenol

4,354

kg

Catechol

6,895

kg

PAH total

2,994

kg

Cresol/Cresylic Acid

998

kg

Xylenes

907

kg

Benzene

5,443

kg

Arsenic

998

kg

161,932

kg

2,268

kg

Pollutant

Acetonitrile Selenium

Table 2: Air Emissions from the Great Plains Plant in 2011

22

Figure 5 is a historical progression of air pollution levels at the Great Plains Synfuels plant. It clearly shows that sulfur dioxide emissions were extremely high in the early years and declined significantly after 2002. The plant was not able to meet emissions standards when it began commercial 25 operations and even after the GPGA bankruptcy, the DOE nationalization and restructure, these problems remained unsolved. When BEPC took over, it promised to work toward compliance with environmental standards, but despite years of attempts, was still unsuccessful. From the beginning of operation, the Stretford sulfur recovery unit continued to have problems and was ultimately replaced with a sulfolin unit, but it also failed to operate smoothly. Eventually the operator decided to abandon sulfur recovery and to incinerate hydrogen sulfide instead. However, the incineration of the hydrogen sulfide produced large amounts of sulfur dioxide. In order to control sulfur dioxide emission, the Great Plains plant spent $100 million in 1997 to install a flue gas desulfurization 26 unit. Unfortunately, the desulfurization device was unstable and the plant spent yet another $8 million to improve it. In the end, the problem was still not completely resolved.

In 1997, the North Dakota Bureau of Health issued a Notice of Violation to the Great Plains Synfuels plant.

With the threat of a $1.3 million fine,

23

The U.S. Experiences in Coal-based Synthetic Natural Gas and Lessons for China

portion being recycled, a portion being evaporated, and a portion consumed in ash treatment, which is then sent to be buried in a landfill. The remaining portion of wastewater that cannot be processed is condensed and injected 29 into deep wells. As the original incinerator for waste liquids was prone to mechanical failures and consumed too much fuel, it was removed in 1993, and the evaporated, concentrated waste liquids were redirected back into the gasifier.

50 ,000 45,000

Metric ton / year

40,000 35,000 Ammonia

30,000 25,000

Sulfur Dioxide

20,000

Nitrogen Oxides

15,000

Carbon Monoxide

10,000

Volatile Organic Compounds

The gasifier liquid contains several organic compounds including

5,000 0 1990

1996

1997

1998

1999

2000

2001

2002

2005

2008

phenols, catechols as well as acids and alcohols. Bacteria reactions of these organic compounds create odors at the cooling towers and wastewater systems. Over more than 20 years, these odors have resulted in complaints by nearby residents.

After improvements at the plant in recent years, including a $77 million investment in a cooling tower dirty 30 water separation system in 2013 , complaints about the smells were reduced significantly. In 2012 there had been 16 complaints and in 2013 there 31 were only 3.

2011

Figure 5: Historical Progression of Emissions Levels at the Great Plains Plant

the plant agreed to spend $35 million to install a wet electrostatic precipitator (completed in 2001) and reached a 27 settlement with the Bureau of Health.

After numerous attempts to improve the equipment, the Great Plains Synfuels was finally able to comply with environmental standards after over a decade of violation.

Waste Water The Great Plains SNG Plant is located in the Missouri River basin and is only 16km from Lake Sakakawea, which is

24

the third largest man-made lake in the United States (Figure 5). The average volume of Lake Sakakawea is around 29.4 billion cubic meters, nearly the same as the full capacity of Poyang Lake, the largest fresh water lake in China. Therefore, the Great Plains Synfuels plant enjoys the advantage of abundant water resources nearby.

The average annual water usage of the Great Plains plant is around 9.24 28 million cubic meters and it produces 3,000 gallons (about 11.36 cubic meters) of wastewater every minute, but the plant does not discharge any wastewater externally. All wastewater is processed within the plant, with a

Figure 6: Great Plains Plant and Environs

25

The U.S. Experiences in Coal-based Synthetic Natural Gas and Lessons for China

Zero wastewater discharge does not completely eliminate the problems of water pollution, because deep-well disposal of wastewater can potentially pollute groundwater. This prompted the Great Plains Synfuels plant to install over 130 groundwater monitoring wells in a 640 acre area (around 2.59 million square meters) surrounding the plant.

It also hired professional environmental hydrologists to test groundwater quality every six months to ensure that the injected wastewater did not leak 32 into the surrounding groundwater.

In a report by the U.S. DOE on the experiences learned from the Great Plains Synfuels over its first twenty years, it pointed out that engineers at the plant had consistently recommended against using the same gasifiers on future plants. Although the Lurgi gasifiers there were stable and dependable, the gasifier liquid waste was complex and difficult to process.

Many engineers recommended that new coal-based SNG plants may consider using new fluidized bed gasifier technology, which they believed would reduce the volume of liquid waste and make wastewater 33 treatment easier.

Solid Waste Solid wastes at the Great Plains

26

Synfuels include laboratory solvent wastes, heavy-metal solid wastes, acetone/toluene/acetonitrile, mineral spirits, spent caustic/acids, waste 1,1,1-trichloroethane, spent shift catalysts, laboratory waste chemicals and process clean outs. The Great Plains Synfuels plant has a dedicated dump site for the gasifier ash and other 34 types of solid wastes.

Synfuels is around $20 per ton. In recent years, the increasing demand for carbon dioxide in EOR has brought the purchase price up to over $28 per 37 ton . If the crude oil price remains over $100 per barrel, oil producers could go as high as $40-$45 per ton of 38 carbon dioxide for EOR. This means that the Great Plains Synfuels may enjoy considerable profit from the CCS operation.

Capture and Storage of Carbon Dioxide

Currently around the world, the scale of CCS for coal remains mostly small or still in planning and development. The CCS at Great Plains Synfuels is the largest and longest-running program of its type in the world. However, even with profit to be made and being the world leader in its field, the percentage of carbon captured at Great Plains 39 Synfuels is only up to about 50%.

In 1997, the Great Plains Synfuels and PanCanadian reached an agreement whereby PanCanadian would purchase carbon dioxide from Great Plains Synfuels for enhanced oil recovery (EOR) at its Weyburn oil field. Carbon capture and storage (CCS) facility at the Great Plains SNG plant started operation in October, 2000 and delivered captured carbon dioxide to oil fields in Canada through a 328km pipeline.

The Great Plains Synfuels considers the costs of its CCS operation a commercial secret. The total capital investment for the CCS facility was 35 about $100 million , while investment in EOR by PanCanadian was over $1 billion. Scholars estimate that the cost of collecting and transporting carbon dioxide at Great Plains

36

According to data released by Great Plains Synfuels, the plant is capturing around 3 million short tons of carbon dioxide every year. An American short ton is equivalent to 2,000 pounds or around 0.907 metric tons. Three million short-tons is equivalent to 2.72 million metric tons. The Great Plains Synfuels plant consumes around 6 million short tons (about 5.44 million metric tons) of lignite from the nearby Freedom Mine, which employs surface mining and has an average heat value of 40 6,775 BTU per pound. According to data from the U.S. Energy Information Administration, the carbon dioxide

emissions factor for lignite in North 41 Dakota is 218.8 pounds/MMBTU. Based on the above data, I can calculate the carbon dioxide produced from lignite consumption at the Great Plains Synfuels to be 8 million metric tons per year (this includes emissions from downstream burning of SNG). Because lignite from Freedom Mine is mined in a surface mining environment, energy consumption is much less than that of an underground mine. The average amount of carbon dioxide emissions for surface mined coal in the United States is around 40.65 kilograms/short ton (about 42 44.82 kilograms/metric ton). Based on this number, I can estimate that annual carbon dioxide emissions from the mining of lignite coal for use at the Great Plains Synfuels at 244,000 metric tons. Since Freedom Mine is less than 10 miles (about 16 kilometers) from the Great Plains Synfuels, the carbon dioxide produced in transportation is negligible. From these numbers, I estimate that CCS at the Great Plains Synfuels can reduce life-cycle emissions of carbon dioxide from SNG by roughly one-third. Figure 6 compares the amount of carbon dioxide produced by the Great Plains SNG process and natural gas/shale gas.

If coal-based SNG produced without CCS is later used to generate electricity, its carbon intensity will be higher than direct coal-fired power generation. Based on the CCS capture

27

The U.S. Experiences in Coal-based Synthetic Natural Gas and Lessons for China

Under an ideal condition, CCS would be able to store carbon dioxide underground and mitigate greenhouse effects. However, in the long-term, carbon dioxide stored underground could possibly be released because of tectonic

movements, human negligence or even sabotage. Therefore, once stored, it must be monitored over the long term. However, in order to prevent greenhouse effect, at the minimum, CCS storage facilities must store carbon dioxide for thousands of years to be meaningful. The question we must ask now is whether the CCS monitoring mechanism currently in place can be maintained for centuries.

The truth is that no one knows.

From the perspective of energy

1400 gram CO2 eq / kwh

ratio at the Great Plains Synfuels, the carbon intensity of its SNG-fired power with CCS is slightly lower than coalfired power generation, but still higher than conventional natural gas-fired electricity.

1200 1000 800 600 400 200

Life-cycle CO2 Emissions

0

Kg CO2 eq/m3natural gas/synthetic gas

7

Figure 8: Comparison of carbon intensity for coal-based SNG-fired, coal-fired and natural gas-fired

6 5

efficiency, using coal-based SNG to generate power is very inefficient.

According to actual operational data from the Great Plains Synfuels facility in recent years, energy conversion efficiency from coal to SNG was 60%.

Meanwhile, the thermal efficiency of a large-scale combined cycle gasfire power plant is around 50%. This

4 3 2 1 0

Natural Gas

Great Plains w/CCS

means that the energy efficiency of gas-fired power generation using coalbased SNG would be 60% x 50% = 30%. The thermal efficiency for large-scale coal-fired power plants is generally over 40%. To generate the same amount of electricity, SNG-fired power will consume one-third more coal than a coal-fired power plant.

Great Plains w/o CS

Figure 9: Comparison of carbon dioxide emissions for Great Plains SNG and natural gas

28

29

The U.S. Experiences in Coal-based Synthetic Natural Gas and Lessons for China

Water Consumption

be a very important part of planning.

In recent years, China is leading the world in deploying air cooling technology in coal-fired power plants.

A very large portion of water usage at coal-based SNG plants is for cooling.

For this reason, I recommend that China’s water efficiency standards for coal-based SNG should be much stricter than those at the Great Plains Synfuels.

6 5 4 3

1 0 Great Plain SynfuelsC

onventional Natural Gas

Shale Gas

Figure 8: Comparison of water consumption for SNG at Great Plains, conventional natural gas and shale gas

Consumption of Water Resources There are abundant water resources available at the Great Plains Synfuels facility. Therefore, water conservation is not a severe concern there. In recent years, water consumption for shale gas extraction has become a point of contention among environmental

30

1. After more than a decade of violation and many upgrades to pollution treatment facilities, the Great Plains Synfuels finally comply with environmental standards.

2. The coal-based SNG produced at Great Plains Synfuels is a carbonintensive energy, and even with CCS, its life-cycle carbon emission is still twice as high as conventional natural gas.

3. Power generation with coal-based SNG will consume 1/3 more coal than coal-fired power generation.

2 negligible

Water ( Liter ) /m3 natural gas/synthetic gas

7

Chapter Highlights:

4. Great Plains Synfuels has abundant water resource to support such waterintensive industry. The standards for water efficiency in China’s coalbased SNG projects should be far stricter than those at the Great Plains Synfuels.

groups in the United States. In general, water is more plentiful in the United States than in China, but the American people still are very cautious about the impact of shale gas on water resources. The water consumption of coal-based SNG is dozens of times higher than shale gas, while China plans to build new coal-based SNG plants in regions with extremely arid climates. Water conservation should

31

The U.S. Experiences in Coal-based Synthetic Natural Gas and Lessons for China

4. Lessons from Great Plains Synfuels and Warnings for China In the history of coal-based liquid and gas development worldwide, the vast majority of attempts have failed and those succeeded were all under unique conditions, which make their successes difficult to replicate elsewhere. GPGA, the original investor of Great Plains Synfuels, invested nearly half a billion dollars, but went bankrupt and never recovered its investment. The U.S. DOE acted as guarantor for the project and in the end had to pay off over $1 billion in defaulted loans. BEPC, which finally took over ownership of the Great Plains Synfuels facility, spent over ten years working to diversify products before it was able to make a profit. Such an experience cannot serve as a proof of the economic feasibility of coal-based SNG at all.

In terms of environmental protection, the Great Plains Synfuels facility has been at best decent. Air emissions were way above compliant levels for over ten years before they were brought under control and comply with environmental standards.

Odors from the plant bothered neighboring residents for over twenty years and have only seen improvement within the last couple of years. While the emissions of toxic organic compounds are within the limits set by U.S. environmental regulations, they cannot be simply regarded as harmless. The threat of deep-well wastewater storage to groundwater quality must still be monitored over the longterm.

The Missouri River basin surrounding the Great Plains Synfuels enjoys abundant water resources, marking the biggest difference with regions developing coalbased SNG in China. The Great Plains Synfuels facility is also able to effectively reduce its impact on the greenhouse effect by capturing carbon dioxide and selling them for a profit. Most of the regions developing coal-based SNG in China do not have similar conditions. Furthermore, even with CCS, carbon intensity of SNG from Great Plains Synfuels is still twice as high as conventional natural gas.

32

Determination on the Maturity of Technology Many Chinese discussions refer to coal-based SNG as a mature technology. Such discussions mistakenly confuse the maturity of technology with how old the technology is. The maturity of a technology is based on the amount of experience and the extent of its use, which means that an old technology is not necessarily a mature technology.

For example, the technique of drilling wood to start fires is ancient, but modern men rarely have experience of using this method. For a modern man this ancient technique is not mature.

If a person today were suddenly to try this technique, he would very likely fail. Although coal-to-liquid was produced at large scale in Nazi Germany during the Second World War, when it was first introduced to South Africa, there were still many technical difficulties that took more than twenty years to resolve. While sulfur recovery was successful in actual operation in South Africa, the attempts in the United States failed again and again. They ultimately had to give up on the technology. With the exception of the Great Plains Synfuels in the United States, coal-based SNG technology has not reached scaled production in any other country (with the exception of China’s two less-

than-successful plants since last year).

After only one month of commercial operation, the Datang coal-based SNG plant malfunctioned and had to shut down for two months to repair. If the technology had been mature, this kind of situation would not have happened. The judgment of maturity should be based on its actual experiences and not imagined on theoretical grounds. If there are only a few examples of actual uses and even these few are not operating smoothly, then the technology is not mature.

The demonstration projects in China have proven that coal-based SNG technology is still premature and is not ready for widespread adoption.

The Dilemma of ‘Too Big to Fail’ Projects like coal-based SNG that require massive investment often have a great impact on local economies and employment. Should they fail, the government is often forced to step in to avoid a detrimental shock to the local community. The U.S. government’s bailout of the Great Plains Synfuels after its bankruptcy is a clear example of this. When you owe the bank a million dollars and can’t pay, that’s your problem; when you owe the bank $10 billion and can’t pay, the problem is between the bank

33

The U.S. Experiences in Coal-based Synthetic Natural Gas and Lessons for China

and the government. It is possible that because these projects are ‘too big to fail’, investors make rush decisions believing that if it makes money, they will be the sole beneficiaries, but if it loses money, society at large will foot the bill. The ‘too big to fail’ phenomenon makes it difficult to hold investors accountable. Therefore both the government and the society must treat these massive projects with extreme care.

Concern over Sunk Cost and Technological Lock-in The fact that the Great Plains Synfuels went bankrupt but did not stop production is an important reminder for China’s path of energy development. Coal-based SNG is a capital-intensive industry and if unprofitable after the plant is finished, even if the plant is dismantled to sell off the parts, the majority of the upfront capital investment will not be recoverable. In economics, such unrecoverable investment is called ‘sunk cost’. Sunk cost is usually not taken into consideration when making the decision on whether to continue production after bankruptcy. In capitalintensive industries there are many examples of production continuing after bankruptcy. Once completed, many renewable energy projects,

34

like photovoltaic and wind power generation, which are also capital intensive, do not stop production even see losses or go bankrupt, and continue producing clean energy over the long-term.

However, in addition to being capitalintensive, coal-based SNG consumes huge amounts of water, emits high levels of carbon dioxide and many other pollutants. In continuing production after bankruptcy, it continues to pollute. Once China completes the large number of planned coal-based SNG projects, high-carbon energy production will inevitably continue in the next several decades. This will lock China’s energy infrastructure into a high-carbon path. Even if these coal-based SNG plants all go bankrupt, China will find it difficult to revert to a low-carbon path.

The Importance of Transparent Information in Demonstration Projects China has a lot to learn from the United States in terms of transparency.

The U.S. EPA National Emissions Inventories periodically release emissions statistics on dozens of major pollutants at over one million stationary sources throughout the United States.

U.S. DOE and GAO reports on the

bankruptcy and divesture of the Great Plains Synfuels are all available to the public. Transparency of information not only benefits academic research, but also provides an objective perspective on the experiences and lessons, helping people to avoid making the same mistakes. It also provides accurate data to support meaningful policy discussions and avoid speculations. A recent media report indicated that the Datang coalbased SNG plant, which is China’s first SNG demonstration, is facing serious 43 financial losses, but no information is available to the public. This lack of transparency may misguide other investors to unknowingly invest in this sector. When large amounts of investment rush into a risky business with little potential of profit, the government will have to step in and clean up the mess in the case of mass bankruptcies, by which the loss will be transferred to the government and ultimately the taxpayers.

Long-term Energy Prices Difficult to Predict, Resource Endowments Are Changeable The natural resource endowments of a country are not only defined by their geological or natural environment, but

also by technological development, their political and economic systems and social preferences. From the 1970s to the early 1980s, Americans believed that the country was rich in coal and poor in natural gas. After the government decontrolled natural gas price in the early 1980s, not only did the investment in the exploration of natural gas increase, more investment also went into technical innovations that made previously unreachable gas deposits available. Since the 1980s, natural gas has occupied an increasing share in the overall U.S. energy portfolio, while the share of coal has decreased. Not only have natural gas reserves not declined, they have actually increased. China’s pricing and institutional reforms on natural gas have just begun. The majority of conventional natural gas deposits in China are still unexplored, and the development of unconventional natural gas is on the rise. China’s neighbor, Russia, has the world’s largest proven natural gas reserves and China has just signed a long-term natural gas import agreement with Russia. According to recent reports in the Economist, the cost of natural gas liquefaction has declined rapidly in recent years and competition on the supply of liquidized natural gas has become increasingly 44 intense. At a time like this, making massive investments in coal-based SNG is an extremely risky bet. Even if this bet is won, the profit will still come

35

The U.S. Experiences in Coal-based Synthetic Natural Gas and Lessons for China

with serious environmental costs. If the bet is lost, China will suffer massive economic losses on top of irreversible environmental damages.

Long-term energy price predictions have always been highly unreliable.

History shows that when price controls are first eliminated, most people expect prices to rise. One example of this is when the United States decontrolled natural gas price in the early 1980s, the expectation of an ever-rising natural gas prices resulted in the bankruptcy of the Great Plains Synfuels. Another example is China’s coal price decontrol in the early 2000s.

At first the price of coal skyrocketed.

The expectation of an ever-rising coal price resulted in excessive investment in coal mining, which then led to a steep drop of coal price. Whether the recent pricing reforms of natural gas will follow the same trajectory depends on whether the Chinese government and investors can learn from history.

Energy Infrastructure Must Be Planned with Long-Term Vision Investment in energy infrastructure must never expect quick returns.

Investors of energy infrastructure must look to the long-term and consider the global trends, national policy and

36

the overall directions of technological advancement.

Over the past two decades, global warming has become an increasingly important topic in environmental protection and a consensus on lowcarbon development has emerged.

China is leading the world in many low-carbon energy and energy efficiency programs and is praised by many countries. China’s plans on coalbased liquid and gas, unfortunately, go against the global calls for lowcarbon development. Coal-based SNG is not competitive even without CCS. If CCS becomes required in the future, the added cost of CCS will become a heavy fiscal burden.

Environmental standards all over the world are becoming stricter and China is no exception. Coal-based SNG may meet current environmental regulations, but investors should not be so naïve as to assume that China’s environmental standards will remain unchanged in the coming decades.

Historical trends show that not only will environmental standards become more stringent, but also more types of pollutants will be regulated. Even if coal-based SNG could be profitable in the near-term, as environmental requirements tighten, the cost of pollution control will only get higher.

There are currently no controls on carbon emissions in China, so it costs nothing to release carbon dioxide into

the atmosphere. However, there is no guarantee that in ten or twenty years China will not put limits on carbon emissions. There is already discussion in the media that China may begin limiting carbon emissions during the Thirteenth Five-Year Plan. Once China begins collecting a carbon tax or forcing companies to reduce carbon emissions, those high-carbon coalbased SNG plants may be among the first targets. If investors devote billions of dollars in coal-based SNG today, they may not be able to recover their investment before China started to phase out high-carbon industry.

In the decades since reform and opening-up, China’s overarching national policy has always been moving toward marketization and to encourage competition. The natural gas industry is among one of the last few sectors in which China has yet to complete this transformation. Both natural gas pricing and mineral right allocation are still not fully marketized.

However, institutional and pricing reforms have clearly sped up in recent years and it is very likely that these reforms will continue to encourage investment and competition. Major investment and development in both conventional and unconventional natural gas, as well as its import, have only just begun.

Technological innovations are always difficult to predict. However, one

general trend is for certain. In markets with intense competition, companies will put more resources into research and development to maintain their competitiveness, and the research and development accelerates technological progress. The United States used to be rich in coal and poor in natural gas. Once it established the world’s most competitive natural gas markets, not only did new discoveries of conventional natural gas exceed original estimates, technological innovations also made it the world leader in coal-bed methane and shale gas. Now natural gas is so cheap in the United States that even coal-fired power plants are being converted to burn natural gas.

Investment in projects like coalbased SNG must look at least forty years into the future. Forty years ago, no one in the United States would have imagined that the world would be like it is today, with natural gas reserves not only not yet depleted, but becoming even richer than they were at the time. Forty years ago, wind and solar power were nothing more than a pipe-dream without any market competitiveness. Today, wind power has become a mainstream source of electricity and the cost of solar PV is becoming increasingly competitive.

In recent decades, the price of solar PV has halved nearly every ten years and in the next ten to twenty years, the cost of solar power may drop to

37

The U.S. Experiences in Coal-based Synthetic Natural Gas and Lessons for China

about similar levels as, if not cheaper than, that of coal-fired power. By that time, if it is cheaper to heat and cook using solar power rather than coalbased SNG, the SNG plants built today will have to be shut down. If the shutdown happens after only twenty years of operation, it will be very difficult for investors to recover their upfront capital cost. The construction

of the Great Plains Synfuels at a time when natural gas price controls were being phased out was a painful lesson.

Similarly, blind investment in coalbased SNG now is extremely risky for China. We hope that government and investors alike will reconsider this choice and not push ahead blindly along a risky path for the entire nation.

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