| China's LNG market development is at risk | Domestic supply, demand | Missed opportunity |
| Tight market for supply | Special approval process | Great Potential; great delay |
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LNG Observer April June 2006 Vol. 3, No. 2
Chinese government efforts to slow development of LNG regasification terminals will prevent the country from becoming a major LNG importer until after 2010.  Despite proposals for more than
20 LNG regasification
terminals in the long term, government-imposed limits last year
effectively
undermine mid-term development of several projects.
Limits of one terminal per province (with the exception of Guangdong) have been implemented, and restrictions on the number of terminals in northern and southern China have also been introduced. This government move appears to be a reaction to the escalating numbers of terminal proposals announced last year. It is possible that government actions to control project development are meant to buy time for officials to develop a long-term strategy that incorporates the new global supply, demand, and price fundamentals of LNG. Or, since many investment projects are financed through Chinese banks, the government may be simply trying to head off a financial investment bubble in energy projects. Regardless, Wood Mackenzie believes that the only LNG terminals that will be commissioned in China before 2010 are Guangdong and Fujian based on the fact they have contracted supplies and construction is underway. Although plans exist to develop terminals in Shanghai, Zhejiang, Tianjin, and even Hainan around 2008-09, these are unlikely in this time frame owing to the lack of committed supply and progress on construction. Continued delays in supply-contract negotiations driven by new market opportunities for LNG producers and the lack of clear Chinese government policy and strategy ensure the loss of a further Chinese LNG market before 2010. This article analyzes these issues to highlight the limits for mid-term LNG growth in China (Fig. I). The future size of China's natural gas market is a subject of much debate. Demand is tied to many variables, including economic growth expectations, power-demand load growth, domestic gas-supply development, infrastructure build-out, and investment capital. Owing to large reserves and reasonable costs, coal will continue to dominate near-term fuel use in China, although not uniformly throughout the country due to transportation (rail) bottlenecks. Gas will achieve significant growth through physical access (pipeline and LNG regas) and feedstock use in power and industrial applications where coal or oil cannot be used or are uncompetitive. Its share in the national market, however, will remain small. Gas will struggle to meet expectations for increasing market penetration in light of the delay in LNG regas terminals but also because proposed import pipeline projects are unlikely to be commissioned within the next 10 years. In October 2005, TNK-BP, developer of the proposed Kovykta pipeline, announced a delay in its expected commissioning from 2008 to 2010-12. But this is even unrealistic. The Kovykta project is the most advanced of the proposed gas import pipelines; its delay is a harbinger that other projects will commission after its eventual start-up. Wood Mackenzie, however, does not expect any terminals beyond Guangdong and Fujian to corn, mission before 2010 for two primary reasons: Contracts to secure mid-term supply have not been signed and, as CNOOC delays acceptance of higher LNG prices from producers, the window for securing supply for delivery this decade is closing. The government has yet to make an executive decision on the future pace of LNG development, creating uncertainty and exacerbating development risks Table I contains the major projects proposed for commissioning by 2010. More speculative projects have also been proposed for this timeframe, but the plants in Table I are the only ones Wood Mackenzie considers likely to be commissioned in China before 2015. Wood Mackenzie estimates that China's gas market could grow to 88 bcm (3.1 tcf) by 2010 from around 45 bcm as 2006 began and to about 160 bcm by 2020, when it will account for around 6% of total energy market consumption (Fig. 2). Gas markets in China to date have developed as separate, regional markets primarily around supply areas. The commissioning of the West-East Pipeline in 2004 saw the completion of China's largest trans-regional gas infrastructure project. In line with this, regional markets far away from supply sources are developing in areas of economic prosperity like Shanghai, Guangzhou, and Fujian. A few relatively small-scale domestic liquefaction plants have also been developed to enable LNG to be trucked from supply sources in Xinjiang to demand centers in Guangdong. Guangdong and Fujian, with high levels of wealth with large urban areas, present some of the best options for China's mid-term LNG markets. Far from China's main coal reserves and particularly dependent on overburdened transportation infrastructure, the coal they receive is more expensive than in other regions. These wealthy provinces will be China's first gas importing markets and Wood Mackenzie understands that latent gas demand in these two provinces, particularly from the power sector, will be more than sufficient to keep demand at levels needed for planned LNG terminals. In addition, some high-tech industries that exist in these provinces demand a high quality of electricity supply which makes LNG supplied gas-fired power plants attractive options because they can provide the required superior standard of supply. When CNOOC signed contracts for the supply of Guangdong LNG in 2002, it managed to secure an impressively low price from Australian suppliers, North West Shelf. Although the deal was low- $3/MMbtu (exship@$20/bbl), there were expectations that it could even be beaten. Contracts to supply Fujian were signed in 2003 and a price of $2.80/MMbtu (ex-ship@$20/bbl) was reached. CNOOC expected these experiences to set the precedent for China's future LNG projects. Government policy, which is still in place today, was to treat Guangdong and Fujian as test cases. Only if these projects were successful would further proposals for LNG terminals be approved. If the government had given more support to the development of the LNG market in China at this time, it would have been possible to secure the necessary supplies for additional LNG terminals. The global LNG market shifted in 2004, however, due to strong demand in North America, which is hampered by only modest gas-supply growth, creating newfound competition to China's aspirations of capturing incremental LNG supplies to fuel its rapid economic growth. Time is running out for end-of-decade supply. In the current LNG market, CNOOC is being confronted with much higher prices and a market that has fundamentally shifted from a buyer's market to a seller's. As stated above, higher prices are prompting reconsiderations for the future role of gas in China, and there is the argument that given alternatives that won't hamper economic growth, CNOOC and the government may not need to accept the current price of LNG in the Pacific market. CNOOC's refusal to accept new market prices was the major stumbling block during the long running negotiations between CNOOC and the Gorgon LNG project for supply to Zhejiang. On the supplier side, Gorgon was locked into an exclusivity agreement with Zhejiang that meant Gorgon was unable to market gas to any other terminal in China. The Zhejiang exclusivity has now expired, freeing Gorgon to market its LNG elsewhere, but had an agreement been reached in 2005, it could have been possible for Gorgon supplies to enter Zhejiang in 2010. Given that negotiations with new suppliers will take time and that CNOOC will ultimately be faced with high prices from any supplier, the company's hunt for cheaper LNG for Zhejiang or Shanghai before 2010 is likely to prove of little success. An opportunity for CNOOC to secure supplies was missed. The new global gas market dynamics-high prices with strong competition from buyers-will ultimately require CNOOC and other Chinese buyers either to forego many LNG regas projects or accept the new dynamics. As gas demand growth and high prices in the US persist, which Wood Mackenzie expects to continue for the foreseeable future, Chinese buyers will have to contend with the prospect that LNG producers will be seeking terms for China LNG sales that reflect the alternative US market. Given the expected tightness in the LNG supply market, securing supplies now for a pre-2010 delivery will be very difficult. Gorgon is in a good position to supply gas to China from 2010, but even if supplies begin by this time, they will be small, as volumes have already been sold to other consumers, namely Japan and South Korea. Negotiations by CNOOC with other potential suppliers have yet to reach a stage where mid-term supplies look realistic, and going into 2006 CNOOC and other Chinese buyers will only find themselves in more difficult negotiating positions because in 2008-09 a supply shortfall is expected in the region.  Fig. 2 illustrates
this by showing that uncontracted demand
in the Pacific Basin during 2007-09 is higher than uncontracted supply. Consequently, China will almost certainly be
unable to secure deliveries for this time.
Competition for uncontracted supplies up to 2010 will come from several countries: Japan continues to sign supply contracts; South Korea is expected to tender; and US demand is growing steadily. Given the high prices that will be demanded by suppliers, China is unlikely to be very competitive. Government indecision
As of March 2006, the government in Beijing had yet to make
an executive decision about China's gas strategy. Policy
makers in the National Development and Reform Commission
(NDRC) and the Energy Commission have split into two camps.
One side supports development of China's energy and economy through the use of coal as China's most economically competitive fuel option on a national basis. The security of coal supply also provides rationale for promoting it as a continued fuel of choice. The second group supports gas and the development of regional gas markets based in areas of economic wealth. Gas campaigners also have environmental and corporate backing. The strength of the coal lobby in China is significant, however, composed as it is of some of the country’s largest companies. Despite headline-making fatal accidents that occur in China's coal mines regularly, there is still strong support for the continued growth of the sector. Coal currently accounts for around 60% of China's energy mix and the sector employs millions of people. Urgent action critical
If any terminal beyond Guangdong and Fujian is to commission
by 2011, urgent government action is needed.
Recently, reports of scaling back long-term plans for LNG have been announced. Limits of one terminal province (with the exception of Guangdong Province) are to be implemented, and restrictions on the number of terminals in northern and southern China are also being introduced. These cut backs still leave room for an ample number of terminals to be developed in the long-term. This move by the government appears to be a reaction to the reports of escalating numbers of terminal proposals that have been released over recent months, and with more than 20 speculative terminals in total, the announcement of limitation could be seen as a logical move. This move still falls short of decisive action, however, regarding the mid-term development of LNG. The characteristics of LNG demand for terminals in other regions will not be the same as for Guangdong and Fujian. The power sector will be key for Guangdong and Fujian, as the two terminals expect 60% and 70% of their gas off-take, respectively, to come from the power sector. The stepped availability of LNG, as opposed to smooth delivery growth, is conducive to power-plant developments and off-take from this sector is crucial for initial LNG demand. In the case with both Guangdong and Fujian, power plants are being developed as part of the wider LNG projects, specifically in order to be able to provide sufficient demand when the LNG becomes available. With the terminals proposed further north on the east coast, LNG off-take will be more mixed and a much higher percentage of demand will come from the industrial and residential sectors. To guarantee this demand, more direct policy and enforcement will be required from the government. Unlike other projects that obtain approval from the provincial level before moving through the central government approval process, LNG terminals are approved from the top down. A successful LNG terminal proposal will have lobby campaigns for both the state council and NDRC in order to obtain central government approval before moving to secure approval from provincial governments. Without this initial central government approval, plans for the LNG terminal cannot move forward. This top-down approval process for LNG terminals reflects the government's centralized strategy for the development of a national LNG sector. Thus, the central government's decision to move forward with an approved and fully developed LNG market is crucial for mid-term developments to be realized. Look to 2020
Even though LNG will not make the significant impact on
China's energy markets by 2010 as hoped, it will be an important future
source
of supply. Wood Mackenzie expects as
many as eight LNG regas terminals to be built along coastal China by
2020. The power and industrial sectors
will be the
primary drivers for gas growth, but residential and commercial sectors
will
also provide off-take opportunities to support long-term growth.
It is unlikely the government will decide to abandon LNG simply over price terms; few energy importers can ignore an important fuel supply. Consequently, Wood Mackenzie anticipates an improving environment for LNG for use after 2010. Even with growth, however, there is still the possibility that LNG will become no more than a peripheral energy source in the greater Chinese energy market. For gas demand needs before 2010, LNG will fail to meet expectations as the time has passed for new supply contracts to be concluded and for regas terminals to start construction and be completed before the end of the decade. In the current market environment, producers have attractive alternative buyers and China has alternative fuel options to LNG, primarily coal. Hence, a meeting of the minds is unlikely to occur in the next year for LNG supply to be fast-tracked to China before the end of the decade. The enormous amount of speculation surrounding China's developing gas market has been fuelled by ambitious plans for growth, and although some plans for LNG terminals well be realized, the limits for mid-term growth have already been set. |