China’s voracious appetite for energy has been blamed as one of the main reasons that oil is now selling for more than $100 per barrel. That appetite is also a factor in the ongoing political scrum between the U.S. and militant oil-producing countries such as Iran, Venezuela, and Russia.

But natural gas is becoming the sleeper energy source for China. Gas only provides about 3 percent of China’s primary energy needs. For the U.S. and the rest of the world, it’s about 23 percent.

Coal is still king in China, providing nearly 70 percent of all primary energy, a share that the West last saw in the nineteenth century. But its coal-based economy causes enormous environmental problems. That’s a key reason why China is making natural gas exploration and development the centerpiece of its energy strategy over the next decade. As gas demand increases, the government will need to invite foreign investors to tap complex gas reserves and encourage companies to build gas pipelines from the far west to booming markets in the south and east.

In recent years, China’s domestic gas business has enjoyed remarkable success. Gas production has grown by about 20 percent over the last three years. In 2007, production hit a record high of 68 billion cubic meters (2.4 Tcf). Of that, CNPC accounts for 76 percent and Sinopec and CNOOC each account for 12 percent.

But even with these big increases, domestic production is unlikely to meet gas demand, which according to a government forecast will hit 127 Bcm per year by 2010. Demand is expected to double again by 2020.

China’s gas demand is booming, thanks to the increasing buying power of consumers along the affluent coastal areas. According to the National Development and Reform Commission, about 60 percent of China’s gas demand is from the eastern and southern provinces that include Guangdong and Fujian. The government has outlined a gas utilization policy, which gives priority to using gas in the residential sector. By 2020, the power generation and residential sectors are expected to consume more than 60 percent of China’s gas.

Rising coal prices are also pushing gas demand. As the price of coal gets closer to that of gas (on a Btu basis), buyers are opting for the cleaner fuel. Add in the pressure from the central government to cut emissions and the demand for gas becomes yet more obvious.

To meet demand, China will have to add proven gas reserves by 500 Bcm per year over the next five years, to ensure a domestic production capacity of 90 Bcm/year by 2010 and 150 Bcm/year by 2020. The looming gas shortfall will likely be met by imports of pipeline gas from central Asian countries, including Russia and Turkmenistan, and the country’s southern neighbor Myanmar. Additional LNG supplies will be shipped in from various suppliers.

Currently, China’s gas supply comes largely from fields operated by PetroChina in the northwest and CNOOC in the East China Sea. By 2010, two more supply sources will be added to the portfolio: gas from Sinopec’s Puguang field in Sichuan and LNG imported by CNOOC and PetroChina. By 2012, gas from central Asia will begin arriving in southern China.

China’s estimated natural gas reserves are pegged at 27.47 Tcf; 10.7 Tcf are in offshore areas, and 3.36 Tcf were confirmed recoverable by the end of 2006. About 60 percent of the total gas reserves are trapped in 10 basins: Tarim, Sichuan, Ordos, East China Sea, Bohai Bay, Yinggehai, Qiongdongnan, Pearl River Mouth, Junggar, and Qaidam. Each contains minimum gas resources of 1 Tcf. Currently, the bulk of gas production comes from Sichuan, Ordos, Tarim, Qaidam, Yinggehai, and East China Sea, as well as Bohai Bay, Songliao basin, and Junggar.

Offshore China, CNOOC has 7.6 Tcf of natural gas into development. Plans call for putting another 8.4 Tcf of reserves into development before 2010, when the recoverable reserves are expected to reach 10.7 Tcf. About 47 percent of the 7.6 Tcf are under production, 26 percent are under development, and 27 percent are under assessment. CNOOC now produces from four gas fields, and is developing eight more and assessing another five.

On the domestic front, China will focus on the exploration of Longgang and Puguang gas fields in Sichuan basin, Sulige in Ordos basin, and Tarim in Tarim basin. PetroChina has reportedly discovered 24.6 Tcf of gas reserves at Longgang gas field, and Sinopec has confirmed 12.5 Tcf of gas reserves at Puguang. At Longgang, PetroChina is building a processing plant with capacity of 4 Bcm (140 Bcf) per year and a 100-kilometer export pipeline linking the producing wells to the plant. At Sulige, PetroChina is aiming to set up an annual gas production capacity of 10 Bcm (350 Bcf) by 2010, rising to 20 Bcm (700 Bcf) by 2013. Sinopec has also kicked off development at the Puguang gas discovery, aiming to bring first gas to eastern China in 2010.

Since 2002, China has opened investment opportunities to foreign companies involving all segments of pipeline construction, but foreign oil companies including BP, Shell, and ExxonMobil remain lukewarm due to uncertainties in the upstream development and taxation concerns.

By the end of 2006, China had 30,000 kilometers of natural gas pipelines, with a total transmission capacity of 45 Bcm (1.6 Tcf). The third West-East gas pipeline will cover 8,000 kilometers from Xinjiang to three consumption centers: the Pearl Mouth delta in the south, the Yangtze River delta in the east, and Bohai Bay in the north.

In late February, China started construction of the second West-East gas pipeline. The 8,794-kilometer pipeline consists of one trunk-line and eight branches and will cost about $20 billion. An extension of the Turmen-China gas pipeline, the trunk-line will start operation in 2010 and run 4,945 kilometers from Khorgos in Xinjiang to Guangzhou, capital of Guangdong Province in the south.

PetroChina is already operating China’s first flagship West-East pipeline, connecting gas fields in the Xinjiang region with the financial hub of Shanghai, 4,000 kilometers away on the east coast. Sinopec has started construction of the 1,674-kilometer line to move gas from Puguang field in Sichuan to Shanghai. The line, to be completed in 2010, will have annual throughput capacity of 15 Bcm (526 Bcf).

Foreign Investment Needed

Given the huge costs and technical challenges of developing its gas reserves, China cannot go it alone. It will have to incorporate foreign technology to tap some difficult reservoirs with high sulfur content. PetroChina offered the largest such deal to Chevron last year. The company has a 49 percent stake in the Chuandongbei natural gas development in Sichuan basin. The block covers nearly 2,000 square kilometers.

Chevron and CNPC expect to build two sour gas plants with a throughput capacity of about 740 million cubic feet of natural gas per day. Chuandongbei boasts an estimated resource base of 5 Tcf. PetroChina offered Chuandongbei to Chevron because it was unable to handle sour gas exploration and development. It gave up the exploration there in 2006 after several gas explosions.

Shell is also a major player in China’s gas sector. Shell is now operating the Changbei gas field in the Ordos basin. The Anglo-Dutch supermajor plans to double output at the field to 3 Bcm (105 Bcf) per year by early next year. Shell began commercial production there last March. The field has reserves of 70 Bcm (2.46 Tcf) of gas. To expand the development, Shell signed a supplementary agreement with PetroChina to develop the adjacent Shaan 207 block which covers 103 square kilometers and contains 3.58 Bcm (125 Bcf) of gas.

At Sulige South prospect, also in Ordos basin, France’s TOTAL has discovered an initial gas reserve of 140 Bcm (4.9 Tcf). The company will now start work on an overall development plan for the block, which covers 2,390 square kilometers, for submission to CNPC by October.

TOTAL is obligated to produce gas from the block for 30 years. The French company will maintain its operation for 9 to 10 years if CNPC does not exercise its option.

In the northern part of Sulige, CNPC has built up a total production capacity of 4 Bcm (140 Bcf) per year by the end of 2007, which is expected to increase to 10 Bcm (350 Bcf) by 2010 and to 20 Bcm (700 Bcf) by 2013. TOTAL and CNPC signed a production-sharing contract for Sulige South in 2006, marking the French company’s first attempt to exploit China’s onshore gas reserves.

Obviously, China faces challenges as it diversifies its burgeoning economy away from coal. With its increasing natural gas use, more opportunities will become available to foreign companies. But as the global gas market becomes more integrated and LNG becomes a bigger player in the market, China’s energy appetite could also drive up the price of gas, just as it helped drive up the price of oil.