China has a stated goal of increasing its natural gas consumption. But gas only accounts for less than 3% of the country’s primary energy consumption while coal provides more than 70%, a share not seen in the West since the nineteenth century. The paltry gas consumption in China is miniscule even compared to primary consumption levels in Asia and around the world. Gas accounts for about 8.8% of primary energy use in Asia and for about 24% of total energy worldwide.

Total Energy Consumption in China, 2006

Source: EIA, By Seth Myers

Increasing natural gas’s share of the Chinese primary energy market is being made more difficult by the central government’s meddling with prices.

Since 2003, the country has had to deal with chronic natural gas shortages, which are exacerbated by artificially low prices. In 2004, the average wellhead gas price from PetroChina was only 40.7% of that of the average price in the US. And by 2008, the Chinese price was still only 42.4% of the US price.

China’s regulated natural gas price ranges from 25 to 33% of the oil price by heat value equivalent, while in developed countries, the number has been about 65 to 80%. These artificially low gas prices have resulted in a push by industry to replace coal and oil with gas, as fuel as well as raw material for industrial use. This has intensified gas demand and exacerbated the shortages.

Natural gas consumption by China in 2009 was 3 trillion cubic feet (tcf), about one seventh of United States consumption and less than Japanese consumption, a country with less than one-tenth as many people as China.

About 6% of Chinese natural gas consumption has been imported since 2008 and gas pricing has become a critical issue. For example, in 2008, the average domestic gas price was about $5.70 per mcf, while the average imported gas was twice as much. In winter 2009 the domestically produced gas had a cap of $6.25 per mcf, but LNG imported from Qatar cost as much as $14.60 per mcf. The second west-east pipeline gas from Central Asia is already at $8 per mcf at the northwest border.

Within all this mess where the same gas molecules from one source cost far more than from another, the NDRC, China’s most influential policy making body, has been controlling domestic prices to protect economic development and, especially, to keep residential utility costs down. Because gas production and transportation are tightly controlled by the three big energy companies, PetroChina, Sinopec and CNOOC, the low domestic gas prices provide little motivation for producers to increase the supply. For importers, forced to sell at these prices, there is no incentive.

This creates an anomalous situation. While the rest of the world has had a gas surplus in the winter of 2009-10, gas shortages in China have worsened.

And again, pricing is the problem. Long-time gas customers pay less for their fuel than new customers; commercial customers have to pay much higher gas prices than industrial and residential customers. The gas price close to inland gas fields is only half that of the coast areas which are far from gas fields. For residential gas, the eastern part of China has to bear the highest gas price. For instance, Ningbo residents (on the east coast) had to pay $23.80 per mcf in 2008, while Chongqing residents (close to some gas fields) only paid $5.80.

The most reliable estimates suggest that China will have gas shortage of 1 tcf in 2010 and 1.4 tcf in 2015. Shortages will persist because domestic resources are quite limited and production has peaked. These future shortages will have to be met by increased gas imports. This means one thing: Gas pricing reform is inevitable.

But there are major hurdles to any such reform. First, the price gap between the domestic gas and imported gas is very large. Ratifying domestic prices with international ones is a big challenge. Second, the current pricing system is confusing and unfair. It will take huge effort to correct it and make it acceptable. More problematic, the entire chain from production, importation, to pipeline transportation and distribution is fully controlled by the big three companies mentioned earlier.

One certainty: natural gas prices in China will rise over the next few years, perhaps by as much as 100%. This will greatly affect everyday life since residential use is the biggest portion of gas consumption. Chemical processing, such as methanol and ammonia manufacturing, is the second biggest user. Major gas price increases will certainly kill some of these businesses.

Although for now the NDRC refuses to disclose how the gas price reform will be accomplished or when it will happen, the three major companies hope that the government will set reasonable pricing mechanisms to smoothly coordinate the domestic gas with the imported gas. They would like the reform to take place before the second west-east pipeline is fully loaded to deliver imported gas in 2012. In the meantime, expect continued confusion in the Chinese gas market.