China has forged ahead with its ambitious west-east natural gas pipeline, a key part of its plan to boost the economy in its lagging inland regions. It has corralled foreign investment and is scheduled to start delivering gas next year. But it has failed to put in place the policies that will encourage the gas consumption that is needed to make the project viable.
"The planning for the project has been based on political decisions and not the market," says a foreign consultant who asked not to be identified by name.
Construction of the 4,000km pipeline will cost about US$6bn, while the upstream and downstream market development will account for the rest of the project's total price of nearly US$18bn.
The pipeline, which will be the longest on the Mainland, has been embraced by Beijing as a major tool in developing the western hinterland where economic growth, foreign investment and living standards lag far behind the fast-growing coastal region.
Premier Zhu Rongji, who stepped down as premier last month, has hailed the project by saying, "the curtain has been raised for the large-scale development of the western region." Zhu and other political leaders fear that a failure to close the gap could lead to political instability.
The pipeline will bring natural gas from the Tarim Basin in the western region of Xinjiang to the fast-growing markets of the east coast. It will be built in two sections: the first linking Jingbian in the Ordos gas region of Shaanxi province with Shanghai, while the second will connect the Tarim's Lunnan gas field with Jingbian.
The pipeline will cross the Yellow, Hui and Yangtze rivers as well as the Gobi desert and several high mountains as it snakes across eight provinces and regions. Work began in earnest in July last year.
PetroChina, the listed subsidiary of state-run China National Petroleum, has predicted that the pipeline would achieve break-even point in 2005 when it delivers 72 percent of its 12bn cubic meter-a-year designed capacity for natural gas. It anticipates reaching full capacity by 2007.
While BP balked at direct participation, a foreign consortium led by Royal Dutch Shell and including ExxonMobil, Gazprom and Hong Kong electric power firm CLP Holdings, has signed a joint venture framework agreement to take 45 percent of the project. China will retain control, however, with PetroChina owning 50 percent and Sinopec, the big state-run oil refiner, holding 5 percent.
Other ambitious natural gas pipelines are also being planned. China National Offshore Corp, for example, wants to build a 2,100km pipeline between Guangxi and Shanghai, where it will meet the west-east project. It would pass through the important southern cities of Shenzhen and Fuzhou and could be completed in five years.
Analysts say there is plenty of economic growth in the main target market area. Shanghai and four nearby provinces of Jiangsu, Zhejiang, Anhui and Henan have combined gross domestic product of US$300bn and a population of more than 290m.
The central government sees good reasons to promote greater use of natural gas, which now accounts for less than 3 percent of the Mainland's energy. China would reduce environmental pollution if it limited its dependence on coal, which accounts for 68 percent of all energy consumed on the Mainland. In addition, Beijing would like to cut demand for imported fuel oil.
PetroChina's president Huang Yan has said that he was satisfied with the marketing of the gas so far. His company has signed agreements with 45 users, most of them gas transmission companies but also 13 big industrial users.
However, the gas from western China may prove too costly for many prospective end-users. While it can compete with alternative energy sources for household use, it is far too expensive for industrial or electric power generators, which will continue to rely on coal or fuel oil.
A study by the International Energy Agency (IEA) maintains that gas must be available at Yn0.70-0.90 per cubic meter so as to be competitive for the chemical industry and Yn1.10 for the electric power sector. It adds that the present price of natural gas in Shanghai for industrial users is above RMB1.70 per cubic meter.
Robert Dencher, general manager for gas and power business development at Shell China Ltd, stresses that not all chemical firms are the same. "You can't be generic," he says. Whether gas is competitive or not, he adds, depends on the type of industry and the availability of alternative energy sources at specific locations.
'If there is free competition, it will be difficult for chemical plants in east China that use [west-east] pipeline gas to compete with those at the wellheads of gas rich countries such as Malaysia and Indonesia,' the IEA study says.
One company that could be out on a limb is German chemicals firm BASF, which is moving ahead with a US$2.6bn integrated petrochemical complex in Nanjing, capital of Jiangsu province. Its BASF-YPC joint venture, which is expected to be one of the pipeline's biggest customers, would use natural gas for electric power generation as well as a raw material.
So far it has not reached a final agreement on the price of the gas. "BASF is currently discussing the issue of gas prices with the Chinese government," says BASF spokeswoman Mary Yuen. "China has implemented a series of gas pricing reforms to encourage gas production. It now needs to adopt a new pricing approach that would encourage consumption."
She goes on to express optimism that a deal can be reached: "We are confident that the government will ensure that gas prices for the domestic industry, including foreign investors, will be competitive."
PetroChina expresses similar sentiments. "They believe the gas is too expensive," says a marketing official at PetroChina, speaking of BASF. "It's too early to talk about the price now but I think there may be some way to reduce it."
Shell also expects an adjustment on the guideline price. "Clearly, they are not rigid," says Dencher. "There is flexibility."
The IEA study states that, in order to ensure sufficient demand, China needs to take a series of coordinated steps, including financial incentives for gas users, electricity pricing reforms and tougher environmental regulations. China must define a clear pro-gas policy, it concludes.
The study calls for 'take or pay' contracts that ensure major customers purchase a minimum amount of gas. This would require additional legal safeguards, including a national law on natural gas.
'The potential for gas demand is undoubtedly there in east China but what counts in the end is transforming this potential through active marketing into the actual or legally committed off-take volume by end users or the payment from off takers under take or pay contracts,' says the IEA study.
The study also suggests delaying construction of the western portion of the pipeline to allow development of the market using gas from the Ordos Basin. That would be sufficient in the initial years but it would run counter to the political objective of using the pipeline to help develop the hinterland, the study acknowledges.
If there is insufficient demand on completion, it would not be the first such instance in China. The Jingbian-Beijing pipeline was similarly unsuccessful after it opened in 1997, operating well below capacity as it waited for the local market to mature.
Dencher argues that, with all the environmental restrictions now being put in place, a new gas power station could be competitive. For older stations, the high cost of conversion from coal to gas would likely have to be paid for by a local government or through subsidy. In addition, Dencher stresses that gas is competitive for peak load power, though maybe not for baseline power. "It is the cleanest and most efficient way of producing power," he says. In some cities like Shanghai, there is a big enough difference in peak and off-peak power prices for gas to play a significant role during peak times.
Indeed, Shanghai appears to be putting some of the IEA recommendations into practice. For example, it now uses natural gas from the Pinghu field, a small offshore producing area. The city has paid for gas conversions in the district of Pudong. It has banned new coal-fired furnaces in the inner city, ordered installation of dust-extraction equipment and levied special pollution charges to control vehicle exhaust fumes.
Gas conversion projects
"The government's big objective is to control the expansion of coal use," says Zhang Shurong of the Shanghai Energy Research Association. The analyst adds that other tax incentives and rebates on customs duties for equipment used in gas conversion projects are likely.
The city is already converting a power plant in the Zhabei district from fuel oil to natural gas at a cost of RMB196m. In addition, electricity firm Shanghai Huaneng Co is building a gas-fired plant at the site of its existing Shidongkou Number 2 plant and it will take gas from the pipeline.
The IEA study adds that cities such as Shanghai would also need to make mandatory conversions of coal-fired boilers to gas. 'If [China] relies solely on price competitiveness to develop its market, natural gas will essentially be for small users,' the study says. 'In order to develop the market in other sectors, there is a need for [compulsory conversions].'