Études de l’Ifri CHINA’S QUEST FOR BLUE SKIES The Astonishing Transformation of the Domestic Gas Market Sylvie CORNOT-GANDOLPHE September 2019 Center for Energy The Institut français des relations internationales (Ifri) is a research center and a forum for debate on major international political and economic issues. Headed by Thierry de Montbrial since its founding in 1979, Ifri is a non-governmental, non-profit organization. As an independent think tank, Ifri sets its own research agenda, publishing its findings regularly for a global audience. Taking an interdisciplinary approach, Ifri brings together political and economic decision-makers, researchers and internationally renowned experts to animate its debate and research activities. The opinions expressed in this text are the responsibility of the author alone. ISBN: 979-10-373-0059-1 © All rights reserved, Ifri, 2019 Cover: © humphery / Shutterstock.com How to cite this publication: Sylvie Cornot-Gandolphe, “China’s Quest for Blue Skies: The Astonishing Transformation of the Domestic Gas Market”, Études de l’Ifri, Ifri, September 2019. Ifri 27 rue de la Procession 75740 Paris Cedex 15 – FRANCE Tel. : +33 (0)1 40 61 60 00 – Fax : +33 (0)1 40 61 60 60 Email: [email protected] Website: Ifri.org Author Sylvie Cornot-Gandolphe is an independent consultant on energy and raw materials, focussing on international issues. Since 2012, she has been Associate Research Fellow at the Ifri Centre for Energy. She is also collaborating with the Oxford Institute on Energy Studies (OIES), with CEDIGAZ, the international centre of information on natural gas of IFPEN, and with CyclOpe, the reference publication on commodities. Sylvie Cornot-Gandolphe has a deep understanding of global gas and coal markets, gained during her past positions at CEDIGAZ/IFPEN, the UN/ECE, the IEA and ATIC SERVICES. She is the author of several reference publications on energy markets. Her latest publications include reports on natural gas, coal, and shale in Europe and the world. Sylvie graduated from École Nationale Supérieure du Pétrole et des Moteurs (ENSPM). Executive Summary China’s gas industry has been moving into a new era. China’s natural gas demand has skyrocketed amid a state campaign that encourages coal-to-gas switching. In just two years, China added 75 billion cubic meters (bcm) to global gas demand, the equivalent of the UK gas market, the second largest European market. Despite steadily rising, Chinese gas production has not been able to cope with such a huge increase and gas imports have also surged, with strong global repercussions. In just two years, China has become the world’s largest gas importer and is on track to become the largest LNG import market. The boom in gas demand is policy driven. The fight against air pollution and the acceleration of coal-to-gas switching in the industrial and building sectors have been the key drivers of the rapid increase in gas demand. Climate change has not been a direct driver of the gas demand boom, but coal-to-gas switching has also helped to reduce China’s carbon intensity. Looking ahead, the growing recognition of the role of natural gas to tackle poor air quality and climate change provides the foundations for a bullish outlook for China’s gas demand. In its move to a clean, low-carbon, secure, and efficient modern energy system, the Chinese government has set a clear goal of making natural gas a key source of energy. It is expected to be the third largest energy supply source after coal and oil, with a 10% share in the domestic energy mix by 2020 and 15% by 2030, against 7.8% in 2018. China’s gas market has entered a golden age that can propel gas demand to some 600 bcm by 2030, from 280 bcm in 2018. The nation will lead the growth in global gas demand and become the second-largest gas market already by 2025. Yet the spectacular annual gas demand growth rates seen in the past two years are expected to be slightly more moderate in the medium term. The longer term demand outlook is brilliant, provided domestic natural gas production steps up, alongside storage capacity and that import dependency remains at an acceptable level for policy makers. Seasonality of Chinese gas demand is a major challenge. Despite rising production and surging imports, a major gas shortage affected northern China in winter 2017-18. This has exposed the key bottlenecks of the Chinese gas market: an underdeveloped gas transport and storage system and the lack of adequate incentives for investment in China’s Quest for Blue Skies… Sylvie Cornot-Gandolphe the gas industry. The gas crisis has not derailed the coal-to-gas switching policy but it has changed the pace and way of its implementation, with strict planning. The promotion of natural gas is changed from “coal-to-gas” to “change with gas”. Clean heating plans now integrate specific local conditions and affordability of gas supplies. This new policy highlights the high stakes for successful switching to gas, both to provide winter heating and improve air quality. A disruption of supplies could raise risks for social stability on both counts. The gas shortage has been a catalyst for adopting short-term measures to alleviate winter gas supply/demand imbalances, accelerating the construction of key infrastructure and reinforcing and improving security of gas supply. The short-term measures combined with a milder winter than the previous one helped China’s gas market to balance smoothly in winter 2018-19. Looking ahead, higher storage capacity and better interconnectivity of the transmission network will enhance winter security of supply and smooth out the seasonality of China’s LNG imports. In the short term, the implementation of a compulsory peak shaving mechanism will create additional LNG demand. The gas shortage has also been a catalyst for intensifying gas market reforms to improve market competition and security of gas supply. Reforms have been particularly successful on the consumption side. The downstream market of the gas industry has been liberalized and full market competition has begun to emerge. Chinese policy makers have adopted new gas pricing for residential users to solve cross-subsidization between customers and better reflect procurement costs. Trading on exchanges is encouraged. However, in the upstream and midstream segments, the degree of competition is still low. Growing gas demand has put more pressure to rapidly reform these segments. A fundamental step has been taken with the creation of the national pipeline company, an independent oil and gas transmission system operator. The move will facilitate utilisation of the transmission pipeline network by third parties, allowing more and more players to enter the market and fostering competition. As a result, it will facilitate the growth of gas supplies, unlocking the potential for new upstream suppliers and possibly have a downward pressure on prices, making natural gas more affordable to end users and further boosting gas demand in the long run. But there is still a long way to go before the system is fully liberalised. NOCs’ strategic role in the gas supply chain is expected to remain dominant despite anticipated growth in non-NOC players. 6 Table of Contents INTRODUCTION .................................................................................... 9 A NEW ERA FOR CHINA’S GAS MARKET ............................................. 11 Fast growth in gas demand ................................................................... 11 Steady increase of gas production ........................................................ 15 China has become the world’s largest gas importer ........................... 17 THE SURGE IN GAS DEMAND IS POLICY DRIVEN ............................. 19 The fight against air pollution is the key driver ................................... 19 Restructuring of the energy mix and climate change challenges ....... 23 The role of economic activity ................................................................. 24 INFRASTRUCTURE IS LAGGING BEHIND ........................................... 25 Seasonality of gas demand is a key issue............................................. 25 Short-term measures to prevent winter gas shortages ...................... 27 Construction of a production, supply and marketing system ............. 28 Gas infrastructure enters a period of rapid development ................... 31 DEEPENING OF GAS MARKET REFORMS ............................................ 35 Gas pricing reforms are intensified ....................................................... 35 Creation of a national oil and gas pipeline group ................................. 38 Opening up the upstream sector ........................................................... 39 BRILLIANT OUTLOOK FOR GAS DEMAND .......................................... 41 Policy targets .......................................................................................... 41 Outlooks by key institutions .................................................................. 43 CONCLUSION ...................................................................................... 47 LIST OF TABLES, GRAPHS AND BOXES .............................................. 49 Introduction In a bid to tackle air pollution and “turn China’s skies blue again,” Beijing has adopted a bold policy plan. Part of this initiative is an extensive government-led switch from coal to natural gas for heating and industrial purposes. The switch was accelerated in the last two years, leading to a spectacular