Energy companies are facing growing losses due to their inability to pass rising costs on to buyers. Although price regulations have relaxed since 2015, there is still a long way to go.
Photo from CFP
By HOU Ruining
The comprehensive import price index for liquefied natural gas (LNG), published by Shanghai Petroleum and Natural Gas Exchange (SHPGX), was up 223 percent year-over-year on December 12.
Importers, who are already making huge losses, are unable to pass on the costs to end-users due to price regulations. PetroChina lost 6.4 billion yuan (US$1 billion) on imported LNG in the first three quarters of 2021. Sinopec, another state-owned energy company, plans to control costs to curb price increases as the country enters the winter heating season.
The natural gas market in China is tightly controlled to keep fuels affordable for residents and key industries. As prices threaten to run out of control and demand keeps rising, the urgency for reform grows ever more pressing.
Gas from two main sources is currently selling below cost ‒ spot LNG imported at prevailing global prices, and pipeline gas obtained through futures contracts PetroChina entered ten years ago. Together, they account for about 15 percent of China’s total gas consumption.
Which product is sold to whom for how much is determined by a patchwork of rules issued over the years. Domestic pipeline gas is price-controlled, for example. Shale, coal-seam, and synthetic gas are not. Imported pipeline gas is not subject to price regulation if the pipelines were built after 2014. The story for LNG is even more complicated.
The latest central government pricing catalog mandated that LNG prices be set by the market. This has proved difficult to implement. LNG is often mixed with price-controlled gas in the pipeline and capped at 20 percent above government-set benchmarks. The benchmark price was set at 2.04 yuan per cubic meter in 2019 and has been not updated since. This means energy companies such as PetroChina cannot sell LNG for more than 2.45 yuan per cubic meter, even though the price of imported natural gas is now 8.1 yuan per cubic meter.
The situation is similar for local distributors who sell to end-users below cost. They are also allowed to increase prices by as much as 20 percent of the benchmark, but price adjustments are often small and largely symbolic. Distributors face even heavier losses in the heating season. The average price increase for residential use is 0.1 yuan per cubic meter from January to November.
China imports 43 percent of its natural gas. With demand growing, efforts to expand domestic production are hampered by the price problem will hamper its efforts. SHPGX’s domestic gas index is currently 56 percent lower than the import index (3.5 yuan per cubic meter vs 8.1 yuan). Domestic increases this year have been much smaller than those in the global market.
“Domestic producers will be a lot more motivated if prices follow supply and demand,” said an energy industry expert. “It will boost domestic production, lower energy costs and alleviate China’s reliance on imported gas.”
Around 45 percent of China’s natural gas is free of price regulation. Another 35 percent is market-influenced but not completely free. Policymakers are cautious to open things up completely, out of concerns for social and economic stability. The pricing catalog removed price controls from natural gas but replaced them with “oil and natural gas transportation,” many industry insiders saw it as a signal of the government’s intention to eventually free prices completely.
China would need a dynamic natural gas pricing mechanism in the transition to a free market, said GUO Jiaofeng, of the State Council’s development research center. To do this, the commodity market would need s diverse instruments to price and hedge natural gas products. China’s first LNG futures contract is currently under review.
The lopsided dynamics between supply and demand need to be rebalanced. Local distributors cannot compete on even footing with “Three Barrels" (CNOOC, PetroChina, and Sinopec), who monopolize the natural gas supply. PipeChina, established last year, is still getting up to speed.
Industry practitioners believe that natural gas market reform will likely follow the path of oil, once as underpriced as natural gas today. Price controls were significantly relaxed in 2013, which brought domestic prices more in sync with global ones. But some argue that global prices may not truly reflect local supply and demand. The solution? A domestic natural gas market, large and powerful enough to influence global prices.