REPORT

Charting China's Natural Gas Future

Rice University's Baker Institute and Harvard University's Kennedy School Trevor Houser and Beibei Bao | October 31, 2013

China’s rise has reshaped international energy and commodity markets. Over the past decade, China has accounted for more than half of global energy demand growth and today consumes more than half of the iron ore, cement, copper, and a host of other commodities produced around the world. Natural gas markets, however, have been less impacted by this China-led boom.  Natural gas accounts for only 4% of energy demand in the coal-rich Middle Kingdom, compared to more than 20% globally. And until recently China produced as much natural gas as it consumed.

That’s beginning to change. Natural gas is economically competitive in China as a fuel source for heating and cooking in the residential and commercial sectors and is increasingly being used as an oil alternative in taxis and other fleet vehicles. Gas is used as both a feedstock and fuel in the manufacturing sector and as a source of power generation in a few parts of the country.  Natural gas demand has grown twice as fast as energy demand overall in China over the past decade and is now large enough to have global market significance. In 2009, China surpassed  Japan to become the world’s third largest natural gas consumer and the fact that gas is still such a  small share of overall Chinese energy consumption raises the prospect of considerable growth in  the years ahead. Urbanization will continue to drive demand for fuel in the residential, commercial, and transportation sectors. And as urban China gets richer, the desire for cleaner air and demand for “peaking power” (electricity generation that can be easily switched on during
periods of high demand) will grow.

As a relatively clean and flexible source of energy, natural gas is well positioned to benefit from these trends. But unlocking that potential will require policy action. Increasing the penetration of natural gas as a source of fuel for urban heating and cooking requires natural gas price reform.  Moving beyond fleet vehicles to private natural gas cars will require new fueling infrastructure.  And switching from coal to gas in the power sector will require new and more strongly enforced environmental regulations and a change in the way electricity is sold.

Beijing has indicated strong support for natural gas and introduced a range of pro-gas policies over the past few years. The effectiveness of these policies remains to be seen and forecasts for future Chinese natural gas demand are all over the map. Government and private sector projections for 2020, for example, range from 220 billion cubic meters (bcm) to 500 bcm, up from 147 bcm in 2012. At those numbers, China could account for anywhere between 15% and 50% of projected global demand growth over the next eight years. And the uncertainty only grows beyond that.

Perhaps the most important factor in determining how far Chinese policymakers push natural gas demand is the cost of supply and the outlook for domestic production. Until 2006, growth in Chinese consumption was fed entirely by relatively low-cost domestic supply. In recent years, however, the country has increasingly turned to imports, the cost of which has risen considerably  alongside the price of oil. Chinese companies’ willingness to import, and Chinese consumers’ willingness to buy natural gas is of course price-dependent, but so too is Chinese policymakers’ willingness to push pro-gas policies given persistent concerns about inflation and political discontent. In addition, given the rapid growth in Chinese oil imports, many in Beijing are nervous about the strategic and security implications of becoming overly dependent on foreign supply of an additional energy source.

The prospects for continued growth in domestic output are promising. China is already the world’s eighth largest natural gas producer, with a decent conventional resource base and a well established oil and gas industry. There has been promising growth in unconventional gas production as well in recent years in the form of tight gas, coal-bed methane (CBM), and coal-togas (CTG) conversion. And recent estimates suggest China possesses shale gas reserves comparable in scale to the United States. How successful China is in developing these resources also depends on policy choices Beijing makes—from pricing policy to competition policy. As such, the supply side of the Chinese natural gas equation is just as uncertain as the demand side, and of equal international significance.

In this paper we provide an overview of the drivers of Chinese natural gas demand, sources of domestic and international supply, and the economic, commercial and political factors that will shape how both develop in the years ahead.