China is the world's largest developing country, the third-largest importer of oil and the largest producer of coal. Its energy needs are met mainly by coal (approximately 70 per cent) and oil (approximately 21 per cent), but demand for cleaner fuel has resulted in a steady increase in its use of gas.
It has long been recognized that China's current energy policies and strategies do not adequately support the country's strong energy demands, economic growth potential or environmental responsibilities – and proper management of China's energy industry is critical to secure its economic growth over the next two decades.
To address these shortcomings, China released a new draft Energy Law on 1 December 2007 and its first white paper on energy, entitled "China's Energy Conditions and Policies", on 26 December 2007 (White Paper). Together, these provide some insight into how China will manage its energy industry going forward and encourage the use of cleaner fuels as alternative energy sources.
The draft Energy Law and White Paper
China has separate energy laws dealing with coal, electricity, energy conservation and renewable energy, but no principal law for oil or natural gas. Moreover, its energy industry is managed by a number of government departments and agencies, with different management systems for each of electricity generation, nuclear power, oil and gas, coal mining and renewable energy.
The main aim of the new draft Energy Law is to develop a unified management system for the entire energy industry. To this end, the draft Law proposes setting up a national 'Energy Department', which would be responsible for managing energy prices, allocating energy resources and coordinating state-owned and private sector energy reserves.
Importantly, however, neither the draft Energy Law nor the White Paper includes detailed policies that can be implemented immediately. The draft Law contains a set of guiding principles for China's energy industry while the White Paper provides a high-level overview of energy strategies and policies going forward.
The Energy Law is not expected to come into force until 2009. Nevertheless, taken together, the draft Law (as it is currently drafted) and the White Paper do provide some insight into how China will manage its energy industry in the future.
One area that could undergo significant growth as a result of the new unified energy policies is the gas industry.
Gas demand in China
As China's energy supply is heavily dependent on coal, the draft Energy Law attempts to encourage the use of cleaner energy fuels, such as gas and other renewable energy sources, to meet the country's energy demands. For its part, the White Paper notes that while one aspect of China's energy strategy will be to continue to develop its coal industry, it will also continue to implement a policy of "simultaneous development of oil and gas" in order to boost the country's recoverable reserves1.
China's Long Term Energy Development Plan sets a target of 12.5 per cent for gas use by 2020.
As it turns its attention turns towards gas as one of the fuels of the future, China has taken steps in recent years to develop its natural gas market to meet the forecasted demand. While domestic natural gas production is increasing, however, it will not be enough to meet total demand, and this means that China will have to rely on imported gas to fulfill its future energy needs.
At present, China has one operating LNG terminal, located in Guangdong province and operated by CNOOC (China National Offshore Oil Corporation). This facility has an annual capacity of 3.7 million tons and currently receives shipments from Australia's Northwest Shelf project. CNOOC also has agreements to import LNG from Indonesia and Malaysia to supply LNG terminals under construction in Fujian and Shanghai.
Current plans are to have up to nine LNG terminals as part of China's coastal import network. At full operation, these terminals will have a total annual capacity of approximately 28 million tons.
So, while coal will continued to be used in China for the foreseeable future, from an environmental perspective it is encouraging to see that China is implementing polices and strategies through the draft Energy Law and the White Paper to reduce its reliance on polluting coal as a primary energy source and that favour cleaner energy sources such as gas.
Pricing challenges
China has started securing more long term LNG supply arrangements to meet the country's forecasted gas demand. One of the key factors that will contribute to China achieving its 12.5 per cent gas target by 2020 – as well as the policies set out in the draft Energy Law and White Paper – will be ensuring there are sufficient economic incentives to promote continued growth in gas demand.
China's domestic gas pricing structure does not, of itself, support growth, and consequently is a barrier to increasing the supply of gas into the country.
Residential customers pay higher prices for gas than industrial customers. Given the tight supply of gas, this is an incentive for energy companies to supply residential customers in preference to industrial customers, which means an unreliable supply for industry. This uncertainty and unreliability, together with the high cost, has resulted in industrial customers choosing to rely on coal as their primary energy source.
With industry accounting for over 70 per cent of the country's final energy consumption, China will need to make further changes to its gas pricing model and regulatory system to give industrial customers confidence in using gas as a reliable energy source. This, in turn, would support the country's desire (which is underpinned by the draft Energy Law and the White Paper) to rely less on coal as an energy source.
The draft Law states that China will adopt an energy pricing system under which prices will largely be determined by a combination of market forces and government control. The draft Law also states that pricing should reflect "the degree of rarity of resources and the cost for environmental damage".
What is not clear, however, is to what extent these new pricing principles will encourage ongoing investment in China's gas industry and whether they will have an effect on reducing the price differential between coal and gas. Much is left to be said.
Conclusion
China's draft Energy Law and the White Paper are positive steps in encouraging the use of cleaner fuels like gas as an alternative energy source.
While there are a number of projects underway designed to increase the supply of natural gas into the country, pricing models that encourage continued growth in gas demand will be needed to achieve the Energy Law's objectives. Currently, the gas industry in China does not adequately support growth in gas demand because of the high costs associated with the supply of gas.
The ongoing challenge for China in implementing its new energy policies and strategies, and in particular achieving its 12.5 per cent gas target by 2020, will be to ensure that the pricing mechanisms better reward investment in the country's gas industry.
Footnotes
1. The White Paper states that part of China's energy strategy is to develop its coal resources in an orderly way, increase its power industry, speed up oil and natural gas exploration, encourage renewable energy and improve energy development in rural areas.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
