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China Gas Crunch Exposes Energy Insecurity – Analysis

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By Michael Lelyveld

China’s sudden push to replace smog-causing coal with natural gas for winter heating has added to the country’s import dependence and energy security concerns.

The government’s badly-managed attempt to avoid another winter smog crisis by banning coal-fired heating in 28 northern cities left thousands of homes in the cold due to gas and electricity projects that could not be completed in time.

Much of the fault has been traced to rigid regulation of fuel replacement directives issued by the National Development and Reform Commission (NDRC), the government’s top planning agency, and Ministry of Environmental Protection (MEP) rules that were not issued until August.

Three weeks after an outcry over reports of frostbitten school children in Hebei province, MEP inspectors said on Dec. 26 that the last 96,000 unheated households had been provided with gas, electricity, or restored coal supplies.

Despite the problems, the government has claimed a measure of success for the fuel-switching campaign. Nearly 4 million homes completed conversions from coal to gas or electricity last year, according to the MEP.

The upside of the initiative is that it appears to have contributed to an improvement in air quality, at least temporarily, this winter.

The average density of smog-forming particles known as PM2.5 dropped 53.8 percent in the fourth quarter of last year from a year earlier in Beijing, according to the MEP.

Long-term improvement unclear

Whether the improvement will continue is unclear. Last Thursday, environmental monitors issued an orange alert, the second-highest level, for severe smog in Beijing and nearby areas this week.

At least three cities in neighboring Hebei province announced their highest red alert warnings, state media said.

But the conversion crunch has had other short-term and long-term consequences.

In December, China’s prices for liquefied natural gas (LNG) shot up 60 percent over September levels. Asian spot prices nearly doubled since June, Reuters said.

On Monday, the official Xinhua news agency suggested that the worst of the price spike was over, citing a 22.6-percent drop in the first 10 days of January from the end of December.

The consequences of the abrupt initiative are not over, however.

LNG imports in November hit a monthly record, climbing 53 percent from a year earlier, making China the world’s second-biggest LNG importer after Japan, Reuters reported.

Total gas imports for 2017 jumped 26.9 percent to 68.6 million metric tons, the General Administration of Customs said.

Over the first 11 months, China’s gas imports rose at nearly three times the rate of domestic production.

While domestic output increased 10.5 percent from a year earlier to 133.8 billion cubic meters (bcm), imports of 81.7 bcm climbed 28.9 percent, the official English-language China Daily said.

Import dependence a major concern

The numbers tell a story of growing import dependence, already a major concern for China with its rising reliance on foreign oil.

According to recent forecasts from the International Energy Agency (IEA), gas imports covered about 35 percent of China’s demand in 2016. That proportion is expected to climb to “just under 50 percent” by 2040 with imports reaching 280 bcm, the IEA said.

Domestic production numbers for all of 2017 are scheduled to be reported later this week, but the 11-month figures suggest that imports already account for nearly 38 percent of consumption.

In its annual World Energy Outlook, the IEA argued that China’s total import dependence for all forms of energy would not rise substantially over the forecast period, starting in 2016 at 21 percent and edging up to 24 percent by 2040.

But the moderate increase is the result of China’s continued heavy reliance on domestic coal, which the government is trying to replace with cleaner fuels like gas.

The growth in import dependence for gas is likely to heighten concerns about China’s reliance on foreign oil.

According to the IEA, the country’s import dependence will grow to 80 percent for oil in 2040 from 64.5 percent in 2016.

The ratios mean that China will rely increasingly on overseas energy sources not only for its economic growth but also for its environmental goals.

The combined challenges are expected to become a major motivation for China to increase its presence abroad and project its military power to safeguard energy supply routes overseas.

By 2030, China will consume about one-fourth of all the world’s gas traded over long distances and nearly 30 percent of internationally traded oil, the IEA said.

Rising energy risks

Edward Chow, senior fellow for energy and national security at the Center for Strategic and International Studies in Washington, said the long-term forecasts and China’s sudden spurt in gas demand are both signs of rising energy security risks.

“In the long run, this really shows a major deficiency in the Chinese system,” Chow said by email.

“In spite of fast growth in renewables and nuclear power, coal use has not been reduced sufficiently to improve air quality. Infrastructure for distributing electricity and gas effectively is still lacking. Price controls and slow adjustment in prices have led to chronic shortages,” he said.

Chow said that President Xi Jinping’s policies based on government control and the use of state-owned enterprises in key sectors “have led to increased vulnerability in energy security.”

China’s gas deficit is expected to increase the importance of overland pipeline deliveries from Russia’s Power of Siberia project and other routes that Moscow has promoted, as well as China’s existing lines from Central Asia.

Last year, pipelines from Central Asia delivered 38.7 bcm of gas to China, a 13.4-percent increase, Xinhua reported.

But heavy reliance on waterborne LNG could be problematic for both security and economic reasons. LNG from 16 countries accounted for nearly half of China’s gas imports in 2016, the IEA said.

While China has invested heavily in LNG import terminals and covered some of its bets with supply contracts, it has leaned on the spot market for cargoes to balance seasonal needs and supplement domestic supplies.

That approach poses problems for both energy security and infrastructure.

“LNG cannot be a long-term solution without exacerbating the country’s reliance on seaborne energy imports. Nor does it make business sense to commit to more long-term LNG contracts without adequate gas storage facilities,” Chow said.

Not enough storage

Insufficient storage has been seen as an energy security problem for China in both oil and gas.

After a decade of investment in a strategic oil reserve, the National Bureau of Statistics reported this month that China had stored 37.73 million tons (276.5 million barrels) of crude by mid-2017.

While the level rose 13.5 percent from a year earlier, the reserves represent only about 35 days of imports, far less than the 90 days of import coverage required for IEA member countries.

But China’s vulnerability due to inadequate gas storage may be even worse.

The country has only 8 bcm of gas storage capacity, according to Kerry Anne Shanks, head of Asia gas and LNG research at the energy consultancy Wood Mackenzie, as quoted by Reuters in October.

“We worry that China doesn’t have enough storage,” Shanks said.

Even if it were full, the storage would cover only 32 days of imports at the 11-month level. In relation to demand, the capacity is only one-fourth to one-sixth of the amount available in the United States and Europe, Shanks said.

The IEA forecast for China’s domestic production may also be optimistic because it assumes a 12-fold increase in shale gas output to 100 bcm in 2040. China produced 7.9 bcm of the unconventional gas in 2016, the Ministry of Land and Resources said.

Shale gas production costly

Although China has the world’s largest shale gas reserves, production in the fledgling industry has remained costly and modest due to difficult geology and changes in government subsidy policies.

Ambitious shale targets for 2020 of up to 100 bcm were set in 2012, then scaled back in 2014 to 30 bcm. Recent reports make it unclear whether even these will be met.

Subsidies for shale gas production are set to be slashed by half with no commitment for any support after 2020, the IEA said.

The nation’s biggest shale gas resource—Sichuan province’s Fuling field, developed by state-owned Sinopec—produced about 6 bcm in 2017, falling far short of the 10-bcm target for the year.

The disappointing returns may suggest even greater import dependence than forecast without significant changes in incentives for production.

Nearly all of the projected growth in China’s gas production by 2040 is expected to come from unconventional sources, including shale and coalbed methane, the IEA said.


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