The Future of Natural Gas in China: Why the World Cares

Thirty-five years ago China embarked on a new policy path of “Reform and Opening Up.” One cannot but marvel at the tremendous economic progress that has been made since, as well as at the pace and scale of change experienced by Chinese society. Some time this decade, China will become the world’s largest economy; it is already the world’s largest energy consumer (and consequently its largest greenhouse gas emitter); and China will almost certainly surpass the United States as the world’s largest oil importer in 2014.

What happens to energy in China matters very much to global markets, as we have already witnessed with oil and other commodities. At the same time, as China climbs the income ladder, its population increasingly demands better quality of life after basic necessities are met. Chinese citizens (and therefore their leaders) will no longer tolerate the sort of environmental degradation the previous development path has wrought, particularly in air and water pollution.

This is why the future of the natural gas industry in China is an important topic for both the country and the world. Today natural gas is severely underrepresented at 4 percent of China’s energy. Yet it provides the best option for a cleaner fuel to satisfy increasing energy demand, without further reliance on coal and before clean renewable alternatives can be made available in sufficient quantities. However, unless China can produce significantly more natural gas from conventional and unconventional sources, rapidly hiking the share of natural gas in the energy mix (as is planned), it may repeat the experience of oil with great leaps in import demand for gas, which can disrupt international markets as well as raise energy security and cost concerns for China itself.
There is a lot of international interest in the future of natural gas in China that goes beyond estimates of technically recoverable reserves, which appear to be abundant particularly for shale gas. Unfortunately, most foreign researchers do not have good access to Chinese data and, even when they do, may not interpret them accurately given the vagaries of national statistics.

Therefore, the China Energy Fund Committee has contributed mightily by commissioning a survey of Chinese expert opinion on natural gas and compiling articles written by well-respected Chinese scholars, researchers, and energy industry practitioners, having them translated into English from the original Chinese, and making them available to enhance international understanding of issues related to the future of natural gas in China. It was my distinct privilege and pleasure to have reviewed these articles and participated in their editing. I take this opportunity to offer some personal observations gleaned from the articles before encouraging you to read all of them carefully for the insights they provide.

First of all, one is struck by how thoroughly Chinese scholars understand their internal situation and are willing to discuss it, including all the deficiencies in the Chinese system that can be significant barriers to achieving targeted domestic production levels and optimal utilization of natural gas. From seemingly minute details—illogical classification of unconventional gas and other statistical definitions that inhibit both central planning and a functioning market—to broader and more difficult issues:
 

• Reform of gas pricing from a complicated cost-plus system, including cross-subsidization;
• State-owned enterprises exercising monopoly power;
• Overlapping mineral rights;
• Limited access to exploration acreage for domestic and foreign private capital;
• Unbundling petroleum service contractors from the major Chinese oil companies to gain efficiency;
• Fair access to critical infrastructure and direct access to consumers, etc.

They were all well covered. The critical need to introduce more competition into the natural gas sector was reiterated by the authors.

Although the papers were written long before the recently concluded Third Plenum of the 18th Congress of the Chinese Communist Party, they resonate with its call for the market [or market forces] to play a “decisive role” in the allocation of resources. This apparent consensus between the expert community and policymakers in China explains perhaps my second observation, which is the overall sense of optimism and confidence from the authors that China will realize its goals for increasing domestic natural gas production from unconventional sources and utilize a lot more natural gas, particularly in power generation, in spite of the numerous obstacles that they delineated, which will not be overcome easily.

Thirdly, Chinese experts recognize very well that the conditions that gave rise to the American shale gas revolution (i.e., mineral rights for private landowners, deregulated pricing, small to medium-size exploration and production companies and service contractors, regulations governing the natural gas industry developed over decades, well-defined division between state and federal authorities, industry access to investment capital, etc.), are very different from China’s current circumstances. Consequently, China will need to adapt the lessons learned from the American experience and adjust them to fit Chinese conditions.

Chinese pragmatism, “crossing the river by feeling the stones,” is so central to the entire reform process and will serve China well in succeeding in shale gas with “Chinese characteristics.” The demonstration effect of foreign investment can serve a useful purpose that goes along with the provision of capital and technology, which is why “opening up” must accompany reform.
Incidentally, this pragmatic approach is not so different from the American experience of constant experimentation and refinement of techniques applicable to different shale plays, driving down costs to remain profitable even when prices decline with abundant supply, and shifting to tight oil or liquids-rich plays. The entrepreneurial spirit, nimbleness, and cost consciousness required are reasons why small to medium-size companies appear to be more successful than large companies or organizations in shale operations.

My last observation on these papers is that it was striking how little concern there was over the level of Chinese natural gas imports. The authors seem to agree that the planned increases in pipeline and liquefied natural gas (LNG) import capacity will be needed through 2020, but after that increased domestic production from unconventional sources will mostly take care of China’s future gas needs. There was little consternation over the reliability of gas import sources, unlike a similar discussion in Europe or Japan. Imports from specific countries, such as Russia, were hardly mentioned. To the extent that gas supply security was discussed, it was over security of maritime supply routes more than insecurity of import sources.

It seems the authors have great faith that most of the policy recommendations they made to advance the domestic natural gas industry will be implemented during the 13th Five-Year Plan period from 2015 to 2020. Given China’s track record since 1978 of executing economic policies and adjusting them as necessary, foreign observers like me are in no position to question this faith and indeed should wish China well, as the consequences of success or failure would be so important to China and the global community. We will certainly be watching closely and with deep interest.
[This commentary originally appeared as a “guest editor’s note” in China Energy Fund Committee (CEFC), China Energy Focus: Natural Gas 2013 (Hong Kong: CEFC, 2013). It is reprinted here with permission.]

Edward C. Chow is a senior fellow with the Energy and National Security Program at the Center for Strategic and International Studies in Washington, D.C.

Commentary is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

© 2013 by the Center for Strategic and International Studies. All rights reserv