City gas swells in China [NGW Magazine]

China’s gas demand surge this winter on the back of the worst cold snap in decades benefited local city gas distributor. This sets them up for positive momentum in the first half of this year.

Replacing coal with gas has helped the financial health of city gas distribution companies as well as the physical health of their customers. City gas distribution is the strongest driver of China’s domestic gas sales and grew by 14.7% year-on-year in 2019 to 113bn m³, representing 37% of total gas demand, according to data from PetroChina.

The country’s five biggest city gas operators are Kunlun Energy, China Gas Holdings, China Resources Gas (CR Gas), ENN Energy Holdings and Towngas China, which are estimated to have a total share of more than 60% of the city gas market. Kunlun is owned by PetroChina while the other four are independent firms traded on the Hong Kong Stock Exchange.

China’s top economic planning body has yet to release an official figure for domestic gas consumption last year, but all signs point to a strong recovery in the second half of 2020 –especially for the cold months of November and December.

The Chongqing Petroleum and Gas Exchange, a gas trading hub in southwest China, reported that apparent gas demand growth accelerated from 5.9% in October to double digits in November 2020 to January 2021. In addition China’s LNG imports in December increased by 15% year-on-year to a record high of 9mn metric tons.

Apparent gas demand from January to November had already expanded by 6% from the same 11 months of 2019, surpassing the mid-year expectations of various forecasters who had felt the demand outlook was unclear because of uncertainties about economic growth, global market conditions and secondary waves of infection.

Winter demand snowballs

A much colder than expected winter will have boosted demand during China’s current heating season, which began at the start of November – two weeks earlier than usual – and is expected to finish in mid-March. The average temperature in China in December dipped as low as -4°C, which was the coldest since 2013.

For gas distributors, taking ENN Energy as an example, a 1 °C drop in temperature can increase gas sales volume by 2mn m³/day. Over the course of the four month-long heating season, a 1 °C cooler winter can contribute an additional 200mn m³ of gas sales – or roughly 1% of total annual sales volume.

The market view in the run-up to this winter was that China was adequately prepared to meet winter demand and was even facing a surplus. However, freezing weather and some disruptions upset the supply-demand balance.

Shortages were reported in some northern parts of the country, which NGW understands prompted central authorities in early January to hold an impromptu conference call with dozens of state-owned gas firms to berate their inability to secure more supplies for winter.

Temporary outages in the Central Asia-China Pipeline, as well as the Beihai LNG terminal – which stayed offline for all of November and December – further contributed towards gas supply disruption. Northern provinces curbed commercial and industrial gas use in an effort to preserve residential supply.

The gas crunch in December and last month was reminiscent of three years ago, when ambitious efforts to switch homes and factories from coal to gas created shortages in the middle of winter. Were it not for the shortages, last year’s gas demand would have been even higher to the benefit of gas distributors.

Deregulated gas prices spiked in response to the tighter supply-demand balance. Spot prices for domestic LNG more than doubled in northern China and surged by 60% in southern China from November. The LNG price in the northern provinces of Jilin and Liaoning, and the key LNG consumption markets of Shandong and Hebei exceeded RMB 10,000/metric ton ($29.8/mn Btu) in late December. That was almost four times the average RMB 2,700/mt in June-August 2020.

Prices at the pump for LNG-powered vehicles almost doubled within the month of December, from RMB 4,400/mt at the beginning of the month – 14% lower than a year ago in 2019 – to a high of RMB 8,300/mt on December 23. The average price in December reached RMB 6,500/mt, which was one-quarter higher than December 2019.

In past years, the higher prices would have been a risk to the margins of city gas distributors  squeezed between higher wholesale costs from upstream suppliers and government-led retail prices for piped gas use.

However, insiders at ENN Energy, China Gas and CR Gas told NGW that the impact will not be as significant as feared as many city gas projects operated by distributors have established automatic price passthrough mechanisms – meaning that higher costs are simply passed onto customers.

Upbeat for 2021

China’s gas demand growth is expected to accelerate this year, as the country continues to lead the world in post-pandemic industrial production recovery. The International Monetary Fund expects China’s economy to grow by 8.1% this year, while the World Bank has forecast 7.9%, outpacing global and Asian economic growth of 5.2% and 6.9%, respectively.

A pick-up in property construction activity after this winter also bodes well for China’s gas distributors as they will earn fees from connecting new apartments and houses to the gas grid. So-called connection fees have a higher profit margin than gas sales and will continue to provide a stable source of profit for distributors over the next three to five years.

This year will also mark the first full year of operations for PipeChina, the national pipeline operator that officially kicked off operations last October. The company could begin to make a positive impact on city gas operators this year as it opens up access to gas infrastructure previously monopolised by China’s three NOCs. Market liberalisation will provide an opportunity for larger distributors to diversify their gas supply and lower their gas sourcing cost.

Diverging outlooks

But while 2021 is shaping up to be positive for gas overall, the performances among China’s leading distribution firms are likely to be mixed. Last year ENN Energy significantly outperformed peers as it increased gas sales volumes faster and benefited from access to its parent company’s Zhoushan LNG terminal, which it use to import lower-cost Brent-linked cargoes before the winter.

China Gas and Kunlun Energy were the two next best performers but Beijing Enterprises and Towngas China significantly under-performed as Covid-19 put greater pressure on their business models.

These trends are likely to extend into this year. The sense among industry analysts is that ENN Energy and China Gas have the best growth outlook. ENN has a healthy pipeline of projects – the company reported 141 integrated energy projects in operation or under construction at the end of October, the majority of which burn gas. ENN also grew gas sales strongly entering the winter, with volumes up by 18.2% year-on-year in the third quarter of 2020 and 8.2% for the first nine months of 2020.

Gas sales at China Gas have also remained robust, with the company recently recommitting to a target of expanding sales by 15% in the year up to March 2021. Meanwhile Kunlun Energy, the downstream gas distribution arm of state-owned PetroChina, is investing significantly in expanding its business following the sale of pipeline and LNG import infrastructure assets to PipeChina.

Kunlun will receive RMB 41bn from the transaction, of which RMB 37bn will be paid in cash. The PetroChina subsidiary intends to earmark RMB 15bn on expanding its downstream business, a move that would follow the acquisition of 10 city gas projects in October for RMB 682mn.

It is the chasing pack that could struggle. Among the major city gas operators, CR Gas is most dependent on connection fees but struggled last year to increase the number of households linked to the local pipeline network. The company said it aimed to connect 2.6-2.8mn households in 2020, representing a decline of 15-20% from 2019, and the likelihood is that connections will continue to drop this year. Towngas China suffers from the same overreliance on connection fees.

Policy trends

The policy trend entering the 14th Five-Year Plan period, which began this year, is the biggest area of uncertainty for the Chinese gas market and will play a significant role in shaping gas demand growth over the next five years. But industry insiders are sanguine and expect policies will continue to be supportive in the short-to-medium term as gas will remain an important transition fuel as China moves towards carbon neutrality by 2060.

After this decade, with China’s net zero pledge in mind, the main long-term risk for local gas distributors is if the country follows in Europe’s decarbonisation footsteps and gas demand starts to decline after 2030. Both the International Energy Agency and the Oxford Institute of Energy Studies anticipate European gas demand declining after 2030.

However, gas accounts for a far smaller share of the energy mix in China than in Europe – 9% versus 21%. China’s central government has targeted the share of gas to reach 15% by 2030, implying there is still room for gas to grow in the energy mix over the next decade.

China’s decarbonisation will also offer opportunities for city gas operators to expand into zero-carbon energy. There is the potential for hydrogen blending into the grid, an area where ENN Energy is already exploring.