Gas Marketing in South China Xiuguang Zhao, CNOOC, China Dan Westbrook, BP China Josh Fu, BP China Abstract.

The gas industry in China is currently limited to certain regional markets and accounts for less than 3 % of primary energy consumption, compared to about 15%-20% in the OECD countries. In the past twelve months however, there has been a staggering change in emphasis on gas in China. The Chinese government has sanctioned two mega gas projects: the trans China West-East pipeline project (WEP) bringing 12 bcmy of indigenous natural gas from the remote western regions to coastal cities like Shanghai; and the Guangdong LNG Regasification Terminal & Trunkline project (GDLNG) initially importing [7 bcmy] LNG into south China. The total infrastructure investment will exceed US$5 billion and will significantly transform the non-existent gas economy in China to prominence. South China1 in this paper refers to four provinces and two Special Administrative Regions (SAR). The total area of South China is 570k sq. kilometres and a population of 170 million. The total gas demand in South China is estimated to triple from the current 3.5 bcmy to over 23 bcmy by 2010. Despite the proximity among the provinces, they exhibit fairly diverse market characteristics in terms of demography, accessibility to gas resources and infrastructure, gas price affordability and elasticity, interfuel competition and environmental regulations. East Pearl River Delta (EPRD) of Guangdong for example, being the recipient of GDLNG gas from late 2005 onwards will initially be developed as a LNG market, yet the West Pearl River Delta, Hong Kong and Macau SARs will be open to competition between GDLNG and indigenous South China Sea (SCS) gas. Hainan and Guangxi are geographically located as SCS gas markets and Fujian as the potential LNG market from 2008 With such a huge market potential yet varied market characteristics, the gas marketing strategy must ensure in the first place, that the gas economy can be developed under an appropriate legislative and regulatory framework so that gas supply is competitive and sustainable in the long run. The focal point of this presentation is to highlight the South China gas market characteristics and articulate the market development strategy taking into account the potential giant leap of gas demand, the supply boundary conditions, the evolving regulatory and policy development, and what efforts are being undertaken by China government to create an new gas economy in the area, including environmental and incentives policies.

Introduction
Up to now gas has been very much a niche fuel in China. In 2000, natural gas accounted for approximately 3% of the PRCs primary energy consumption. Natural Gas is primarily used as chemical feedstock (mainly for fertiliser production) and for distribution as town gas (mainly for residential consumption). However, the government has set a target of increasing gas usage to 7% of primary energy demand by 2010. Although this may appear a relatively modest ambition, the size of the country is such that this requires an additional 60 Bcm/a of gas supply (equivalent to more than 40 mtpa of LNG) taking the market to five times the size of the Korean market. This is a significant challenge. The government has responded by launching two major gas market development projects in 2001. The West-East Pipeline project to bring indigenous gas from remote Western China to the demand centres of the East and the Guangdong LNG import project. This paper explores some of the implications for gas market developers, concentrating on the market in South China and particularly on the development of the Guangdong LNG Terminal and Trunkline project.

The Current Energy Picture

1

South China refers to Guangdong, Guangxi, Hainan and Guangxi provinces and Hong Kong SAR and Macau SAR. 1

Chinas energy supply is dominated by coal for the very good reasons that it is cheap, available in large quantities and indigenous. It is not, however equally distributed across this vast country and the prosperous south is relatively poorly provided. Coal use is also a major factor in a growing pollution problem that is becoming serious, particularly in the cities. Tables 1and 2 illustrate the distribution of energy production and consumption of in China:

Table 1: Chinas Energy Production & Production Pattern, 1980-2000

Year 1980 1985 1990 1995 2000 Source: ERI Production (in MTCE2) 637 855 1,039 1,290 1,090 % in Energy Production Coal Crude oil Natural gas 69.4 23.8 3.0 72.8 20.9 2.0 74.2 19.0 2.0 75.3 16.6 1.9 67.2 21.4 3.4 Hydro power 3.8 4.3 4.8 6.2 8.0

Table 2: Chinas Energy Consumption & Consumption Pattern, 1980-2000

Year 1980 1985 1990 1995 2000 Consumption % in Energy Consumption (in MTCE) Coal Crude oil Natural gas 603 72.2 20.7 3.1 767 75.8 17.1 2.2 987 76.2 16.6 2.1 1,312 74.6 17.5 1.8 1,280 67.0 23.6 2.5 Source: ERI Hydro power 4.0 4.9 5.1 6.1 6.9

In most countries, particularly since the advent of CCGT power generation technology, this would be a clear signal to shift the balance of energy use firmly towards gas. The conditions in China are rather different from most countries, however, and a move to greater usage of gas presents policy and economic challenges that are special to China. Although the government of the Peoples Republic (PRC) does want a substantial increase in gas use it faces some quite difficult choices in implementing the policy. Although China is far more open to overseas trade than it has been (as demonstrated by its recent entry to the WTO) it prefers to be self sufficient in strategic resources as far as possible. Gas reserves within the country are limited; adding to the dilemma, the largest source of new gas lies in Xinjiang in the far west of the country, many thousands of kilometres from the main centres of demand in the rich cities of the east and south. The cost of transmitting this gas to market across large tracts of desert and semi-desert with little prospect of capturing demand along much of the route is a formidable obstacle to its development. But the west is far less developed than the coastal fringe and the government has a very understandable need to redress the balance. Even with Xinjiang gas development, a massive expansion of gas use would undoubtedly require substantial imports, the main option being pipeline gas from eastern Siberia and LNG. China therefore does not have access to particularly low cost gas. Put together with the availability of cheap coal and an established local industry capable of building low cost, coal fired, generation plant but not CCGTs this means that gas does not necessarily provide the lowest cost power generation as well as one of the cleanest. In addition and in common with Japan Korea and Taiwan, imported gas is unlikely to be able to compete head to head with heavy fuel oil (HFO) in industrial applications. Gas clearly has a significant place in the future of the Chinese energy market but its expansion does present the gas developers and the Chinese government with some particular challenges.

million tonnes of standard coal equivalent 2

The Wider Gas Market in China

Natural Gas is consumed in China mainly in the medium to large cities in the gas producing regions and only in a few non-producing regions such as Beijing and Shanghai. Gas production is dominated by three state owned companies The Chinese National Offshore Oil Company (CNOOC), PetroChina Company Limited (PetroChina) and Sinopec Corporation (Sinopec). China produces very little natural gas and output growth has recently declined. As of 2001, China has natural gas reserves of 48 Tcf (1.36 Tcm), equivalent to 0.9% of the world total.3 In 1983, the discovery of natural gas off Hainan Island by Atlantic Richfield (now BP) provided a major boost for Chinese reserves and production growth. In 2000, the discovery of the countrys biggest natural gas field in the northern part of the Tarim Basin in Xinjiang Province is estimated to provide China for more than 7 Tcf (199 Bcm) of gas. China currently produces natural gas from four established regions : Sichuan Province; Shaanganing (the Ordos basin); Xinjiang Uygur Autonomous Region (the Tarim, Chungeer, and Caidamu basis); and Nanhai West in the South China Sea.

Sichuan Province is the largest producing area, providing 202 Bcf (5.7 Bcm or 7 MTCE equivalent) per year of natural gas. The South China Sea is the second largest producing region, providing about 113 Bcf (3.2 Bcm or 4 MTCE) per year to Hong Kong and Hainan Province. Currently, Chinas pipeline system is regionally segmented. The pipelines only connect producing fields to nearby end users.

Source : Energy Information Administration / International Energy Outlook 2001 3

Fig 1: Chinas major gas pipelines

Source: Energy Information Administration / International Energy Outlook 2001 To expand its natural gas supply, China has a number of options: Fully develop its domestic reserves. Most of the domestic reserves are essentially underdeveloped, with reserves to production ratios ranging from 30 years in the Northeast to 65 years in Sichuan Province and 243 years in Western China. Utilise reserves from surrounding countries. In Russia, the Irkutsk basin, Krasnoyarsk, and Sakha regions contain approximately 50 60 quads4. Import LNG

The governments strategic response has been to promote the west-east pipeline taking gas from Xinjiang ultimately to Shanghai, and to launch the Guangdong Terminal and Trunkline project as a pioneer LNG import into a region with few alternative possibilities of gas supply in the short term. It is also examining schemes for the import of Russian pipeline gas. A bidding process was launched for foreign participation in the west-east pipeline which was won by Shell. It represents a real economic challenge but it is not the purpose of this paper to discuss it. The viability and desirability of importing LNG has been studied for more than a decade and it was eventually decided that a pioneer project should be developed in Guangdong. A similar bidding process in early 2001 resulted in the selection of BP as the foreign partner for the Guangdong LNG Terminal and Trunkline project and the rest of this paper will concentrate on the gas marketing issues that have arisen in south China and to examine how they have been approached.

South China Gas Market

4

Quads : Quadrillion BTU 4

Fig 2: South China Gas Market

Pop. 33 mm GDP p.c. $1,300

Fujian
Pop. 73 mm GDP p. c. $1,475 Pop. 47 mm GDP p.c. $500

Guangdong Macau
Pop. 0.45 mm GDP p.c. $16,000

Guangxi
LNG

Hong Kong
Pop. 7 mm GDP p.c. $24,000

Pop. 8 mm GDP p.c. $870

LNG

H
Yacheng

SCS

South China5 in this paper refers to four provinces Guanxi, Hainan, Guangdong and Fujian and two Special Administrative Regions (SAR), Hong Kong and Macao. The total area of South China is 570k sq. kilometres and the population 170 million. Despite the proximity among the provinces, they exhibit fairly diverse market characteristics in terms of demography, accessibility to gas resources and infrastructure, gas price affordability and elasticity, interfuel competition and environmental regulations. Nevertheless BP has estimated a potential demand of 18 Bcm/a of gas by 2010 compared with the 3.5 Bcm/a supply at present. As has already been mentioned gas from the South China Sea already supplies Hainan with about 0.5 Bcm/a and is piped to Castle Peak Power in Hong Kong where it fuels power generation but not a wider gas market. The western part of region is likely to remain a market for SCS gas. The extent of this will depend to a degree on future exploration success in the area but there is undoubtedly some remaining potential. The eastern part of the region will require LNG imports and, inevitably there will be an area of overlap where LNG and SCS gas will compete for market.
5

South China refers to Guangdong, Guangxi, Hainan and Guangxi provinces and Hong Kong SAR and Macau SAR. 5

We will look at the regional market province by province. Hainan Hainan already takes about 0.5 Bcm/a of gas from the Yacheng field. Potential supply will be expanded with the commissioning of Dong Fang 1-1 in 2003. There is a trunk pipeline following the western and northern coasts of the island and it is planned to extend this into a full coastal ring main. Demand in Hainan is primarily in the power generation and chemical sectors. Existing buyers, notably the Nanshan power plant and Fudao fertilizer plant need more gas. A new ammonia plant is planned at Baosuo and there are new chemical projects in the planning stage notably a Du Pont /BASF nylon plant. CNOOC, in anticipation has taken positions in phase 2 of the Fudao fertilizer plant and in the Yanpu power project. BP expects the province to take some 2.5 Bcm of SCS gas by 2010, mainly in the chemical sector. The province is considering using its advantageous gas supply position to become an exporter of electricity, which could provide greater upside. Currently gas price in Hainan is kept artificially low and there is greater incentive to move SCS gas towards the more lucrative markets in Hong Kong and Guangdong where price is more clearly driven by competing fuels. This is fairly characteristic of the regulatory anomalies that persist in China at present. Guangxi Guangxi has a rather small industrial base and is rich in Hydro resources. It benefits from policy incentives to export cheap hydro and coal fired power. Nevertheless its coastal region is reasonably close to the sources of SCS gas and if supply does become available gas could play a role. Currently a 750 MW gas fired CCGT power plant at Qinzhou is planned by Unocal. Unocal has an MOU for gas supply with CNOOC and this plant may take Dong Fang 1-1 gas. This would provide an anchor for gas development in the province and a base from which gas demand could be grown. Potential for around 2 Bcm of gas by 2010 is realistic expectation. Fujian Fujian is a more developed coastal province with strong links to Taiwan. It is one of the areas being considered by the Chinese government for a future LNG terminal and is currently the preferred location for a follow up terminal to Guangdong in about 2008. The provincial government is strongly in support of a terminal. Pre-feasibility work has been carried out and suggests that the initial development would be based on three new gas fired power stations and replacement of manufactured gas in five cities. Potential demand is 3 Bcm by 2010. Guangdong Macao and Hong Kong The area with the largest and most immediate potential is Guangdong province and particularly the Pearl River Delta (PRD) area together with Hong Kong and Macao. Guangdong has more than 70 million inhabitants, and its GDP accounts for more than 11% of Chinas total. Within the region there is a wide range of per capita GDP (Shenzhen for example has a per capita GDP of $13,000), but at US$1,472 on average it is 1.4 times the national average. The economy of Guangdong Province has been developing rapidly, particularly since the Chinese market reforms that started in the early 1990s, and its GDP growth has been faster than in any other Province of China. Its reported annual average GDP growth was 19.68% over the last 20 years (although rather slower in recent years). It has benefited from the movement of some production and labour from Hong Kong, and continues to be a major exporter and net earner of foreign exchange. Within the Pearl River Delta, which is the source of most of the regions development (with a population nearly half that of the whole region) per capita GDP is four times the national average. This area is responsible for about 40% of total foreign exchange earned in all China.

Guangdong is only about 10% sufficient in energy supply, and the fast growth of demand has in some years created shortages, particularly of electricity. Recent improvements in electricity capacity have been again overtaken by growth in demand, so that shortages are again expected. At present the annual output of coal is only 7,500,000 ton. Coal mining in Guangdong is difficult and costly, and coal enterprises have been mostly loss making. The output of coal has been decreasing year by year, and although coal use has grown. In the last five years there has been a marked reduction in the share of coal in the Guangdong energy market. There has been to a worsening of pollution in the region and Guangdong Province has now forbidden any new coal fired power station building (although it is not certain that this prohibition will be adhered to). Guangdong is rich in oil shale, but it has a low heat value and high dust content, and exploitation is not commercially practical. Because of its shortage of indigenous energy and is relative prosperity Guangdong was an obvious candidate for LNG imports. The anticipated market for regasified LNG was both power generation and town gas reticulation and initially the east PRD area and Hong Kong were targeted. However, the government foresaw a second phase of development extending to the West PRD area and Macao. However, SCS gas already reaches Hong Kong for power generation and if sufficient supply becomes available SCS gas might be supplied to the West PRD area. Over the long term supplies of LNG and SCS gas are both likely to be available and required in the region. They are to an extent complementary to each other and it is common for LNG and pipeline gas to co-exist with each other in Europe and the USA. However the possibility of alternative supplies presents some regulatory and industry structure issues for China which will need to be resolved to ensure that the industry will operate smoothly and in an integrated fashion, whichever source of gas it uses. Power Demand Guangdong has a large power market. Generating capacity is 32 GW (2000) broken down as follows:

Table 3: Capacity Composition of the Guangdong Grid (2000)

Nuclear Power 6%

Hydro Power 15%

Pumped Storage 8%

Thermo Power 71%

Some 60% of the thermal capacity is coal fired and the remainder oil fired. Electricity demand is expected to grow briskly and in fact peak demand is growing faster than average demand as the region becomes more prosperous and air conditioning loads increase; the demand is significantly 7

higher in summer than in winter

Table 4: Projections of Demand for Electricity on the Guangdong Grid, 2001 - 2010
2000 GDP, million Yuan Growth rate % (5 years) Population, million Middle projection, TWh % p.a. increase (5 years) 73.25 133.5 95.06 2005 146.26 9.0 77.3 196.0 8.0 79.4 240.0 2008 2010 214.9 8.0 80.87 275.0 7.0

per capita consumption, kWh/ 1823 2536 3023 3401 person/ year Source: Planning Commission of Guangdong Province and the Guangdong Grid Company The Hong Kong and Macao power markets are separate from each other and from the Guangdong market. Hong Kong has two electricity suppliers, Hong Kong Electric and China Light and Power which together have about 10.5 GW of generating capacity. Demand is growing more slowly in Hong Kong than in Guangdong itself. Potential power generation demand in Guangdong Hong Kong and Macao in 2010 is equivalent to some 11Bcm. Town Gas There is no gas fired power generation in Guangdong but there is a small existing town gas market. Somewhat surprisingly none of this is coal gas. Because the arrival of natural gas, either in the form of South China Sea gas or LNG has been anticipated for a long time, the major municipalities in the PRD area have been encouraged to develop gas reticulation systems. The largest of these is in Guangzhou where gas manufactured from oil is distributed. Shenzhen and several smaller cities distribute piped LPG but all the systems have been designed with the eventual use of natural gas in mind. More than 3.2 million tonnes of LPG were used in Guangdong in 2000 but piped LPG only accounts for 122,000 tonnes of this and there was in addition 0.13 Bcm manufactured gas. The potential demand for town gas in the province based on consideration of the potential for displacement of existing liquid fuels and for supply to households could exceed 3mtpa of LNG (4 Bcm/a) but only some 2.5 Bcm is expected to be achieved by 2010. There is a larger manufactured gas operation run by Hong Kong and China Gas (HKCG) in Hong Kong which is expected to be taking 0.3 Bcm of natural gas in 2010.

Guangdong LNG Project

This then was the background facing the Guangdong Terminal and Trunkline Project when it started its feasibility study in April 2001 and set about marketing regasified LNG. It was clear that an initial scale of around 3 mtpa of LNG imports was necessary for viability and likely to be achievable. However, the market development task needed to actually deliver these volumes was distinctly challenging. Three new CCGT plants would be developed in Guangdong, two by Yuedian Asset Management (formerly the generating arm of the provincial electricity company) and the third by Shenzhen Investments. Each was to be a1050 MW plant. In addition Hong Kong Electric (HKE), one of the two electricity companies in Hong Kong would convert its peak shaving gas turbines from liquid fuel to gas and also planned new CCGT capacity. On the town gas front HKCG would initially replace half of the naphtha feedstock to its gas manufacturing plant by natural gas equivalent to some 250,000 tpa of LNG. Six other companies in the east PRD area also planned to take gas: 8

1. Guangzhou Gas, currently distributing manufactured gas 2. Panyu Gas distributing and LPG/Air synthetic natural gas (SNG). 3. Shenzhen Gas, 4. Foshan Gas, and 5. Nanhai Gas distributing LPG and 6. Dongguan gas, which has no reticulation at present but which sells bottled LPG The project developed plans for the terminal and pipelines to serve these customers:

Fig 3: Project Location

Foshan Dongguan Huizhou Guangzhou

Guangdong Province
Guangzhou Foshan Zhongshan Zhuhai Dongguan Huizhou Shenzhen Hong Kong

Shenzhen Jiangmen Qianwan Power Plant Zhongshan

Pingshan
16Km

Huizhou Power plant

LNG Terminal Shenzhen Eastern Power plant (integrated with terminal)

Y 13-1 Line

Trunk Pipeline Length

LNG Terminal - Pingshan(Phase I) Pingshan - Foshan(Phase I) Foshan - Zhuhai(Phase II) 16 Km 199 Km 182 Km 397 Km

South China Sea

Zhuhai

Total

Branch Pipeline Length Connect to Nanhai Offshore gas Phase I: Trunk PipelinetoShenzhen, Dongguan,Guangzhou and Foshan (300Km) Phase II: Trunk Pipeline extends to Huizhou, Zhongshan, Zhaoqing,Jiangmen and Zhuhai (182Km)

Pingshan - Huizhou Power Plant (Phase I) 33 Km LNG Terminal - Shenzhen (Phase I) 52 Km Total 85 Km

Although the basic marketing framework was established there were considerable challenges to overcome in converting this into the long term take-or-pay contracts required to support the project investment and the purchase of LNG.

Power Market Challenges

Because gas does not provide the lowest cost form of power generation, it is seen in Guangdong as a fuel for intermediate and peak load. (It is economically preferred to oil which accounts for nearly 30% of generating capacity in the province.) Gas market developers on the other hand have become accustomed to using baseload CCGTs as anchor customers. Gas suppliers are used to supplying CCGTs on long term take-or-pay contracts and the electricity offtake is guaranteed by a power purchase agreement with similar take-or-pay, usually in the form of a high capacity charge. The baseload character of the generation has the added benefit of providing the even offtake pattern that gas sellers need. The second major challenge for the Guangdong LNG project is that the power industry in China is in the process of being liberalised. Guangdong is in the forefront of this process and in August 2001 the generating assets of provincial electricity company were separated from the grid and placed in a separate company (there are also a large number of independently owned power plants amounting to 45% of total capacity). At present the power from each plant is individually priced but the province wishes to move rapidly to a more competitive pricing mechanism with, at least an element of, pool pricing but, as yet, no firm proposals have been formulated.

In fact LNG supply is quite well suited technically to supporting mid load power generation as the receiving terminal provides a measure of storage that allows the gas supply to handle daily and weekly variation in offtake. It is much less good at providing seasonal variation as the quantity of storage required would be very costly. Therefore, contracts are being developed to allow the use of gas for mid load generation while controlling offtake pattern to the practical limits of the LNG supply. This in turn requires the generators to have certainty of dispatch within the constraints of this offtake pattern and an adequate price for their electricity. The uncertain state of power market reform does not give the long term confidence that the project and the generators require and as a result the project has been working with the Energy Research Institute (ERI) of the Chinese State Planning and Development Committee (SDPC) and has devised regulatory assurances and possible pricing arrangements (including peak pricing) that will give adequate security of offtake without compromising the power market reform process when they are approved by SDPC. Tax relief is also being considered to give some recognition of the environmental benefits of gas utilisation and some economic incentive for its use.

Gas Market Challenges

The town gas sector presents a different set of challenges but they are also largely connected with the structure and regulation of the market. The existing market is quite small as would be expected given the relatively high cost of LPG and manufactured gas. However, in order to compensate for the high cost the municipalities that own the gas companies keep gas sales prices as low as they reasonably can and therefore the business is not particularly profitable. Pricing is set by individual municipalities and, with the major exception of Shenzhen, does not automatically or rapidly allow the flow through of changes in LPG or feedstock price. The advent of natural gas will reduce costs and will provide a spur to significant market expansion. However, capturing this potential requires substantial investment by the gas distribution companies and their customers in conversion to natural gas and extending the network. Some 96% of all existing burners must be replaced and substantial extensions of distribution pipe systems are planned. Because the municipalities have limited resources much of this burden falls on the users who generally have to fund their own conversions and pay connection charges. The ability of the LDCs to extend credit to the end users to accelerate market growth is extremely limited. Because the industry has grown up as a number of isolated, municipally owned LDCs, which will now be connected by trunk pipelines, it is necessary to consider the appropriate structure of the industry as a whole and clarify the roles of the constituent companies. Shenzhen has a formally defined franchise area but the other companies do not and there is no overall gas legislation; nor is there a clear demarcation as yet between the role of the LDCs and that of the transmission company. Here again the project has been working closely with ERI to develop a regulatory and structural framework for the industry to present to the SDPC for approval. It is drawing heavily on Shenzhen as an example of good local practice which can be adopted across the region as a whole. It is also particularly valuable that most of the LDCs are also partners in the terminal and trunkline project and therefore that interests can be aligned and issues dealt with in a fully transparent and open manner. It is recognised that it is important in the early years of the market development to give the LDCs security of market within their franchise areas to allow them to make the investment required to grow. (The same considerations apply to extensions of the trunkline system.) ERI is also keen to see the LDCs opened up to foreign investment so that external expertise and capital can be injected and it has recently been announced that minority foreign ownership is now permitted in this sector.

Conclusions
The first steps in developing a new gas market are always the most difficult. Markets must be found and customer wooed away from their existing fuels. But it is also necessary to build an industry structure and regulatory framework that creates a climate in which the massive investment needed can be made with confidence while ensuring that customers are adequately protected. In many ways the institutional arrangements are more of a challenge than convincing buyers of the advantages and

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convenience of gas. As we have seen what is needed for gas has significant repercussions for the structure of the electricity market and vice versa so the two cannot be considered in isolation. Guangdong has made great progress; the authorities have been most supportive and we are very confident that a sound and supportive industry structure and regulatory regime will emerge. Once a pattern has been set it will be much easier to build on it and we are very optimistic that the benefits of gas development can be extended rapidly from the eastern part of the Pearl River Delta area to the western half and then more widely in Guangdong, Guanxi, Hainan and Fujian. In Hainan and Guangxi and Western Guangdong pipeline gas from the South China Sea is likely to play a major role, which will present new challenges in the zone where pipeline gas and LNG come into competition with each other. Fujian to the east will be an LNG market and may well be the site of a second LNG terminal before the decade is out. The future for gas in South China looks very exciting and is well on the way to being delivered and based on a sound industry and regulatory structure.

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