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China and India hope higher prices will spur gas production

Send by email (http://w w w .arcticgas.gov/printmail/china-and-india-hope-higher-prices-w ill-spur-gas-production)

By: Jeannette Lee (/bio/lee-jeannette)

Researcher/Writer, Office of the Federal Coordinator

jlee@arcticgas.gov (mailto:jlee@arcticgas.gov)

Release Date: August 21, 2013

China and India last year imported just 12 percent of global LNG supplies, but liquefied natural gas

producers worldwide are counting on burgeoning sales to the world's two most populous nations.

Both countries are moving toward steep growth in their natural gas consumption within the decade.

And while China and India see the need to import more gas, they also want to increase their own domestic natural

gas production as a way to temper dependence on costly LNG supplies.

To spur increased production at home, the two governments this summer said they would allow producers to charge

more for their gas. The intent is to attract more investment in tapping domestic natural gas reserves. By raising the

internal price, China and India hope to energize government-owned and private producers to drill in technically

challenging but gas-rich terrain.

Raising the price of energy involves substantial political risk, but so does running short of fuel. India news media

reported in August that two dozen gas-fired power plants were idle for lack of fuel, blaming a shortfall in domestic

production.

The problem isn't a lack of reserves. Rather, it's getting the gas out of the ground. China's 109 trillion cubic feet and

India's 47 trillion cubic feet of proved reserves each exceed that of Alaska's North Slope.

Yet, companies have not moved aggressively enough to

develop gas sufficient to keep pace with demand in

either country. Prices have been too low to justify much

of the costly exploration and production of new basins.

While government-controlled companies may be able to

function (albeit not without protest) under these pricing

conditions, private-sector partners with the expertise

needed to develop gas cannot.

China and India each covered about 75 percent of their

gas needs with domestic production in 2012, according

to BP's annual compilation of worldwide energy

statistics. Imports covered the rest.

IMPACT ON LNG IMPORTS UNCERTAIN

That imports will remain a must in the short to medium

term is clear. The question is how the domestic price

hikes will affect long-term LNG sales to two of the

world's fastest-growing consumers of natural gas.

LNG shipments from abroad could increase in the short

to medium term if importers are able to count on

receiving better prices for their cargoes, but ultimately

could suffer if domestic production flourishes to the

point of edging out foreign cargoes, as has happened in

the United States. Yet LNG prices significantly

exceeding those in the local market could continue to limit the volume of imports.

LNG suppliers are heavily courting China and India, but have been stymied in part by below-market prices in both countries. The governments' decisions

(sites/default/f iles/documents/Chin

a-and-India-hope-higher-prices-

w ill-spur-gas-production.pdf)

(/sites/default/f iles/images/india-natural-gas-supply-2005-2012.png)

Sources: India's Ministry of Petroleum and Natural Gas, BP Statistical Review of World Energy

India’s private-sector natural gas production fell last year after strong growth from2009–2011. LNG imports covered most of the shortfall. (Domestic production numbersare based on fiscal years 2005/2005 to 2011/2012; LNG import numbers are based oncalendar years 2005 to 2012.) (Click to enlarge. (/sites/default/fi les/images/india-natural-gas-

supply-2005-2012.png) )

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to push prices higher for domestic production are acknowledgements that consumers will have to pay more if the countries are to meet their energy

needs.

Energy demand in the two nations ticks ever upward as

their economies, living standards and census numbers

continue to grow. Both countries are seeking more

supplies of natural gas to meet this need and to beat

back the severe air and water pollution caused by coal,

their top source of heat and electricity.

Under existing pricing regimes, producers in India must

sell gas to utilities and other distributors at no more

than $4.20 per million Btu (there are different prices for

each source of supply), while in China the average retail

cost delivered to consumers was a little under $8. Such

government-imposed price caps, critics say, discourage

domestic production and the growth of imports.

SUBSIDIES DIE HARD

While companies that produce and import natural gas

support higher prices, the governments have had to

consider the arguments of critics who worry the fuel will

become unaffordable for some consumers. The Indian

and Chinese governments must balance the need to

sate suppliers' appetite for a higher price against the

possibility of political turmoil should the general

population find the increases unpalatable.

Placation will most likely take the form of continued

government subsidies to key sectors, most notably the power and fertilizer industries in India and residential consumers in China.

Raising prices while boosting subsidies can be messy but necessary for political reasons, said an analyst with consultancy PFC Energy at a

presentation in August in Anchorage.

Pricing gas below market is common in countries around the world outside North America and Western Europe. Brazil forces producer Petrobras, which

is part-owned by the government, to subsidize oil and gas consumption. Indonesia is moving to cut its fuel subsidies to a point that would effectively

increase natural gas prices in the country by 44 percent.

"Once they are in place, these subsidies are very difficult to remove," Michael Plante, a research economist at the Federal Reserve Bank of Dallas, said

at an international energy economics conference in Anchorage in July.

Gas markets in Japan, Korea and Turkey are decades old, yet remain far from deregulated, according to the International Energy Agency.

And the United States and United Kingdom, often held up as shining examples of fully functioning gas markets, each took a decade or more to see real

results from their price deregulation, a study by the IEA found. The upshot is that relatively young gas industries, such as China's and India's, will likely

take some time to fully open up to market-based pricing — if they do so at all.

INDIA MAKES THE MOVE

In late June, India's government announced plans to alter the formula it uses to determine the price for domestic natural gas production. The decision by

the Cabinet Committee on Economic Affairs could double the maximum price paid to producers to $8.40 per million Btu, analysts say, based on July

2013 global oil and natural gas prices that underpin the formula. The government, however, recently insisted the price will not exceed $8.

The new pricing system is scheduled to take effect April

1, 2014. That's when the government's current contract

expires with private-sector conglomerate Reliance

Industries for its gas from the KG Basin off India's East

Coast. This contract, which serves as a benchmark for

other purchase agreements, links the natural gas price

to oil at a maximum of $60 per barrel, effectively capping

KG gas at $4.20. Oil prices today hover just over $100

per barrel.

India's new pricing formula is based on a 12-month

average of gas prices in other regional markets,

including U.S. Henry Hub, the National Balancing Point

in the United Kingdom, and a netback price at the

source of LNG supply for Japan. It also incorporates the

netback price of Indian LNG-contract imports at the

wellhead of the exporting countries.

The prices will be reviewed every quarter and only apply

to new contracts or renewals of existing contracts, the

(/sites/default/f iles/images/india-projected-domestic-gas-supply-vs-demand.png)

Sources: India’s Directorate General of Hydrocarbons, Mercados Analysis

The Indian government in 2010 estimated natural gas supply out five years as measuredagainst projected demand if more gas were available. (Click to enlarge.(/sites/default/fi les/images/india-projected-domestic-gas-supply-vs-demand.png) )

(/sites/default/f iles/images/india-natural-gas-infrastructure-map.png)

Source: U.S. Energy Information Administration

India has a limited natural gas pipeline network and four LNG receiving terminals, two of

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government said. The new approach to gas pricing

applies to both private- and public-sector petroleum

companies.

The recommendations for the new price formula came from a Cabinet committee set up in early 2012 to review India's gas pricing mechanism. The

formula will remain valid until April 2019. After that, the committee said, "the possibility of pricing based on direct gas-to-gas competition may be

assessed."

FISHING FOR MORE UPSTREAM PRODUCTION

India's annual gas production has fallen well short of potential, causing consternation at the highest levels of government as demand continues to grow

and debt woes and a weak currency strain the country's ability to pay for gas and other imports.

Domestic production in 2012–2013 averaged almost 4 billion cubic feet per day, while consumption was about 5.3 bcf per day — both numbers fell far

short of government projections issued in 2010. The government believes there is substantial unmet demand and more gas would be consumed if it

was available.

India drew exclusively on domestic natural gas until 2004, when it imported its first LNG cargoes from Qatar.

Minister of Petroleum and Natural Gas Veerappa Moily, a major supporter of the new pricing formula, worries the gap between supply and demand will

widen "if effective steps are not taken expeditiously to enhance the domestic production." Demand for gas by 2017 could triple 2012–2013 consumption,

according to estimates by the oil ministry, and price will play a large role in determining whether India can match supply with demand.

Investment in natural gas exploration and development in India plunged from $6 billion in 2007–2008 to $1.8 billion in 2011–2012, according to

government data. The largest gas field, KG-D6, has been in decline since 2011, and by mid-2012 was achieving roughly 30 percent of its production

target.

At the same time, Indian companies invested $27 billion in exploration and production abroad. One example is government-run utility GAIL, which in

2011 purchased a 20 percent stake in Eagle Ford Shale acreage in South Texas for $95 million. India's largest gas transmission company by volume,

GAIL also pledged to invest about $300 million in the play over five years.

In a recent meeting with Iraqi Prime Minister Nouri Al-Maliki, Moily expressed India's interest in importing LNG from Iraq and being involved in gas

projects there.

Most major international companies are still reluctant to invest in India's energy sector, according to a joint report by the International Energy Agency and

the Organisation for Economic Co-operation and Development. The World Bank in 2013 ranked India 132nd out of 185 countries in the world for ease of

doing business. India fared poorly in categories critical for infrastructure and energy investment, ranking 184th in "enforcing contracts" and 182nd in

"dealing with construction permits."

The challenges aren't a complete deterrent. Two major investors include BP, which in 2011 paid $7.2 billion for a share in KG-D6 and almost two dozen

other oil and gas blocks, and Royal Dutch Shell, which owns a 74 percent stake in the Hariza LNG import terminal.

HIGHER PRICES EQUAL HIGHER PROFITS

The credit rating and financial analysis firm Moody's is optimistic, projecting the new pricing formula would "encourage greater exploration and

production activities in India." While the formula will expose companies to greater gas price volatility, "Moody's expects prices to remain well above the

current [price of] $4.20," said Vikas Halan, a vice president at the rating agency.

Halan expects price reform to boost revenue for government-owned Oil and Natural Gas Corp. by $1.5 billion to $2 billion and for Reliance Industries by

$300 million to $500 million in the fiscal year spanning April 2014 to March 2015. The companies reported revenues of $29 billion and $73 billion

respectively in the fiscal year that ended March 31, 2013.

"For upstream producers this is great news. The government has offered them double the price for existing gas fields as well, so it's going to

immediately impact their revenues and their profits," said Mriganka Jaipuriyar, senior editor for Oilgram News.

Others, however, are not so upbeat. BP in March said the committee's recommendation for doubling domestic natural gas prices "will not incentivize

companies to bring high-risk, deep-sea discoveries to production." The government is hoping to entice further development by BP, Reliance and others

of gas reserves off India's East Coast and of shale gas, and needs private-sector expertise to do so.

Attracting private investment is important not just for India's energy sector, but also for its economy as a whole. India has counted on inflows of investor

capital to help balance its trade deficit. The weakness of the rupee and less-than-ideal creditworthiness — based on India's large national debt in

relation to gross domestic product — makes sourcing energy at home even more attractive than buying it from abroad.

There is no consensus on how the new formula will affect LNG imports, which totaled 720 bcf in 2012, an average of about 2 bcf a day. India paid $9 to

$12 per million Btu for LNG imports in the fiscal year ending March 31, 2013. India does not import gas by pipeline.

Should India spark more gas development, domestic production one day could slow the growth of imports. In the short term, if importers are able to sell

at higher prices, imports may increase, but prices deemed too high could stifle demand. A report by the International Gas Union in 2012 said, "India

imports some LNG at the current prices in the region but appears to be limited in its ability to pay high prices for significant quantities of LNG, preferring

to interrupt supplies to customers rather than import more."

Indian Finance Minister P. Chidambaram seemed to confirm that view recently. He noted that although forecasts show LNG imports growing nearly five-

fold to an average of 8.25 bcf a day in fiscal year 2016-2017, "India cannot afford to import that kind of LNG as we do not have that kind of money.

"We have to increase domestic production and for that we must get private Indian and foreign investment," Chidambaram said.

SUBSIDIES WILL SURVIVE

which were commissioned in 2013. (Click to enlarge. (/sites/default/fi les/images/india-natural-

gas-infrastructure-map.png) )

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The coming price increases are unpopular with the

power and fertilizer sectors, India's main users of gas.

The Ministry of Power said gas costing more than $5 will

be untenable for the power sector, which consumed

roughly 40 percent of India's gas in 2011. For every $1

per million Btu increase in the price of gas, the annual

fuel cost for power plants that are running or being built

will go up by $1.73 billion, a recent Platts report said.

The Department of Fertilizers worries government

subsidies will not be able to cover a higher gas price.

Fertilizer manufacturers comprised roughly one-quarter

of India's gas consumption in 2011.

Already several producers of ammonia and urea, the

basic components of fertilizer, face reduced subsidies

as the government is running low on cash. The

department has estimated a $544 million increase in

the annual subsidy bill with every $1 per million Btu

boost in the cost of natural gas.

Whether the national or state governments will agree to

subsidize certain end-users is still unclear. "The finance

minister has hinted at subsidizing," said Jaipuriyar of

Oilgram News. "We're not very sure how it's going to

impact the end user in the country right now."

Subsidies will eat into profits of national oil and gas companies, such as Oil India Ltd. and Oil and Natural Gas Corp. "Though their upstream profits will

go up, they share the downstream oil subsidy burden with the government so that will offset some of the gains," Jaipuriyar said. The private sector,

however, will enjoy the full benefits of higher revenues and higher profits.

Following the decision to revise gas pricing, India's finance ministry requested that the oil ministry consider a price ceiling in the new formula to shield

consumers from price spikes, but Oil Minister Moily said the committee's decision is final.

CHINA'S PRODUCTION COMES UP SHORT

The fourth largest gas user in the world, China until

2006 essentially was self-sufficient but today is a

significant importer. Pipeline and LNG imports fulfill

one-quarter of its demand, with pipeline gas from

Central Asia at slightly more than 2 bcf a day in 2012

and LNG imports at a little under 2 bcf a day. A new

pipeline from Myanmar to China started moving gas in

August 2013.

Seeking to boost both supply and demand, China has

gradually been reforming

(http://www.nortonrosefulbright.com/knowledge/publications/63293/has-china-finally-picked-up-the-pace-on-its-natural-gas-reform) the government-controlled pricing

structure of natural gas to more closely accord to market conditions. In July 2013, China altered the system it uses to compute gas prices, effectively

raising costs for non-residential users nationwide by an average 15 percent, bringing the price from a little under $8 per million Btu to an average $9. It's

the first major price increase in three years.

The decision issued by China's National Development and Reform Commission, the state planning agency, creates a two-track gas pricing system in

all its provinces and autonomous regions. The price increase will apply to natural gas use equivalent to 2012's volume. Gas consumption above that

amount will be priced to customers at 85 percent of the basket price on an energy-equivalent basis of two substitute fuels: liquefied petroleum gas, used

for cooking, and fuel oil, used for power. Local governments will be in charge of setting retail prices.

The price reforms expand on experimental price increases enacted in December 2011 in the southern province of Guangdong and the neighboring

autonomous region of Guangxi for gas produced at onshore fields in China or imported by pipeline.

Source: GAIL (India) Ltd.

The Dabhol LNG import terminal, about 200 miles south of Mumbai on India's ArabianSea coast, was commissioned in January 2013 as the country’s third LNG regasificationterminal. The original developer, failed U.S.-based company Enron, had left the plantunfinished more than a decade ago. GAIL (India), the nation’s largest gas distributioncompany, and its partners completed the plant.

(/sites/default/f iles/images/china-gas-consumption-outpaces-production-2000-2012.png)

Sources: U.S. Energy Information Administration, BP Statistical Review of World Energy

(Click to enlarge. (/sites/default/fi les/images/china-gas-consumption-outpaces-production-2000-

2012.png) )

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MORE GAS CLEANER THAN MORE COAL

The increase in gas prices is a significant step in Beijing's plans to expand the share of the cleaner-burning fuels in China's energy mix.

China wants to increase the use of gas-fired electricity

to reduce the coal- and oil-generated urban pollution

that generates global headlines and public

dissatisfaction with the government. The country's 12th

and most recent Five-Year Plan (2011 to 2015) sets

forth the ambitious goal of doubling China's 2011

consumption of natural gas to an average 25 bcf a day

by 2015.

Still, the U.S. Energy Information Administration expects

China's consumption of cheap and abundant coal to

keep growing, but at a slower pace.

The Chinese government said the current low prices

promote gas consumption in the short term but hurt

supply in the long term by discouraging investment for

developing more domestic gas. Beijing hopes the

higher price will boost profits for upstream producers,

making it economically feasible to explore and develop

additional gas reserves in the country, including coal-

bed methane and shale gas.

Many analysts have noted that although China is rich in

shale gas, extracting and bringing it to market will take

some years. The gas is located in hard-to-reach areas

where few wells have been drilled and little is known

about the geology. Water for hydraulic fracturing is in short supply in areas with good gas potential. Pipeline and gas storage is scant.

And shale gas development is not well-established in the country, meaning that China will need time, and relationships with foreign firms, to accrue

expertise, equipment and technological know-how.

Meanwhile, importers of pipeline gas and LNG would also see higher returns from higher prices, encouraging them to increase supply from abroad.

The increase in both domestic and foreign supplies, so the thinking goes, will fulfill pent-up demand and spark an increase in gas consumption.

The government is trying to balance the need for higher prices with keeping gas competitive when pitted against other fuel sources, including coal,

renewables and nuclear.

CUTTING LOSSES WITH HIGHER PRICES

Higher natural gas prices will curb, but not eliminate, losses at China's three largest energy companies, particularly PetroChina Co., the country's

largest producer and importer of natural gas. The government-owned firm, which supplies about 70 percent of the country's gas, lost 41.9 billion yuan

($6.8 billion) in 2012 from importing LNG and Central Asia pipeline gas because it could not pass on the full cost to consumers.

Industrial users, including power companies, will likely absorb most of the increased costs, but China's government will ensure that natural gas

remains competitive against coal and oil in the power sector given its goal of reducing pollution, according to energy news and analysis firm ICIS Heren.

The government has said some subsidies or price discounts for gas would be available for power-generation firms, but has not provided specifics.

Industrial use includes the petrochemical, iron and steel sectors, and accounts for the largest share of China's natural gas demand.

Analysts project the price increase to downstream users will translate to a 25 percent bump for upstream producers at the wellhead. "This should

provide a clear incentive for increased exploration and production of China's domestic gas resources," Far East Energy, a Houston-based coal-bed

methane developer operating in China, said in a statement following the government's decision.

Households, which account for about one-fifth of natural gas demand, will continue receiving cheaper supplies to avoid triggering high inflation rates

and public unrest. The government usually sets residential prices lower than the industrial, commercial, power and transport sectors, a policy the

International Energy Agency notes is the opposite of the situation in many developing countries, where residential users (excluding the most

impoverished) usually pay higher prices than other users.

"Consumers do not want to see high gas prices, and the government does not want see any protests caused by volatile prices — so, the government

has a dilemma," said Zhang Weiping, an adviser at the China Petroleum and Petrochemical Engineering Institute, a government-linked research body.

Beijing managed the political delicacy of the most recent price hike by first allowing a few larger cities and regions to adopt the new system ahead of the

nationwide roll-out.

The government commission said it may increase subsidies to farmers and encourage local governments to provide temporary subsidies to cab drivers

whose vehicles are natural gas-powered. The price of natural gas used to make fertilizer will not rise by more than $1.13 per million Btu over existing

prices, and farmers could see additional subsidies as well.

The IEA noted in a recent report that holding some gas prices at lower levels compared to other categories has its drawbacks as it "encourages

inefficient use of gas, forces the government or companies to bear the losses and can potentially result in industry or power generators lacking access

to gas, as gas demand is still supply-driven in China (and expected to remain so in the next five years). Such a system can backfire by creating lower

(/sites/default/f iles/images/china-installed-electricity-capacity-by-fuel.png)

Sources: U.S. Energy Information Administration, FACTS Global Energy

(Click to enlarge. (/sites/default/fi les/images/china-installed-electricity-capacity-by-fuel.png) )

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industrial output and lead to public dissatisfaction."

REFORMING WITH CAUTION

Whether the latest price reforms will be sufficient for

China to fully meet its goals of developing its domestic

gas resources and increasing imports is questionable.

Reuters market analyst Clyde Russell noted that much

of the pipeline and LNG imports will remain

unprofitable. Even the latest hike won't completely

eliminate PetroChina's losses.

China paid an average $8.79 per million Btu for pipeline

imports from Turkmenistan and Uzbekistan in May, and

an average $9.07 for LNG cargoes, with major suppliers

being Qatar, Australia, Indonesia and Malaysia. In 2012,

China imported 700 bcf of LNG, an average of 1.9 bcf a

day.

The new domestic price translates to just under $9,

which appears close to pipeline imports. The

government's new $9 price is retail, however, while the

imported pipeline gas and LNG costs do not include

storage, transport and other charges that are part of the

retail cost.

LNG costs come with their own uncertainty.

Oil-linked prices for LNG from projects under

construction in Australia and a renewal of older supply

contracts with Indonesia and Malaysia could drive up

costs for China. Indonesia is already pushing China

National Offshore Oil Corp. to double a 2002 contract

price to $7 as the two tussle over contract renegotiations. (Other Indonesian gas clients, notably Japan, pay up to $17.50).

Then again, LNG exports from the shale boom in the United States may put downward pressure on prices. Other new supplies from East Africa, Canada

or Russia may help buyers play the competitive field and drive better bargains.

Importers may still be wary about bringing in more gas as China's new pricing mechanism does not fully cover the cost of newly imported pipeline gas

and LNG.

Despite the difficulties presented by below-market pricing, Beijing is constrained from making rapid changes.

"If the government raises the gas price too rapidly, it may curb consumption, but if gas prices remain low for a long time, it will hurt developers," said

Jiang Xinmin, an analyst at the National Development and Reform Commission. "So they will be raised gradually."

More White Papers > (http://www.arcticgas.gov/white-papers)

(/sites/default/f iles/images/china-map-natural-gas-lng.png)

Source: International Energy Agency

China’s LNG import terminals stretch along its entire eastern coast, while pipelinesdeliver gas from interior gas fields and Central Asia. (Click to enlarge.(/sites/default/fi les/images/china-map-natural-gas-lng.png) )