China's natural gas sector is in the midst of a transition that could alter Asian natural gas markets for better or for worse, depending largely on how much the country's demand increases and how much shale gas it produces. Beijing knows that it must move away from using coal for almost all of its energy needs, as the environmental costs have begun to offset the strategic and economic benefits. Natural gas is an integral component of solving this problem, but how much demand this will amount to — and where the supplies will come from — is an important issue, particularly for other Asian countries that must import large volumes of liquefied natural gas. Even if China shifts just a small percentage of its energy mix from coal to natural gas, this would mean a gigantic change in the volume of natural gas demand because of the amount of energy China consumes.
China's vast resources of coal have underpinned the country's unprecedented growth the last four decades. Historically, China's domestic coal supplies have also been relatively cheap. This, coupled with the sheer size of its coal resources, has led China to use coal in large volumes not only in traditional coal sectors, such as power generation, but also in numerous unconventional ways.
While using coal for power plants obviously offsets some natural gas demand, China's atypical applications of coal also tend to push down the demand for other energy sources used for energy consumption or transformed into non-energy products. For instance, methanol derived from coal now represents nearly 10 percent of China's transportation fuel pool — and the country is contemplating adopting a requirement that gasoline contain 15 percent methanol (some provinces already have similar regulations). Additionally, most of the world's production of nitrogen-based fertilizers uses natural gas as a feedstock, whereas China typically uses coal.
For China, coal's low cost is only one part of the rationale behind its heavy use. China ceased being an exporter of oil in the early 1990s and is now the world's largest oil importer. China had never been a relatively significant consumer or producer of natural gas until the late 2000s, but today it imports roughly a third of its natural gas. Not wanting to outsource its energy security to international markets, China prioritized using coal over natural gas.
However, there was a marked shift in China's energy strategy, particularly for natural gas, beginning around 2005 that has accelerated in the last three years. China's natural gas demand has exploded. Although Chinese demand for oil and coal also grew during that period, its astronomical growth predated the surge in natural gas demand, which doubled between 2007 and 2012. Clearly, something had changed. This was first reflected in China's 12th Five-Year Plan, which outlined a shift toward natural gas as part of more environmentally friendly initiatives.
The shift is due to a number of factors, but there are three main drivers. First, in the past five years coal has become the focus of growing public anger regarding China's deteriorating environmental conditions. Beijing has begun viewing continued coal emissions, especially in wealthier coastal urban areas, as a potential risk to social and political stability, one of China's geopolitical imperatives. As a response, some cities, such as Beijing, are switching from coal-fired power plants to natural gas-fired power plants, which give off fewer emissions. Second, China's quality of life is gradually increasing, and domestic consumption of natural gas — either for cooking or heating — is on the rise. Finally, China has realized that it possesses massive natural gas resources in the form of shale gas — which means that China's natural gas security could be realized eventually, even if in the interim China must rely heavily on imports.
Estimating China's Potential Natural Gas Demand
China's potential demand is staggering, though estimates of it vary considerably. Officially, the State Council of China anticipates that demand could increase from 2012's level of about 150 billion cubic meters to 200 billion to 250 billion cubic meters by 2020. The 12th Five-Year Plan has it reaching 230 billion cubic meters by 2015 alone. The Ministry of Land and Resources has said it could be 350 billion to 380 billion cubic meters by 2020 and 550 billion to 600 billion cubic meters by 2030. UBS has estimated it could be as much as 400 billion cubic meters by 2020, and Barclays has estimated that demand could reach 450 billion cubic meters by 2020. To put these numbers in perspective, if China's demand increases to 400 billion cubic meters, the increase would be larger than the entire current Asia-Pacific liquefied natural gas market. Thus, other Asian liquefied natural gas consumers are looking at China quite nervously.
Of course, the liquefied natural gas market will not satisfy all of China's demand. China has been securing supplies from Central Asia and Russia through pipelines. China has signed a deal to import 40 billion cubic meters from Turkmenistan that could increase to 65 billion cubic meters by 2020. In September, China signed a deal with Russia for another 60 billion cubic meters, although the deal has not been finalized due to disputes over pricing. (China also has a smaller deal with Myanmar.)
Outside of China's domestic shale resources, Beijing is targeting 80 billion cubic meters of tight gas production and 30 billion cubic meters of coal regasification, and China National Offshore Oil Corp. is hoping to push further offshore for natural gas production. Collectively, these other unconventional sources coupled with conventional natural gas could reach 150 billion to 160 billion cubic meters, up from the 2012 level of 110 billion cubic meters. However, several of its supply deals with Russia and Central Asian countries will not come to fruition until as late as 2020. This means that in the interim there could be a larger reliance on liquefied natural gas, but after 2020 this demand could subside as volumes of shale and piped gas begin to increase.
Thus, sources other than shale and liquefied natural gas imports could supply about 250 billion cubic meters or a bit more, which would only satisfy the most conservative estimates for the growth in China's natural gas demand. While more piped natural gas deals could be signed, those plans likely would not be completed until well after 2020, leaving shale and liquefied natural gas to make up the difference.
Shale Production's Effect on Liquefied Natural Gas Demand
China's potential in shale gas production is nearly as staggering as its potential growth in demand. The U.S. Energy Information Administration estimates that China possesses by far the world's largest reserves of technically recoverable shale gas. Although China's shale gas industry is not as advanced as the United States', it could be the most advanced outside of North America.
China's target is to produce 60 billion to 100 billion cubic meters of shale gas by 2020, but there are severe limitations to hitting the target. China is more likely to produce somewhere around 25 billion cubic meters of shale gas by then. In the longer term, as Chinese oil and gas companies master shale gas extraction techniques, production will reach loftier goals. However, this process is likely to take two decades, not one.
This means that China will realistically be able to access 275 billion cubic meters to perhaps 300 billion cubic meters of natural gas from land-based (both piped and domestic) sources by 2020. It remains unclear as to whether or not this will be able to satisfy most of China's demand. Should China's demand reach higher estimates, such as Barclay's 450 billion cubic meters by 2020 or the Chinese Ministry of Land and Resources' 380 billion cubic meters, China could be forced to import as much as 150 billion cubic meters of liquefied natural gas by 2020.
That kind of demand could very easily overwhelm liquefied natural gas markets internationally, ensuring that liquefied natural gas supply diversification will not lead to lower prices. However, this is unlikely, because there will remain an intrinsic link between China's domestic supply and domestic demand. While China has been pushing for natural gas to offset coal and oil, Beijing still must critically balance two competing needs: the need for natural gas to replace those other sources and the strategic risks of overreliance on foreign sources of natural gas (as opposed to coal, which it can largely produce domestically). As a result, China's overall demand for imported natural gas — including liquefied natural gas — will be related to the success and pace of its shale gas development.
Additionally, the most likely scenario in which China's liquefied natural gas demand would increase dramatically is one in which liquefied natural gas prices do not skyrocket but are low enough that it would be worth importing large volumes of natural gas despite the strategic losses. Either way, China would still be importing small volumes of liquefied natural gas and has every interest in working with Japan, South Korea and other liquefied natural gas importers in order to manage prices. However, China's potential demand spikes leave those other liquefied natural gas importers worried — especially those, such as Japan, that have few options other than importing liquefied natural gas.