Costliest Gas in World Clouds China’s Campaign for Bluer Skies

China has promised to make its skies blue again, but having some of the world’s most-expensive natural gas isn’t helping.

The biggest energy consumer on earth wants to use more of the cleaner-burning fuel in place of the coal that’s choking its skies and causing pollution far exceeding the World Health Organization’s daily recommended limit. China has the ability to increase imports and is seeking to raise domestic production, but high prices risk suppressing demand growth and jeopardizing the country’s ambitious targets.

The challenge is that producers, importers and distributors in China need the government-controlled prices to be high enough to make money. By cutting them too much, the state risks hurting their margins, threatening investment in future production and the country’s energy security. But be too generous to the industry, and the nation’s health is at stake.

“It’s a balancing act for the government that requires on one side stimulating gas demand to increase the percentage of clean fuels,” said Miaoru Huang, a Beijing-based energy analyst for Wood Mackenzie Ltd. “On the other hand, it needs to ensure reasonable returns for upstream players and transmission and distribution companies that are needed to ensure sustained investment so China can maintain its growth in domestic gas production.”

The Chinese government has set a goal of getting as much as 10 percent of its energy from gas by 2020 and 15 percent by 2030, up from 6 percent in 2015. To achieve this, demand will have to grow by about 15 percent a year through the rest of the decade, according to UBS Group AG.

After consumption growth slowed to well below that pace for the past few years, it is once again booming, increasing at a rate of 13.2 percent so far this year. These graphics tell the story of how that’s happening and what the future may hold.

The world’s sixth-biggest producer of gas, China gets about 64 percent of what it needs domestically, according to Bloomberg calculations based on government data. It imports the rest by pipelines from Central Asia and Myanmar, as well as on seaborne tankers as liquefied natural gas.

The Ordos Basin in Shaanxi Province is the largest gas-producing area in the country, according to Sino Gas & Energy Holdings Ltd. It’s where China drilled its first oil well more than 100 years ago. The nation’s experience with petroleum dates back 900 years, when the scientist Shen Kuo found near the Yan River oil seeping out of the rocks, which he noted could be used for lighting, according to China National Petroleum Corp.

In the modern era, the National Development and Reform Commission, the country’s top economic planner, traditionally set gas prices at the well, making sure they were high enough to cover drilling costs and a small profit for the companies.

Even as production exploded over the last decade, China couldn’t keep up with booming demand, so the nation’s big three energy companies — CNPC, China Petrochemical Corp., known as Sinopec, and China National Offshore Oil Corp. — became gas importers. CNPC built a pipeline connecting gas fields in Turkmenistan, Kazakhstan and Uzbekistan to western China, while a link from Myanmar started in 2013. CNPC will start receiving gas from Russia on a Siberian pipeline in 2019. The country also has more than a dozen terminals on its eastern and southern coasts to receive LNG cargoes.

But buying the gas overseas proved costly. The companies inked supply deals at prices linked to the cost of oil, so when crude rose into the $100-a-barrel range, the cost of importing ballooned to levels higher than the energy giants were allowed to sell domestically. PetroChina, the country’s largest listed energy firm, has lost money on gas imports every year going back to at least 2013, according to company filings.

The NDRC responded in 2013 and 2014 by raising prices to a level that was high enough to encourage production and help cover the cost of imports. But that increase had an immediate impact on demand, snapping the run of double-digit percentage growth every year from 2003 to 2013.

In 2015, the government cut wholesale prices. By December 2016, gas was cheaper on a wholesale basis than other fuel sources such as fuel oil or propane, a liquefied petroleum gas typically used for heating and cooking, according to UBS analysts including Ken Liu. However, the final cost to industrial users was still higher because of large margins for distribution companies.

So now the government is taking a knife to the middlemen companies that transport the gas from the state-run giants and sell it to individual users, firms like ENN Energy Holdings Ltd., China Gas Holdings Ltd. and China Resources Gas Group Ltd. The NDRC last month capped investment returns for natural gas distributors at 7 percent.

In January, China’s latest five-year plan called for using gas instead of coal in industrial boilers throughout four major urban areas: the greater Beijing region, northeast China, the Yangtze River Delta around Shanghai and the Pearl River Delta in Guangdong province. Local governments are supporting the efforts with measures including subsidized gas connections and boiler replacements, as well as price caps, according to Morgan Stanley.

The NDRC issued guidelines Tuesday aimed at increasing use of the fuel, including encouraging the participation by private companies in overseas gas investments, expanding LNG import terminals and expanding underground gas storage capacity. Shares of gas companies seen benefiting from rising demand — ENN, China Gas and China Resources Gas — all gained in Hong Kong on Wednesday.

Provincial governments don’t have the budget to keep subsidies going forever, though, so to be able to sustain rapid consumption growth the government will have to find a way to bring gas prices down more, said Michal Meidan, an analyst with Energy Aspects Ltd. in London. Wholesale prices for the fuel in China were the most-expensive among major users in the world last year, according to the International Gas Union.

While lowering prices further may spur more demand, China runs the risk of suppressing production and imports, Meidan said.

Output goals are already going to be difficult to meet because of high costs and difficult geology, according to Bloomberg Intelligence. The government expects most gas production growth to come from unconventional resources, such as shale and coal-bed methane, with production targeted to reach as much as 100 billion cubic meters a year by 2030.

At stake in all of this is the health of the world’s most populous nation. Poor air quality has been a source of social unrest and China had more pollution-related deaths than any other country in 2012, according to World Health Organization data.

Coal still accounts for about two thirds of China’s total energy consumption. Natural gas produces about half the carbon dioxide and just a fraction of the sulfur dioxides and particulates of coal when it’s burned, according to the U.S. Energy Information Administration.

Premier Li Keqiang in March pledged to make China’s skies blue again, three years after the country declared a “war on pollution.”

Progress has been steady but slow. Last year in Beijing, average concentrations of PM2.5 — small particles that pose the greatest risk to human health — fell almost 10 percent, the biggest annual decrease in the past four years.

That trend is reversing this year as power generation and steel output grow, according to a research note from a Greenpeace analyst in late May, making air quality goals for this year seem increasingly unattainable.

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