Competitiveness of Coal-Based Gas, Given Oil Price Fluctuation

By Wen Qian, Li Zhijian, China National Petroleum & Chemical Planning Institute

1. Development of the sector

Coal-based gas is an important supplement to conventional natural gas in China and has developed rapidly in recent years, becoming a highlight of the coal chemical industry. During 2009-2012, Inner Mongolia Datang International Keqi Coal-based Gas Co., Datang International Fuxin Coal-to-SNG Co., Ltd., Inner Mongolia Huineng Group and Xinjiang Kingho Energy Group started coal-based gas construction projects one after another, and the total capacity reached 15.1 billion m3/a. During 2013-2014, China approved 17 coal-based gas projects to launch early-stage work. These projects were distributed in coal producing regions such as Xinjiang, Inner Mongolia, Shanxi and Anhui, and their total planned capacity was 72.2 billion m3/a.
By the end of 2014, the capacity of coal-based gas plants that already started production was 3.105 billion m3/a, the capacity of coal-based gas projects that were under construction was 13.995 billion m3/a and the capacity of coal-based gas projects whose early-stage work had been launched was 70.2 billion m3/a. The three coal-based gas projects already on stream are still in the initial stage of production and have not yet reached full-load operation. By the end of 2014 around 700 million m3 of natural gas was produced (see Table 1 for details).


Table 1    Coal-based gas plants already on stream or still under construction


Company    Location    Capacity
(million m3/a)    Progress    Sales channel
Sole production of natural gas
Inner Mongolia Datang International Keqi Coal-based Gas Co.    Chifeng, Inner Mongolia    4 000    The first phase, with a capacity of 1.35 billion m3/a, started production in December 2013. By the end of 2014 over 354 million m3 of qualified natural gas was already produced.    Enter PetroChina pipeline network
Xinjiang Kingho Energy Group    Yili, Xinjiang    5 500    The first phase with a capacity of 1.375 billion m3/a started production in December 2013. By the end of 2014 nearly 300 million m3 of qualified natural gas was already produced.    Enter the second west-east gas transmission trunk pipeline network, sales of small amounts of LNG added
Inner Mongolia Huineng Group    Erdos, Inner Mongolia    1 600    The first phase, with a capacity of 400 million m3/a, started production in November 2014. Output is around 600 t/d.    Totally LNG
Datang International Fuxin Coal-to-SNG Co., Ltd.    Fuxin,
Liaoning    4 000    Project is still under construction and production has not yet been started.    Enter Shenyang fuel gas pipeline network
Co-production of natural gas
Yunnan Xianfeng Chemical Co., Ltd.    Kunming,
Yunnan    200    Production was started in April 2014.    Exclusively LNG
ChinaCoal Erdos Energy & Chemical Co., Ltd.    Erdos, Inner Mongolia    800    Production in the first phase was started in February 2014.    To be finalized


In addition to the above-mentioned coal conversion projects that produce only natural gas, some new coal chemical plants constructed in recent years also co-produce small amounts of natural gas or LNG. Examples include a 200 kt/a coal-based gasoline (via methanol) plant with co-production of 150 kt/a LNG (equivalent to around 200 million m3/a of natural gas) already put on stream by Yunnan Xianfeng Chemical Co., Ltd. and a 2.0 million t/a ammonia, 3.5 million t/a urea and 800 million m3/a natural gas project still under construction by China Coal Erdos Energy & Chemical Co., Ltd. (the first phase already started production).
If all the projects under construction are completed and all the projects with early-stage work underway make smooth progress, coal-based gas capacity will reach 30.0-40.0 billion m3/a by 2020.

2. Conformity with China’s clean energy development strategy  

China has made greater efforts in the development of natural gas and actively developed alternative energy sources such as coal-based gas. The market demand for natural gas keeps going up, the market-geared pricing mechanism of natural gas is being promoted and major coal-based gas process technologies are maturing. All these factors signal development opportunity for the coal-based gas sector.
Judging from the construction and development of conventional natural gas production capacity in China today, it can meet only around 45% of demand in 2020. The proportion of unconventional gas (coal-bed methane, shale gas and coal-based gas) in the natural gas supply will increase further. The goal for 2020 defined in the Energy Development Strategic Action Plan (2014-2020), formulated in November 2014, is that “the output of conventional natural gas will be 185.0 billion m3, the output of shale gas will be over 30.0 billion m3 and the output of coal-bed methane will be 30.0 billion m3”. The proportion of coal-based gas in China’s natural gas supply is expected to reach 11% in 2020 .
The production of natural gas from coal is a comprehensive clean conversion process for coal, integrating quite a few chemical units such as purification and synthesis. The emission of pollutants is lower than other processes that mainly use coal as fuel. According to the energy restructuring orientation defined by the state, new markets of natural gas will mainly come from units with central heating and residents with private home heating. Suppose the output of coal-based gas is 30.0 billion m3 in 2020 and the sulfur content of raw coal is 1%, based on the equivalent heat value conversion (converted to standard coal), 36.0 million tons of fuel coal can be replaced a year. The use of coal-based gas to replace fuel coal can play a remarkable role in controlling smog and improving the environment.

3. Link between natural gas prices in China and international oil prices

Due to substitutability between oil and gas, there is no denying that long-term changes of oil prices will indirectly impact gas prices. In terms of direct correlation, however, natural gas pricing mechanisms around the world differ widely, and gas prices are directly correlated with oil prices only in some regions. Unhooking natural gas prices from oil prices has gradually become a trend in the international gas trade. According to results of a survey of global natural gas wholesale prices, issued by the International Gas Union, there are mainly three pricing modes: (1) Gas prices in North America and some parts of Europe are totally left to market competition and have no direct relation with oil prices. This applies to 40% of the world’s natural gas consumption, making it the most popular pricing mode. (2) Controlled pricing of natural gas (based on a combination of service cost, social/political cost and production cost) is used mainly in Russia, the Middle East and Africa, so the gas prices in these areas also have no direct relation with oil prices. This mode applies to around 35% of global natural gas consumption. (3) Gas prices are tied to the price of competing fuels (such as petroleum, diesel and fuel oil) in some parts of Europe and some parts of the Asia-Pacific region and therefore are directly related with oil prices. This mode applies to around 20% of the world’s natural gas consumption (If the start of hooking nonresidential natural gas prices in China to alternative energies is considered, the proportion is actually around 21%). In some cases, gas prices that are hooked to oil prices are twice as high as those left to market competition. Owing to the stability of the demand and the diversification of import sources in recent years, some parts of Europe and some parts of the Asia-Pacific region are gradually shifting the gas pricing mode to a market model. It is expected that the volume of natural gas priced according to oil prices will decline overall, and the comparatively high prices paid for gas in the Asia-Pacific region will be eased.
The mechanisms relating natural gas prices in China to international oil prices are quite complicated on the whole. The ideas used to set prices on the supply side (ex-factory price or border price) are completely different from the concepts of pricing on the consumption side (gate price). The former have no direct relation with the oil price, whereas the latter are oriented to the oil price. On the whole, the natural gas pricing system in China is still mainly guided by state policies.
Let’s have a look at the supply side first. Sources of natural gas in China today include domestic natural gas, imported LNG and imported pipeline gas. The pricing of domestically supplied natural gas is based on a cost-plus concept. The ex-factory price of domestic natural gas for industrial uses is RMB1.2-1.6/m3. When the pipeline transmission cost fixed by the state and rational charges in other links such as distribution are added, the price of gas transmitted to Shanghai Gate is around RMB2.4-3.0/m3. The supply-side price of imported natural gas is mostly fixed by long-term contracts, so impacts from fluctuations of the oil price are quite small. The contract price of imported LNG is only hooked to oil prices to a certain extent (Japanese LNG pricing formula). The prices of some imported pipeline gas are fixed through government negotiations, with “bilateral monopoly”. The prices of some imported pipeline gas are hooked to oil prices. The tax-inclusive price of imported natural gas has no great fluctuations. The tax-inclusive price of imported pipeline gas transmitted to Shanghai Gate is RMB3.0-3.6/m3. On the other hand, the prices of imported LNG can vary widely. In 2014, for example, the tax-inclusive price for previous contracts was RMB1.5-2.3/m3 whereas the tax-inclusive price for new contracts was RMB3.6-4.4/m3. Prices of natural gas from the above three sources have no direct relation with oil prices.
What about the consumption side then? The gate price of natural gas in China is the government-guided price based on the “market net return method”. That is to say, the gate price is fixed by the price parity of alternative energies in central markets, deducting pipeline transmission cost. A price ceiling is set. The ceiling-guided prices are closely related to oil prices. The price of stock natural gas and the price of incremental natural gas are combined into one. The ceiling gate price of natural gas for nonresidential uses is hooked to the prices of LPG and fuel oil in the calculation period, and regular adjustments are made. The ceiling gate price in Shanghai was RMB2.88/m3 in the second half of 2014.
According to policies governing the development of the natural gas sector in China, imported natural gas and unconventional natural gas will be major drivers for the growth of the supply. Both are relatively high-price sources. Natural gas pricing mechanisms in China are mainly guided by state policies. The price of natural gas will more closely follow price fluctuations of large-volume energies in the near future. From a long-term perspective, however, today’s mode is only a semi-liberalized transitional scheme. The ultimate goal is to establish an effective competitive market with natural gas prices totally determined by market supply and demand.
The apparent consumption of natural gas in China in 2014 was 180.0 billion m3, an increase of 7.4% over the previous year, and the dependence on imports was 32.2%. With the slowdown of economic growth and the increase of natural gas prices, the biggest drivers of the rapid development of natural gas have already changed somewhat. Protecting the natural environment and optimizing the energy structure will become major drivers for the growth of natural gas demand in China.

4. Competitive edge of coal-based gas in the context of changing oil prices

The ex-factory prices of natural gas in coal-based gas plants that are already on stream (see Table 1) are basically identical to the ceiling gate price implemented in April 2015, for the areas where these plants are located. An additional cost for liquefaction (RMB0.5-0.6/m3) is added in the prices of LNG. Take a coal-based gas project in Xinjiang for instance. The ex-factory price of natural gas with subsidies from local governments is RMB1.8/m3, close to the ceiling gate price for that area of RMB1.85/m3.
The relationship between coal-based gas projects and oil prices is quite complicated. Impacts of oil price fluctuations usually are not clearly evident. Other factors, in fact, also play a part. Coal-based gas, a variety of unconventional gas, is not restricted by the government guided ceiling gate price in theory. Gas suppliers can by themselves sign purchase contracts and transportation contracts with downstream clients. The ex-factory price is determined by the market. To ensure stable functioning of the market, the ceiling gate pricing formula guided by the government is not set in concrete either.
The implementation of the price trend rules can be observed in the two price adjustments of “incremental” natural gas during 2013-2015, in combination with oil prices in the international market in different periods. When the oil price is at the extremely low level of around US$50/bbl, the gate price of natural gas in Xinjiang is RMB1.85/m3. When the oil price is US$50-110/bbl, the gate price of natural gas in Xinjiang is RMB2.29/m3. It can be seen that coal-based gas plants, in fact, have the ability to withstand extremely low oil prices. If the equivalent heat value conversion for the price change of LPG in East China is taken as a reference along with international oil prices, when the oil price is US$50/bbl, the price of natural gas with the equivalent heat value is around RMB2.7/m3. At the present level of the natural gas price in China, coal-based gas plants can withstand the extremely low oil price of around US$50/bbl.
Compared with other coal-chemical prices having higher correlation with the oil price, the buffer of coal-based gas is stronger, and oil price fluctuations have no direct impact. For many years, the per-capita consumption of natural gas in China has been much lower than the world average. Pushed by urbanization and the increasing demand for clean energy, both the consumption and the consumer prices of natural gas will keep rising in China. Coal-based gas will still have competitive advantages over other unconventional natural gas and imported natural gas.

5. Development of
coal-based gas

According to policies for the development of natural gas in China, imported natural gas and unconventional natural gas will be major drivers for growth of the supply. Comparing the costs of several gas varieties transmitted to clients from production sites, coal-based gas costs about the same as coal-bed methane, less than shale gas and RMB0.4-1.5/m3 less than imported gas. Coal-based gas therefore has great advantages in market competition.
In western regions such as Inner Mongolia and Xinjiang, coal is cheap and abundant, and coal-based gas has evident competitive advantages. Coal-based gas plants in western regions mainly produce a large, stable supply of pipeline gas.
The demand gap of natural gas in central and eastern regions has widened in recent years. A number of renovated or new co-production natural gas plants have emerged in the traditional coal-to-ammonia and coal-to-methanol sector. They produce LNG exclusively and yield good economic benefits. Most of these plants are located in Hebei, Shandong, Shanxi, Henan, Jiangsu and Anhui. These provinces are major grain and cotton producing regions. The demand for chemical fertilizers fluctuates greatly by season. Smog and other pollution are serious results of the use of fuel-coal in chemical fertilizer production. The demand for natural gas in winter is quite big and the co-production of natural gas has the advantage of peak regulation.