By Guo Jiaofeng, Gao Shiji, Cai Shenghua, Bai Yanfeng & Ling Yun

Research Report Vol.19 No.2, 2017

The improvement of the natural gas pricing system is crucial to realizing China’s objectives for developing natural gas as specified in its thirteenth Five-Year Plan and the medium and long-term plan. Sticking to the principle of being “open, fair and just”, the futures market allows multiple players to fully and effectively engage in market transactions and competitions, creating benchmark prices that truly and sufficiently reflect the relationship between market supply and demand and standing as an important facilitator for promoting the market-oriented reform of natural gas prices. Therefore, we should look at the bigger picture and start preparation as early as possible. In order to deepen the reform of natural gas prices in a comprehensive manner, we should start with the establishment of the natural gas futures market and rely on the reform of all sectors of the natural gas industry. We should strive to form benchmark prices that are “open, stable, and predictable”, which will lay the foundation for the ultimate market-decided prices, promote the market-oriented reform of China’s natural gas, and contribute to the systematic restructuring of China’s energy industry.

I. Basic Conditions for Establishing China’s Natural Gas Futures Market

1. The huge market size and the diverse sources of supply predict fierce market competitions among different gas sources

First, an increasingly large part of the overall energy structure is taken up by natural gas. In 2015, China produced 135 billion cubic meters of natural gas and consumed 193.1 billion cubic meters, ranking sixth and third in the world respectively. It is estimated that by 2020 and 2030, natural gas will take up 10% and 15% of China’s primary energy consumption respectively, becoming the third largest energy source after coal and oil. Second, there are diverse sources of supply. In 2015, China’s net import of natural gas amounted to 61.4 billion cubic meters, of which 42% was liquefied natural gas and 58% was pipeline gas. It meant that besides domestically produced gas, China imported pipeline gas from Central Asia and liquefied natural gas from the Middle East, Australia and Southeast Asia. The diversification of gas sources naturally leads to the competition among different sources with their different costs and the formation of a natural gas market that reflects the overall supply and demand situation in China and the Asia-Pacific region at large.

2. The gradual improvement and rapid development of infrastructure provide a favorable delivery basis for natural gas futures

Widespread pipelines and LNG receiving stations have witnessed the rapid development of China’s natural gas infrastructure. As of 2015, the country had completed the construction of Shaanxi-Beijing Pipeline, the West-East Gas Pipeline, Sichuan-East Gas Pipeline, Central Asian Natural Gas Pipeline, China-Myanmar Natural Gas Pipeline and other long-distance pipelines, with the total mileage reaching 64,000 kilometers; 12 LNG receiving stations, with the total receiving capacity reaching 43.8 million tons per year; and 18 underground gas storage reservoirs, with the effective working gas capacity reaching 5.5 billion cubic meters per year. At present, conventional and unconventional domestic gas, pipeline gas imported over land, LNG imported on sea and gas from other sources are complementing each other and contributing to a pattern that provides gas by the principle of proximity and becomes further supplemented by West-East Gas Pipelines and Sea-Land Gas Pipelines. Underground gas storage reservoirs and LNG receiving stations are used as two major tools for peak shaving. The well established storage and transportation facilities provide the basis for physical delivery and thus lay the foundation for the introduction of natural gas futures.

3. The large number of industrial customers and market players provides a favorable market basis for China to introduce natural gas futures

From the production side, upstream participants are becoming increasing diversified. Besides the three major state-owned oil companies, Shaanxi Yanchang Petroleum (Group) Co., Ltd and other oil companies are leveraging existing blocks to participate in upstream exploration and mining. Some private capital begins to invest in the exploration and mining of unconventional gas. Sinopec OilfieldService Corporation, Greatwall Drilling, Yantai Jereh Oilfield Services Group Co.,Ltd. and other entities are becoming involved in oil service. With respect to LNG production, participants include state-owned enterprises (such as CNPC and Shaanxi Yanchang Petroleum), private companies (such as Xinjiang Guanghui) and foreign enterprises (such as ECO Shanxi Coalbed Methane Co., Ltd), contributing to a rather active market. At present, China’s major natural gas importers are CNPC, Sinopec Group, and CNOOC. With the launch of private receiving stations for liquefied natural gas and the improvement of their storage and transportation capacity (e.g. the technological progress of transporting liquefied natural gas with containers), there will be more private capital and overseas capital flowing into the natural gas market and an even larger variety of market participants. From the consumption side, the major wholesalers of natural gas are CNPC, Sinopec Group, and CNOOC. Except for direct supply to power plants and other industrial users, their gas is further distributed to provincial pipe networks, city gas companies, and small LNG factories, etc. It takes two or more rounds of sales before gas reaches residents, industry, CNG filling stations and other end users. At present, there are more than 200 gas companies in domestic cities. The large number of participants and the multi-level market network provide a favorable market basis for China to introduce natural gas futures.

4. While the spot trading platform is gradually being established, preparations for futures trading are well under way

In terms of spot trading, Shanghai Petroleum Exchange Ltd[ ]. launched spot LNG bidding transactions in 2010 in order to cope with natural gas peak shaving. In January 2015, Shanghai Petroleum and Natural Gas Exchange (SHPGX) was established, which officially launched spot and bidding transactions for pipeline natural gas and LNG in November 2016. Ningbo Commodity Exchange, situated in the vicinity of Shanghai, launched medium and long-term spot LNG contractual transactions in 2014. In addition, a number of private enterprises, encouraged by the “Internet plus” policy, have started to invest in e-commerce platforms for liquefied natural gas. These platforms, modeling after Taobao, provide valuable supplements to the liquefied natural gas trading market. A flourishing spot market with many vigorous electronic trading platforms lays the foundation for futures trading.

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