Jonathan Fenby

Chairman, China team and Managing Director, European Political Research
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China’s gas reform – not as far or as fast as we had hoped

The Chinese government has talked a lot about reforming the country’s gas sector (tariffs, third-party access to infrastructure, capping returns) to lower prices for end users and stimulate demand as a way of reducing China’s dependence on coal and improving the quality of the environment. The aim is for gas to account for 8.3–10 per cent of energy use by 2020; achieving that goal requires a 15 per cent increase in gas use every year from now until 2020. Pressure to phase out coal use will clearly drive some of the increase, but pricing and access reforms are also key to stimulating demand growth.

Progress on reform has been mixed with resistance from entrenched interests. The latest developments suggest t the government has yet to overcome them if it wants to reform the sector.

The National Development and Reform Commission (NDRC) had proposed that gas distribution companies should earn a rate of return of 6 per cent on their pipelines. That cap was aimed at bringing down prices to end users (an 8 per cent limit has already been imposed on the NOC’s trunk pipelines). However, new NDRC guidelines cap the IRR at 7 per cent rather than the 6 per cent previously proposed – perhaps because of the outcry when the 6 per cent cap was trialed in Hubei province. The 7 per cent cap had a positive impact on the share prices of distributors, which suggests that it is not likely to meet the government’s aim of liberalizing China’s gas market and increasing gas demand.

The independent ENN Energy suggested that the 7 per cent cap would have almost no impact on its business since it typically earned a rate of return of 6-7 per cent on its distribution pipelines. It also said that it believed a 6 per cent cap could lead to a decline in capital investment and therefore a fall in gas demand. The company highlighted that it lost money on residential gas sales (where prices are lower than in the industrial sector) - it cross-subsidizes those losses from the profits it makes in the distribution business.

The new guidelines leave unclear whether connection fees and service fees, which have larger margins, are caught by the cap. At present, based on our reading of regulations, it appears they are not – and that, too, is positive for the gas distributors’ earnings and therefore probably not for gas demand in China. Some industry observers believe the cap is bad for distributors because of the government’s aim of lowering end-user gas prices. However, in its present form and level, we believe it is a missed opportunity to reform the sector, reduce prices and stimulate demand.

Some cities, including Beijing and Shanghai, will see price cuts because their distribution charges are higher than average. The new pipeline tariffs – and their impact on end-user prices - are set by provincial level pricing bureaus and are likely to be in place by mid-2018.

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