In late December 2011, the NDRC issued a notice announcing a natural gas price reform pilot scheme. According to the notice, the pilot scheme will be implemented in Guangdong province and the Guangxi Autonomous Region. This pilot scheme has sent a positive signal to the market that China is finally stepping up its natural gas reforms.
This is a summary of the key features of the scheme:
The scheme lays down the goals and processes of the natural gas price reforms. The ultimate goal of the reforms is to liberalise and let the market decide the well-head prices. The government will only supervise the pipeline transmitted gas prices. The process comprises the following:
- The pricing mechanism is to be changed from a 'production cost' base to a 'market net return' base. The new pricing mechanism applies to gas produced at onshore gas fields in China and imported pipeline gas.
- The new city gate prices will be linked to the import price of two types of substitute fuels: fuel oil (giving a 60 per cent weight in the final prices) for power generation and LPG (having a 40 per cent weight in the final prices) for cooking in Shanghai, and the prices of these substitute fuels are to be used as a starting point by the government to derive a benchmark price in Shanghai. This benchmark price will in turn be used to calculate the gas prices for Guangdong and Guangxi, which are the two regions initially subject to the scheme.
- The city-gate prices are adjusted, initially annually, then semi-annually or quarterly, according to the change in prices for the above mentioned substitute fuels; and
- The prices of unconventional gas such as shale gas, coal seam methane and coal to gas will be liberalised and decided by the market.
The pilot scheme is viewed as an incentive to unconventional gas and will likely boost gas imports as well as output of cleaner fuel in China.
However, another important incentive introduced last year has been quoted by some as a less positive message to those hoping to see more drastic gas price policy changes. This is the value added tax (VAT) rebate scheme introduced by the Ministry of Finance in August last year. According to the scheme, the government will grant VAT rebates for LNG and gas imported between 1 January 2011 to 31 December 2020. By way of background, the gas imported by Chinese companies is exempted from customs duty but is subject to 13 per cent VAT. It is widely perceived that the purpose of this scheme is to help alleviate the huge losses assumed by the big state-own entities who, under the central government's direction, paid international prices for large quantities of imported gas and LNG but were unable to pass on the costs to domestic gas off-takers due to the natural gas price ceiling imposed by the central government. Some observers commented immediately after the rebate policy was announced that the rebate extension would likely delay the central government’s progress on natural gas price reform. However, other energy analysts argued that the rebate would only cover a fraction of the imported costs; unless the natural gas prices in China are raised significantly, the big state-owned oil companies in China would not be able to offset losses from their gas imports. Hence, price reform will continue.
Considering that the rebate scheme was announced four months earlier than the pilot gas price reform scheme, it seems more likely the VAT rebate will only serve as a temporary measure to set-off a small portion of the price disparity between the international gas prices and the domestic natural gas prices. If China is to realise its plan to increase gas consumption to account for a significant portion of its total energy consumption, it will have to pick up the pace of price reform.
As the NDRC mentioned in its notice introducing the pilot scheme, the aim of the gas price reform pilot scheme is to assist the government to determine a reasonable pricing mechanism, a suitable basket of indexed fuels and an appropriate price adjustment system. If the pilot scheme proves to be successful, the new pricing system will be rolled out nationally. In time, China may be able to reduce the gap between imported prices and its domestic gas distribution prices.