Gas Power Fights Uphill Battle in China

Courtesy: CLP Group

China’s power needs are expected to nearly double between 2010 and 2020, according to the China Electricity Council, and by some projections, demand has already exceeded capacity. The vast majority of the country’s installed generation consists of coal and hydropower, with the remaining elements making up less than 15% of the total as of 2010. Leaving aside the environmental impact of such heavy dependence on coal, this has also meant limited ability to respond quickly to changes in demand. Worse, much of the non-coal, non-hydro generation includes resources like nuclear with little ability to provide peaking capacity, or resources like wind that increase the need for peak management.

China’s installed peak regulation resources are far below that of other developed countries. This has led to increasingly unstable grid conditions in many areas, with baseload plants struggling to manage frequencies across peak and off-peak conditions. In several embarrassing incidents over the past several years, entire wind farms have had to be disconnected from the grid because of an inability to handle the output. The worst episode so far took place on April 17 of last year, when more than 1300 turbines in Gansu and Hebei provinces, representing almost 2 GW of capacity, had to be taken offline to protect the grid. 

Despite this growing need for flexible power sources, China’s gas-fired power sector has long operated on the sidelines, hamstrung by limited supplies, government policies restricting the use of gas for power generation, and fixed prices for gas and electricity that make competition with other sources difficult to impossible. While the country has been working to increase its gas-fired peaking capacity, the plants that have been constructed have needed guaranteed returns in order to operate, according to a Chinese plant engineer who spoke with GAS
 POWER this month.

China’s 2007 Gas Policy largely prohibited the use of natural gas for power generation (except for distributed combined heat and power) because of gas shortages and an official policy in favor of domestic and industrial use. The 2012 Gas Policy, announced in October, partially lifted this prohibition except in a number of large coal-producing areas, and China has begun to look into ways of boosting its gas-fired generation. 

In this, as Max Krangle, director at London-based energy analysis firm NRGExpert, points out, the nation has no choice. “Their current power generation capacity, using traditional methods, can no longer meet their growing demands,” Krangle told GAS POWER in February. “They are sitting on a lot of natural gas and will have to make use of it to meet their capacity requirements.” 

The 12th Five-Year Plan, which covers 2011 to 2015, projects that China’s installed gas-fired capacity will more than double from about 26 GW in 2010 to nearly 60 GW in 2020. Yet impressive as this may sound, it will still represent a mere 3.3% of overall projected capacity, and the increase is dwarfed by the nearly 400 GW of coal capacity planned to come online during the same period. Growth in hydro and wind power, at 140 GW and 120 GW capacity respectively, should also outstrip gas.

China’s need to shift toward cleaner energy sources and to wean itself off historical dependence on coal is driving many of the changes. Unfortunately, a review of the challenges facing gas power in China suggests gas has a long way to go before becoming a meaningful element of the nation’s power mix. 

Structural Impediments

The problem, ironically, is not a shortage of gas—not precisely. By some estimates, China has the largest shale gas reserves in the world. 

“China’s shale gas development prospect is bright—if the government can put in place the right commercial and regulatory frameworks, including those concerning environmental regulations,” Jane Nakano, fellow with the Energy and National Security Program at the Center for Strategic and International Studies, told GAS POWER in February. 

But getting the gas out of the ground, out of the producing regions, and into the plants may prove to be a significant challenge. China hopes to boost shale gas production from an initial 229 Bcf in 2015 to over 2.1 Tcf in 2020, accounting for around 10% of the nation’s total production. Some observers, however, feel these projections are overly optimistic.

One reason is that many of the conditions that fostered the shale gas boom in the U.S. do not exist in China. The geology of its shale regions is more complex, in ways that may both increase production costs and reduce yield compared to deposits in the U.S. The most productive shale is formed from marine deposits, since these contain the most organic material that decays into methane. China is believed to hold marine shale deposits in Sichuan Province and the Tarim Basin in western Xinjiang Province (Figure 1). The other identified shale plays in eastern and northeastern China are believed to be non-marine. 

1. China is believed to possess some of the largest shale gas reserves in the world, though not all will be easily accessed. Source: IEA

Another potential challenge is that many of China’s shale deposits are thought to contain high clay contents, which makes the shale more difficult to fracture and thus reduces yield. Researchers are working on ways to get around this, but the methods will need to be developed before production can begin in earnest.

The biggest natural roadblock, however, is likely to be water. 

China has 20% of the world’s population but only 6% of its freshwater resources, making it one of the most water-challenged countries in the world. The country has already experienced widespread shortages and conflicts over water use, and water-intensive shale gas development seems certain to exacerbate these problems. Given how even U.S. states with ample water—such as Pennsylvania—have seen large-scale shale gas extraction ignite disputes over water supplies, this problem foreshadows substantial impediments in the way of China’s exploitation of its shale gas reserves. 

And where water supplies are limited, these problems may be much worse. Shale development in arid regions like Inner Mongolia and Xinjiang Province in the far west are likely to prove highly challenging. It seems certain that waterless fracturing methods and water recycling technology will be necessary to recover meaningful amounts of shale gas in these areas.

Initial exploration is taking place in Sichuan Province, where conditions are generally favorable. However, even though Sichuan Province has abundant water, the vast majority of it is currently used for agriculture. 

And therein lies perhaps the biggest impediment of all. 

“China’s biggest problem in extracting shale gas,” Krangle says, “is its dense population.” The problems associated with shale gas exploration in the U.S. have thus far shown up mostly in sparely populated rural areas. Not so in China. 

“Fracking natural gas in many areas of China may expose the dense population to the by-products of fracking and damages to the geological table. Simply put, the negative sides of extracting shale gas in the U.S. are less visible compared to China, even though regulations in the U.S. are tighter.”

Experts familiar with gas development in China have highlighted other potential impediments, such as more complex land ownership rules. Land in China is owned either by the state (most urban land) or the collective (most rural land). Companies wishing to explore for gas must obtain a license from the government. If economic deposits are found, a second license must be obtained to begin production—but the receipt of this license is not guaranteed.

Another potential problem is the structure of the oil and gas industry in China, which is dominated by large state-owned companies. Small independent firms similar to those that led the shale boom in the U.S. are so far fairly rare. At the most recent government auction of shale gas exploration licenses, on Jan. 22, of the 16 licenses awarded, 14 went to state-owned firms. 

Imports Galore

While China’s natural gas production nearly doubled between 2005 and 2010, it was not enough to keep pace with demand, as the country became a net importer in 2007. The International Energy Agency (IEA) projects China’s gas demand will grow at a 6% annual rate through 2035. Imports are expected to hit 7.4 Bcf/d by 2020, and analysts anticipate that a significant and growing portion of China’s future gas will come from imports.

Last year, China signed an agreement to buy up to 6.3 Bcf/d of gas from Turkmenistan (Figure 2). This is in addition to about 1 Bcf/d that China has begun importing from Uzbekistan. This gas will pass through the 42-inch, 1,100-mile long Central Asia–China pipeline, which connects to the country’s West-East II Pipeline in Xinjiang.

2. CNPC’s facility at Amu Darya in Turkmenistan is part of China’s enormous investment in importing natural gas from Central Asia. Courtesy: CNPC 

Another major pipeline, this one from Burma, is currently under construction and expected to come online this year. The project will supply up to 1.2 Bcf/d from the Burmese offshore fields to Kunming in Yunnan Province.

Pipeline imports from Russia are also in the works, though unlike the swift construction of the Central Asia pipeline, the negotiations with Gazprom have dragged on for several years. The current proposal is for two large pipelines, one into Manchuria (at 3.7 Bcf/d) and the other into Xinjiang (at 2.9 Bcf/d). Disagreements over gas pricing have stalled the projects, as has, according to some reports, Chinese concern over Gazprom’s repeated meddling in European politics

China also has five operating liquefied natural gas (LNG) import terminals, at least another five under construction, and four more in the advanced planning stages. This should greatly expand the country’s import capacity, from about 11 mtpa in 2011 to 87 mtpa by 2020. 

Price Impediments

Yet far from easing the domestic gas crunch, burgeoning imports are creating new problems. The reason is the fixed-price regime that Chinese energy companies are forced to operate under.

The central government has long kept domestic gas prices under tight control to limit inflation and head off social unrest. Different fixed wellhead prices are set for manufacturers, industrial use, and city gate, with transportation fees added to this. Companies importing gas are forced to sell it under these fixed prices even while paying market prices for imports. The result has been staggering losses by the major oil and gas companies.

China National Petroleum Corp. (CNPC) reported a $785 million loss on sales of gas imported from Central Asia in 2011. PetroChina reported a $1.6 billion loss on domestic gas sales in the first quarter of 2012 alone. The high prices on imported LNG also have the majors facing massive losses in the future unless the price restraints are eased.

“The current system of natural gas pricing is a major bottleneck for shale gas development,” Nakano noted. “Also, it impedes natural gas—unconventional or conventional—from achieving its full potential.” 

The government has taken some minor steps toward pricing reform in the past few years, but the future direction is uncertain. A pilot program in which city gate gas prices are indexed to a hub price (linked to fuel oil and LNG) was launched in 2011 in Guangdong Province and Guangxi Autonomous Region. In these areas, suppliers and customers (whether domestic, industrial, or commercial) can negotiate mutually acceptable prices for gas. The plan envisions that the hub price will be adjusted annually at first and later quarterly. Nakano suspects that this slow pace “reflects how cautious the government is regarding the potential economic effects that liberalized gas prices may bring about.”

And Guangdong, Krangle points out, was not chosen at random. “Chinese residents in Guangdong Province have long enjoyed capitalistic and other economic freedoms that remain illegal in other parts of the country,” he says. “Simply put, Guangdong residents can afford to pay more.”

That means expanding the program may prove troublesome. “Elsewhere in China,” Krangle notes, “prices have been subsidized and held artificially low, in line with Communist Party five-year energy planning policy.” 

The 2012 Gas Policy indicates China will “consider” linking gas prices across the entire sector during the 12th Five-Year Plan period. A national gas trading market is also under consideration, as is implementation of seasonal and interruptible pricing. Some take this to mean that the Guangdong-Guangxi pilot program will indeed be expanded, perhaps nationwide. 

Krangle believes the central government will ultimately allow gas prices to fluctuate more in line with the free market, but only when additional economic freedoms are rolled out to other provinces. Past history suggests that any such expansion is likely to be slow and incremental to limit the risks of inflation and social unrest.

Whether or not the pilot program is expanded, some analysts believe further increases in the fixed wellhead prices are likely. A Barclays Plc report released on Jan. 23 suggested burgeoning imports and environmental concerns will force the government to continue these and other pricing reforms.

Limited Pipeline and Storage Infrastructure

Another key issue is China’s pipeline network. Though the country is ambitiously expanding its gas pipelines, its ability to deliver gas to areas where gas power generation might be used remains limited. “China needs to invest more in infrastructure if they want to see commercial shale gas production take off successfully,” said Nakano. Unfortunately, she explained, the existing pipeline network is already committed to transporting conventional gas.

China’s total network, about 24,000 miles in 2010 according to the IEA, is projected to reach 150,000 miles by 2015 (Figure 3). By comparison, the U.S., with less than a quarter of China’s population, had more than 350,000 miles of gas pipeline as of 2010. 

3. Despite significant additions in recent years, China’s gas pipeline and storage network still falls well short of what will be needed in the future. Source: IEA

Significantly, China’s pipeline network is not yet contiguous. Rather, it remains fragmented between various producing areas and population centers. The network was designed primarily to bring gas from the western fields to the populated areas on the central east coast. Its ability to deliver gas to areas in the south is more constrained. Build-outs planned for the remainder of the decade should address much of this issue, however.

A more striking problem is in gas storage. China’s total working capacity as of 2012 was a mere 260 Bcf—perhaps 20 days’ supply—compared to about 4,300 Bcf in the U.S. China’s storage facilities are also located almost entirely in the northeast, with a single facility in the Xinjiang gas field in the far west. This means there is very limited ability to respond to changes in demand should gas-fired plants become more numerous. 

A possible preview of future problems occurred in the winter of 2009, when unusually cold temperatures caused a spike in gas demand for heating, one the network was simply unable to meet. Pipeline pressures dropped to half design values and the government was forced to cut off non-residential customers, idling numerous factories and businesses.

As with the pipeline network, significant expansions are in the works. According to IEA figures, as much as 850 Bcf of storage capacity is either planned or under construction. However, much more will be needed in the future.

Challenges to Profitability

The 12th Five-Year Plan projects gas-fired capacity in China to reach 58 GW by 2020, though some other estimates project higher figures of around 75 GW to 100 GW. The majority of existing plants are concentrated in the Yangtze River Delta and Pearl River Delta regions and around Beijing. These plants often run at low capacity factors because of an inability to compete with coal. Fluctuations in gas supplies and gas and electricity prices have led to several periods in recent years in which gas-fired plants have been idled, while in other areas, plants were able to continue operating only due to local government subsidies. Yet ironically, when gas-friendly policies were put in place to allow the plants to operate, they have run almost non-stop during the summer because of the demand for peaking regulation.

If gas-fired power is to make meaningful inroads, government pressure may be the only way to do it. The example being set by the capital Beijing may be a way forward—though not an easy one.

Beijing’s air pollution has long been a national embarrassment and this winter has become the stuff of nightmares. The central government famously took an array of heavy-handed measures to clean things up—at least temporarily—during the 2008 Olympics. Its long-term goal is to permanently wean the city off coal, and onto renewables and gas (Figure 4). The capital’s four remaining coal-fired power plants are due to switch over to natural gas by the end of 2014.

4. Beijing’s 780-MW Taiyanggong combined cycle trigeneration plant, which came online in 2008, is one of the new advanced gas plants being added to reduce the capital’s dependence on coal-fired power. Courtesy: Camco Clean Energy

The conversion plan drew almost unanimous opposition from the power sector and city officials, who were concerned about both fuel constraints and skyrocketing costs. When planners sat down to crunch the numbers, they weren’t pretty: Projected government losses ranged from around $3 billion a year if gas and electricity prices remained steady, and potentially far more if gas prices were to rise. This was on top of the estimated $13 billion in construction costs necessary to make the switch. 

The capital’s high profile enabled the central government to force the plan through anyway, and the initial results are promising: the city’s coal consumption is reportedly down 700,000 tons in 2012. This success, however, may be difficult or impossible to duplicate elsewhere. The government effectively subsidizes gas-fired power in Beijing by CNY0.10/kWh by setting a higher price for the electricity the plants generate. 

Similar plans, including coal consumption caps, are being considered in the regions around Beijing as well as the major urban areas along the coast. These are likewise meeting stiff opposition from power companies even as central government officials, starting with incoming premier Li Keqiang, have publicly praised efforts to control air pollution.

Cloudy Skies, Clear Future

For all this, though, the way forward seems clear, if only because there is little alternative. That means more gas, which means China has to develop its shale resources whatever it takes, to ensure that enough gas is available to divert from domestic demands to power generation.

“The generation capacity shortfall will force the government to shift their current restrictions,” says Krangle. “They don’t have any other choice.”

—Thomas W. Overton, JD is POWER’s gas technology editor. Follow Tom on Twitter @thomas_overton.

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