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China’s gas price reforms move in slow lane
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China’s reform of natural gas pricing has been proceeding at a much slower pace than expected, judging from PetroChina Co’s earnings results released last week.
The nation’s largest oil and gas producer posted a third-quarter net profit of 29.8 billion yuan (US$4.88 billion), up 19 percent from a year earlier.
The gain largely reflected performance in its refining arm after the government introduced changes to the fuel-pricing system in March.
In the first nine months of this year, PetroChina’s refining operations reduced losses by 24.7 billion yuan from a year earlier to 5.3 billion yuan. However, China’s largest gas importer showed a net loss of 31.7 billion yuan from the sale of imported natural gas in the domestic market.
The figures suggest the deregulation of gas prices could prove more difficult for the company than that of refined oil products. The government is seeking to address the dilemma of market-based pricing – which could mean higher prices – and affordability as the nation accelerates a transition to gas to cope with pollution.
Impact on motorists
In oil price reform, the government’s chief concern is the impact of higher costs on motorists. In gas, it has to consider wider implications of a price rise, such as the affordability of average households and the industrial competitiveness of sectors such as power generation and manufacturing.
The oil-price changes introduced in March involved more frequent adjustments to domestic pump prices, with the review period shortened to 10 working days from 22.
That aligns prices more closely with global crude rates.
For gas, the government in July announced a long-awaited reform that pegged city-gate prices — or prices at which gas is transferred from pipeline operators, like PetroChina, to distributors — of “incremental gas consumption” to 85 percent of the level calculated on a formula released in December 2011. That was when the government started regional price reform trials in Guangdong and Guangxi provinces.
The formula links natural gas prices directly to those of imported liquefied petroleum gas and fuel oil — the two alternative fuels — for the first time. Imported LPG prices are linked to international oil prices.
For city gas distributors, prices for gas volumes are split into existing usage, with 2012 volume as the base, and incremental usage.
The incremental usage component of gas volumes would see much steeper increases under the July reform, but the National Development and Reform Commission also said existing gas prices are meant to converge towards the new pricing formula by the end of 2015. The July price increase only applies to non-residential users.
When the reform was announced in July, analysts upgraded estimates on PetroChina shares, betting that the company would be the biggest beneficiary from the price hikes. But implementation turned out to be more challenging than expected.
Lower than forecast
Although PetroChina’s gas prices increased 12 percent from 1.15 yuan per cubic meter in the first half to 1.29 yuan in the third quarter, the post-reform period proved lower than a forecast 18 percent gain, according to Neil Beveridge, an analyst at Sanford C. Bernstein & Co.
“Rather than price increases being mandated as per the new policy, gas prices are being negotiated on a customer-by-customer basis, with PetroChina still being forced to offer discounts as large price rises prove difficult to pass through,” he said.
The brokerage, which upgraded PetroChina in July, downgraded the shares to “market-perform” last week.
Even worse for PetroChina, the company is set to double gas imports over the next two years, with new supplies from Myanmar and central Asia, via new pipelines, and from Australia’s Gorgon liquefied natural gas project, now under construction, via ships.
PetroChina’s gas imports may rise to 65 billion cubic meters from 35 billion in the next two years. That would mean losses could continue to rise from 42 billion yuan this year to 51 billion yuan in 2015, Beveridge said.
PetroChina will be required to supply more gas, given its state-controlled status, as China’s pollution crisis deepens. PetroChina has recently signed up for an additional 25 billion cubic meters of annual supply from Turkmenistan and will potentially sign a major deal with Russia at the end of this year.
“Despite the slower-than-expected gas reform, PetroChina continues to increase gas imports through additional contracts in a clear sign that government gas supply targets matter more than shareholder returns,” Beveridge said.
By 2020, PetroChina’s gas imports will reach close to 120 billion cubic meters, which will erode much of the benefit of domestic gas price rises, he said.
Analysts also said the reform could carry short-term negative implications, albeit marginal, for city gas distributors because companies have to pass on higher costs to commercial and industrial customers.
Those negative effects are mitigated by contractual agreements containing provisions for city gas companies to pass through gas cost increases.
“In its move to align gas prices with actual costs, China will not unduly penalize city gas distributors if the government is keen to support further investments in city gas operations, which is key to shifting more end users to gas from alternative sources of energy,” Fitch Ratings said in a July report.
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