China’s Booming Gas Market: opportunities despite trade war?

I gave a speech at the Annual Unconventional Gas Convention (UGAS) in Beijing.

Another year, another airpocalyps. Last week, Beijing’s air quality deteriorated to the worst in a year-and-a-half. The government is desperately trying to take measure to control the situation with diversifying its energy mix and placing more emphasis on natural gas a key element of its strategy. Only a few weeks ago the government announced it will switch another 1m+ households to natural gas heating from coal this winter.

China holds enormous natural gas reserves including the word’s largest shale gas reserves. However, geological conditions are unfavourable and it’s relatively costly to extract the gas. Hence domestic production, whilst growing rapidly at round 8% per annum, has not been able to meet demand, which is growing at a much faster rate.

IEA expects China’s demand for natural gas to grow by 60% by 2023. China’s internal gas reserves are insufficient to meet this demand and the country has been diversifying supply from the Middle East to Russia, Australia and the US. Next year, China will become the word’s largest importer of natural gas. 

But supply from the US hit a snag when China slapped a 10% tariff on LNG and 25% on LPG as part of the ongoing trade dispute. Gas supply from the US is now less competitive and exports to China have been slashed. Furthermore, investment into LNG export terminals in Louisiana have been delayed as a result.

The Chinese government is desperatly looking for ways to increase domestic sources of natural gas. In September, the State Council announced it may extend subsidies on shale and coal seam gas production for five more years beyond 2020 and provide aid to tight gas production for the first time. This announcement came a month after President Xi Jinping told the three national oil and gas giants to boost output to enhance national energy security.

Does it mean that foreign gas suppliers and foreign equipment, service and technology suppliers are now locked out of China’s gas boom? Not necessarily, but companies need different, more localised strategies, that tie more resources and investments inside China, something not everybody will be comfortable with in the current climate. Last month, ExxonMobile announced a billion dollar investment in a LNG storage and distribution outlet in China, with gas supplied from Exxon’s massive LNG projects in Papua New Guinea and Mozambique.

Other players, including China’s domestic oil and gas majors, have also ramped up investments. In May, PetroChina announced to be planning several new LNG import terminals across China.

In the past, foreign players were able to capture a significant share of the equipment required to support China’s expanding natural gas infrastructure needs. But local players have increasingly mastered the technological know-how and pushed foreign suppliers into niche positions. 

Take a closer look at flow control components used in LNG vehicles for instance. Demand for LNG vehicles is exploding. Sales of LNG trucks increased by over 500% in 2017. Foreign suppliers used to dominate the market for flow control products such as regulators, valves, economiser and fill connectors. But local players have mastered the technology and compete at discounts of 25-40% to the foreign brands who are increasingly pushed into niche positions focussed on the most critical, safety related products. 

The same pattern is repeated in other equipment categories throughout the supply chain including centrifugal pumps, reciprocating pumps and ambient vaporisers. China’s massive demand for natural gas and related infrastructure and specialised equipment creates big opportunities for domestic and foreign players alike. But China’s drive for self-sufficiency means that highly localised strategies will have the most chance to succeed and traditional export models are no longer a viable strategy. 

Hence, ExxonMobile is investing billions in local facilities and infrastructure and equipment suppliers will need to think about localising manufacturing, setting up JV’s, licensing technologies, localising R&D etc. They will need local management talents to better connect with SOE customers and they may acquire a domestic player or make a strategic investments. In the current climate this is a tough decision to make but the lure of the massive Chinese market with its rapid growth rates may be too tempting to resist. 

Already, international oil companies and oil service companies have established their presence mostly through partnering with Chinese companies. At present, international oil companies mostly team up with CNOOC in offshore oil development projects while service companies are hired by China’s big three oil majors on both onshore and offshore projects, which often include complex drillings. 

International players have started working with Sinopec, PetroChina, and Yanchang to develop shale gas and tight oil and gas in Sichuan, the Erdos Basin, and Xinjiang. But foreign participation in this area is still limited, and lack of competition and uncertain regulations continue to frustrate international companies’ efforts. Foreign players are happy to sell equipment or provide services but the oil majors don’t want to take on any exploration risk, especially in shale and tight gas which has a lot of uncertainty.

Nonetheless, ample subsidies, legal reform, and productivity targets are among the reasons why companies are still investing in China’s shale gas sector. And given China’s enormous demand and complexity for domestic exploration and production there will continue to be opportunities for international players with specialised expertise and equipment. For instance, Chevron has significant interests in the Bohai, South China Sea and Sichuan Province (gas production). And, at the other end of the supply chain, in retail, both Shell and BP have announced in the past weeks to be expanding their gas station networks extensively in China.

Energy supply is traditionally a sensitive area where the government applies quite restrictive measures for foreign participation. But given the high demand for natural gas fueled by China’s ongoing environmental woes, the required high levels of capital investment, and the technical complexity of exploration and extraction in China coupled with the advanced know-how of the international oil majors, the government is likely going to be open to provide access to foreign players, including from the US.

Michel Brekelmans is Managing Director at SCP/Asia, a consulting firm that supports business executives and investors in business intelligence, growth planning, M&A support and organisational performance improvement across the Asia Pacific region. With over 20 years experience in strategy consulting, and based in China and Singapore since 2002, he is highly experienced in solving complex management decisions regarding the growth path of their business and major investments. www.scpartnersasia.com