14 Apr 2023 | 07:05 UTC

Chinese oil majors in standoff with gas distributors on downstream sales contracts

Highlights

National oil companies offering lesser natural gas, ask for higher prices

Second-tier firms forced to sell gas at regulated prices for residential use

Regulators may propose means to link upstream gas with downstream prices

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The signing of a wide swathe of downstream natural gas supply contracts in China has slowed following disagreements between the three key national oil companies -- PetroChina, Sinopec and CNOOC and its customers that largely comprise second-tier gas distributors, as analysis by S&P Global Commodity Insights showed.

These sales contracts are typically finalized by end-March to facilitate supply for residential and heating purposes, and allow city gas companies to procure from overseas in case of supply shortfalls.

China's five largest city gas distributors -- Kunlun Energy, ENN Group, China Resources Gas, China Gas and Town Gas -- are collectively responsible for a large portion of midstream gas transport and last mile gas delivery.

However, only a handful of the downstream contracts have been signed so far this year due to disagreements over prices, volumes and other terms. Upstream suppliers have trimmed the volume of subsidized gas on offer and raised prices citing higher costs, at a time when second-tier companies are burdened with mounting losses.

China's city gas price for residential use is regulated, which means that distributors have to buy at higher prices from the NOCs and sell at lower prices. The delayed sales contracts also reflect the challenge of gas market reforms in China, as the government balances market liberalization with the need for affordable supply.

Some of the cost burden has been passed on to second-tier companies from NOCs despite the introduction of market-based pricing in several segments. But the implementation has been rough and is likely to prompt more recalibration by policymakers in Beijing.

Gas pricing policy

The NOCs have argued that in a more liberalized market, where they split market share with second-tier and third-tier companies, they should split other supply obligations like energy security too. The non-NOCs have been pushing back.

In early March, the China City Gas Association, a trade body representing gas distributors, submitted a report to the country's top economic planner the National Development and Reform Commission proposing a more equitable gas pricing system, the Shanghai government-owned Jiemian News reported in March.

The report said upstream suppliers have been cutting annual contract volumes by about 5%-20% every year, the uncontracted volume was sold at exorbitantly high prices and the amount of gas committed for residential demand by the NOCs fell short of actual demand.

The NOCs also set an upper limit for provinces with a large proportion of heating gas demand, forcing some city gas companies to buy at high prices to ensure supply stability, Jiemian News reported. Overall the report said the existing framework for downstream sales did not support societal needs.

In response, the NDRC has conducted consultations for formulating a price linkage mechanism between the upstream and downstream sectors and a draft policy could be released as early as the first half of 2023, Jiemian News reported. The NOCs and NDRC did not respond to queries by S&P Global.

China has a complicated downstream gas pricing mechanism, under which the prices of imported LNG, offshore natural gas, unconventional gas, imported pipeline gas under projects launched since 2015, and the city-gate gas prices in a few provinces, are not regulated, while those of onshore natural gas and imported pipeline gas under projects launched before end-2014 are still regulated.

City gas companies want to get more regulated gas from upstream suppliers so that they can make some profit in selling to non-residential users, while the big three want to sell more unregulated gas to their customers at market prices to pass on the high import costs, a trade source in Fujian said.

PetroChina, Sinopec downstream sales

In the 2023-24 gas supply contract released recently, the sales prices of PetroChina's residential gas was 15% over city-gate gas prices, compared to a 5% premium last year, independent financial news agency Caixin reported April 7.

It said PetroChina had raised prices for unregulated gas in both non-heating and heating seasons, and lowered the proportion of regulated gas supply in the non-heating season this year. China's heating season is normally from November to March.

PetroChina produced 126.6 Bcm of natural gas domestically, mostly regulated gas, in 2022, accounting for more than 58% of China's total natural gas production of 217.8 Bcm last year. It supplied about 64% of China's total gas demand in the past heating season, state-owned Xinhua News Agency reported April 7.

In March, state-owned China Daily reported that Sinopec Hebei branch released its 2023-24 downstream sales plan under which contracted supply in the non-heating season only covers 80% of the previous year's actual demand.

China's residential gas is estimated to be around 73 Bcm in 2022, accounting for 20% of its total gas consumption of 363 Bcm last year, data from S&P Global showed.

In order to diversify gas resources, China's second-tiers have been actively expanding natural gas sourcing channels, building LNG receiving terminals or utilizing third party access at state-owned PipeChina's LNG receiving facilities to import LNG.

Out of the 35 long-term LNG supply contracts signed by Chinese importers from January 2022 to February 2023, 66% were by non-NOCs including city gas companies, power plants and private gas companies, with a total contract volume of more than 21 million mt/year.