China's gas sector is falling into an awkward middle ground. It's more expensive than coal, and it's not as green as renewables and alternatives. S&P Global Ratings believes gas volume growth in the country will moderate over the coming five to six years as the government slowly deprioritizes its use in policies. As gas distributors seek new sources of growth, their leverage may rise over the next five to 10 years.

Government decarbonization measures, the rise of renewables, and upgrades to coal power will all weigh on gas demand. State planners are seeing gas as somewhat less helpful in addressing the country's overarching goals of energy security, growth, and emission cutting.

This is all playing out against the backdrop of two grinding land wars, which have kept oil prices--and therefore gas prices--elevated. The economics of this fuel source have shifted, and so have China's policies addressing its use.

Volume Growth Will Likely Stabilize On Moderating Economic Growth

We project rated gas distributors will average volume growth of about 7% in 2024 and 6.5% in 2025. Growth will converge toward national consumption trend-growth of about 5% toward the end of the decade. The shift partly reflects a slowdown in the country's annual GDP expansion to around 4.5% as well as limited greenfield projects.

The pace of growth will differ among distributors depending on their appetite for acquisitions, the number of projects targeting manufacturing plants that are migrating to inland China, and their gas pricing strategies. In the first half of 2024, rated issuers achieved average volume growth of 6.7%, in line with our full-year projection.

Chart 1

Growth in the industrial sector, which consumes 56% of issuers' retail gas volume, will remain in the mid-single-digits over 2024-2025. High growth in gas demand from the clean-tech sectors will help mitigate declining consumption among the property-related sectors. This includes manufacturing of electric vehicles, lithium-ion batteries and photovoltaic glass, where natural gas is used as fuel in industrial boilers.

Meanwhile, residential volume growth will likely decelerate over 2024-2025, as new household connections decline. This tracks a weak housing market and shrinking new housing starts. In the first half of 2024, rated distributors' residential volume grew 6.1%.

Chart 2

The dollar margin will likely modestly expand on lower gas costs.  Rated issuers will achieve an average dollar margin expansion of Chinese renminbi (RMB) 0.01-RMB0.02 per cubic meter (cbm), per year, over 2024-2025. This assumes a 2%-3% annual decline in gas costs, following drops in the Brent crude benchmark. In the first half, gas costs declined 2.7%, on average. We assume gas procurement prices for the coming winter will be on par with that of the previous year given stable supply conditions.

Still, a tight global liquefied natural gas (LNG) market, with its exposure to persistent geopolitical risks, continues to pose downside to costs and dollar margins over the heating season. A cold spell that leads to high residential heating demand may increase the need for spot LNG purchases, which will be the most expensive source if it continues at the current level of above US$13 per million British thermal units.

Meanwhile, despite regulatory efforts for clearer cost passthrough mechanisms, friction persists in the mechanisms to pass on cost increases to residential customers. Consumers in several Chinese cities complained widely online, and to local authorities, following gas-price hikes this year. The backlash highlighted the political sensitivity of raising residential gas prices, especially in a slowing economy.

Chart 3

Rise In Gas Storage Capacity To Provide Crucial Seasonal Flexibility

China has made significant strides in storage, mitigating international supply and price risks. This is important since the country relies on imports for around 40%-45% of its gas needs, a situation that is unlikely to change by 2030 due to limited domestic production.

Sufficient storage is key to addressing seasonal demand swings, particularly as residential heating demand increases. According to S&P Global Commodity Insights, as of end-2023, China's total gas storage capacity (including underground and LNG terminals) reached 36.1 billion cubic meters (bcm). That translates to annual growth of 19% since 2016.

The storage capacity is equal to 9% of annual consumption. Based on planned projects, storage capacity could reach 56 bcm by 2025 and 90 bcm by 2030. The 2030 level would satisfy 16% of China's annual gas demand, putting it on par with U.S. gas storage capacity.

Decarbonization To Restrain Natural Gas Development

Decarbonization policies since 2021 have deemphasized somewhat the role of natural gas. For instance, China's "2024-2025 Energy Conservation and Carbon Reduction Action Plan" and its revised "Measures for Administration of Natural Gas Usage," both released this year, emphasized the "orderly" development of gas consumption, focusing on the availability of local supply and affordability.

This is a shift from the 2017 policy from the National Development and Reform Commission (NDRC) titled, "Opinion on Accelerating the Use of Natural Gas." The measure outlined an aggressive push for coal-to-gas conversion of industrial and residential heating furnaces.

Such developments support our view that China's gas sector is entering a period of slower growth (see "China Gas Sector Easing Into Lower Demand," published on RatingsDirect on Nov. 21, 2022). We expect industrial and gas power sectors to each contribute almost one-third of overall growth toward 2030, with the remaining volume coming from the residential, commercial, and transport sectors.

Renewables And Clean Fuels Will Challenge Industrial Gas Usage

As cheap renewable energy grows rapidly and gas costs remain high, manufacturers may increasingly turn to electricity to meet emission targets. The introduction of energy-intensive sectors (such as cement, steel, and aluminum) into the national emissions trading scheme may accelerate the process.

Emission-reduction plans for various manufacturing sectors point to a preference for increased electrification and improved energy efficiency, over replacing coal with natural gas. For instance, the State Council's "Nonferrous Metals Carbon Peak Plan" encourages increasing electrification of furnaces, and the orderly use of natural gas to replace coal only in areas with stable and affordable supply.

In sectors where electrification may be less achievable, such as cement and glass manufacturing, the China Construction Material Federation's decarbonization guideline suggests using solid-waste fuels, biomass, hydrogen, and electricity to replace coal.

Demand for gas power will depend on the pace of upgrading and retrofitting of coal power.  Gas power has advantages as peaking plants given its flexibility and fast ramp-up times. However, cost constraints hinder its development. At current prices, gas is the most expensive power source in China. As such, capacity expansions mostly occur in provinces with robust gas supply.

Gas power plants are large gas consumers. To put it in perspective, adding 1 gigawatt of new gas power capacity could add 0.55 bcm of annual gas demand. We base this estimate on current sector metrics, such as a capacity factor of around 30% and a unit consumption of 0.22 cubic meters per kilowatt-hour. In 2023, gas power alone accounted for 17% of total gas demand.

Coal-power flexibility and low-carbon upgrades are emerging as new priorities to prepare the power grid for renewable energy. The NDRC's "2024-2027 Coal Power Low-carbon Upgrade Action Plan" outlined strategies such as co-firing with biomass or green ammonia to reduce emissions.

The technology and economics of such low-carbon initiatives remain uncertain. Nevertheless, we anticipate more policies to support coal power upgrades, including on financing and cost recovery. This will limit the need for gas power for peaking plants. This, along with the national target to complete coal power flexibility upgrades by 2027, may reduce the headroom for gas power growth.

Change Is The Constant

Faced with a shifting industry landscape, gas distributors are laying the groundwork for new sources of growth. This includes growth through acquisition, the expansion of sales of gas appliances and services, transitioning into integrated energy, and pushing into renewables. Prudency in capital investments and a competitive cost of funding will be key in maintaining the balance-sheet health of distributors as they enter this next phase.

Editor: Jasper Moiseiwitsch

Appendix

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Related Research

• China Gas Sector Easing Into Lower Demand, Nov. 21, 2022