The following interview with Kang Wu[1] was carried out in Beijing on March 23, 2015 by Patrick Renz and Frauke Heidemann. The main focus of the interview was on the energy market trends in China and Chinese outward investment. All footnotes are remarks by Patrick Renz and Frauke Heidemann, aimed at giving some additional background knowledge and especially giving the links to the cited documents so that the reader can follow up on these issues easily.

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. Chinese Energy Market

The economic development in China has slowed down to a rate of about 7% economic growth.[2] This had quite an impact on China’s coal consumption. How do you see it affect the oil and gas market in China?

You started with a good point. There are three types of fossil energy: oil, coal and natural gas. The big impact is on coal consumption, where consumption has come to a standstill and even declined last year. This is of course a good development, especially for the environment. When it comes to the other two types, my view is that oil demand will be impacted and slowing down. We already see anywhere between 2-3% demand growth now, which has to be compared to 4-5% expected by demand forecasts just a few years ago. In the past, we had about 7% growth in oil consumption annually.[3] Oil is neither promoted nor restricted, despite the high rate of import dependence. It is more or less left to the market.

Natural gas is the only fossil energy still promoted by the Chinese government. There is definitely a need to promote it, whether or not it will be successful is however a different story. The government and researchers in China hope that they can cap or limit coal demand and instead promote natural gas.[4] By promoting natural gas and renewable energy, the government also automatically dampens the demand for certain types of oil products. But for other major types of oil products such as those used in the transportation, petrochemical, and foreign trade (bunker) sectors, the demand is driven by the sector itself and therefore not influenced.

When looking at the role of natural gas in China’s energy mix, how do you assess the potential for shale gas production? Do you see it as an economically viable alternative to natural gas imports or conventional production?

Shale gas currently only accounts for a tiny (none just a couple of years ago) share of Chinese natural gas production. The entire gas sector is being promoted and China has multiple sources of overall gas supply, such as liquefied natural gas (LNG), pipeline gas, domestic conventional gas, coal-bed methane (CBM) and also shale gas. The government intends to increase shale gas production.[5] However, at the end of the day, it does come down to investments and the market itself. China’s government cannot pay for everything and, while they take measures to increase production, on the commercial side of it they can only do so much and it is up to the National Oil Companies (NOCs) and other independent players to invest.

No doubt, the government wants to do it. But in reality shale gas developments were slow for many years. It has been accelerated a bit in 2013 and 2014 led by Sinopec and then followed by PetroChina and other players. From my point of view, there will be rapid growth in shale gas production. Yet, as the starting point is very small, even if you double or triple production, it is not a lot. We at FGE believe that timing is the most important issue. This year, in 2015, the production is better than previously expected. Starting from nothing a few years back, the companies are progressing pretty solidly. From about 2020 on, we believe that shale gas will begin to actually play a role. Among many other things, shale gas, CBM and environmental targets are often missed in China. However, if the target is missed, a new target is set and people get used to that. Ultimately, there is great potential for shale gas in China and it will become a factor in China’s supply. As mentioned above, with CBM, coal-to-gas and other sources, China does however have many big supply alternatives.

So you believe that any environmental concerns or challenges because of the differing geology will be overcome?

This is an economic issue as well. Hence, the geological challenges are related to the economics. The shale sites are in relatively remote areas and need to be linked up to the pipelines.[6] Looking at the environmental challenges, there is a balance. While the ecological impact, especially the water balance, presents difficulties, there are also the numerous environmental benefits from natural gas consumption over coal consumption. There will be ups and downs in terms of people’s view, but given the current economics, there is good potential for shale gas to grow over time.

How does the economic slowdown and the currently low oil and thereby also oil indexed natural gas prices impact the reform of the natural gas pricing mechanism?

The natural gas price is to be lowered for the first time, starting on April 1st this year.[7] This is the final phase of the three-step price reform of natural gas. So by April 1st, China is going to merge the two tier prices into one for non-residential sectors, which account for roughly 80% of the country’s natural gas consumption. The prices are merged through keeping the tier one prices pretty much stable and only marginally increase, while tier two decreases quite substantially. Because of the collapse of oil prices and related natural gas prices, at least for the oil indexed prices, regulated gas is not necessarily cheap anymore in China, not this year, not when the oil price is at a level of $60 or even up to $80.

This was particularly an issue when the prices where set for April 1st. They used the average LPG fuel oil price of the second half of last year, which was the period when prices declined. Today’s prices are about the lowest compared to the last years. If they stick to this formula, the prices for the second half of this year might be even lower.

For years, experts discussed how low gas prices were in China. But after several years and in today’s environment, they are not low anymore. This even challenges the upstream companies. They have to get used to an environment, wherein they can not keep on calling for the government to keep increasing prices, as they are already somewhat high. The challenge is even bigger on the oil side. All oil companies in China have to be more cost effective and there is a lot of streamlining. Ultimately, the companies have to cut cost to survive. For the first time, NOCs actually get more profit from natural gas than oil today. The price of natural gas is simply more beneficial to them compared to the collapsed price of oil.

How do you think that the anti-corruption campaign is affecting the willingness of China’s big oil companies to implement reforms proposed by the government?

The anti-graft campaign[8] seems to have effects that can go both ways. When the NOCs’ leadership is weakened, there is the opportunity for the government or outsiders to implement reforms. With a weakened leadership, it is easier to have them adapt to new reforms that earlier faced strong resistance.

On the downside, people are busy with dealing with this issue, so that they might not have enough time to implement reforms. And if they had bold reform ideas before, they have to think twice now before they move on them. With the ongoing anti-graft campaign, inaction has become a worry. Rather than doing more and getting caught, you do less or do nothing. So this has developed to a big worry, which the government is trying to address. You could make the rule that when doing nothing you get fired as well, but I don’t know how the government will practically counter this trend. All in all, it is a very challenging period of time.

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. Asian Energy Market

Many see the declining oil price as a chance for oil consumers to cut subsidies and multiple Asian nations have done so. Do you therein see a trend in the right direction and a chance for Asian nations?

Yes, they are doing that. We can categorize the impact of lower oil prices into four categories:

First, there are the European countries. They have high taxes as a component of the prices at the pump, so the lower oil price has not that huge of an impact at the pump.

Second, there is the U.S. The U.S. is probably the only country receiving the full impact of the oil price development, as there are no currency conversion issues. When oil prices drop, pump prices drop too. It remains to be seen how the US demand may be spurred due to this development.

The third category is Middle Eastern nations. There is not an opposite development of price and demand but actually a positive correlation. When the price is high, demand is high and when the price is low, demand is low. As they are producing nations, their revenue got cut in half from the lower prices. With less money they have less options for spending.

And fourth, there is Asia. Here, the situation is interesting as there is a mix. India, Indonesia, Thailand and Malaysia are crucial to look at. India already reformed gasoline and diesel taxation.[9] Indonesia removed subsidies.[10] Thailand also removed subsidies, as did Malaysia in some way. If you add in the impact of the currency depreciation, people actually don’t see the full impact of the price drop. In some countries in Asia, the government removed the subsidies, which is why the price remained stable while from now on being closer to the market. In other countries the currency depreciation prevented people from being able to experience the drop of the oil price at the pump. So yes, the countries are using this opportunity from a lower oil price to remove subsidies. They have been longing to do so for years.

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. Chinese Outward Investment

When looking at Chinese outward investment, in how far do you believe that the political and security situation in the host nation plays a role?

It is a factor that often has distinguished Chinese NOCs from the international majors. Certainly, Chinese NOCs are concerned about their safety and security issues. They got burned before. But if you combine political, security and even environmental concerns, China tends not to interfere with affairs of host countries. Of course, if there is a direct threat to people such as during a civil war, Chinese NOCs do worry and will stay away. But if the only concern is that the government is anti-West or not up to the Western standards, China just uses the principle of non-interference as an explanation. But if there are UN sanctions again any potential host country, China observes that. China tries not to interfere and thereby can become active in more countries through investments. But again, if there is an immediate threat to the lives of people, these companies care as well. If it is safe, they go.

Afghanistan however is more an international arrangement and is probably one of the areas where the U.S. wants the most that China is involved. The U.S. provides security (at times) while Chinese companies can help build the country, which is also the objective of the U.S. and the West. The logic is that only Chinese companies can do so, as not many U.S. companies are willing to do so.

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Thank you very much for the interview.

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[1] More about Dr. Kang Wu at: http://www.fgenergy.com/company/executive-committee/dr-kang-wu.aspx.
[2] This “new normal” of reduced economic growth has been highlighted frequently by Chinese government officials and in the state media. As Premier Li Keqiang pointed out during the third session of the 12th National People’s Congress in March, the slower growth will be characterized by sustainable and quality growth: http://www.chinadaily.com.cn/china/2015twosession/2015-03/06/content_19744194.htm.
[3] More on the difficulty of forecasting Chinese oil demand growth: http://www.wsj.com/articles/forecasting-chinas-oil-buying-grows-harder-1424895278.
[4] The Chinese plan to cap coal use by 2020 was seen as a step in the right direction by analyst when announced during a meeting with U.S. President Obama in November 2014: http://www.nytimes.com/2014/11/21/business/energy-environment/china-to-place-limit-on-coal-use-in-2020.html?_r=0.
[5] China has large shale gas reserves, according to the U.S. Energy Information Administration (EIA) even the world’s largest. The target for shale gas output for 2015 is 6.5 bcm/year. The shale gas target for 2020 was slashed from previously 600-100 bcm/year to 30 bcm/year. More on the production forecasts and the players involved: http://www.platts.com/latest-news/natural-gas/singapore/chinas-2014-unconventional-gas-output-soars-42-27013858.
[6] More on the costs associated with shale gas development in China can be found here: http://www.ft.com/intl/cms/s/0/c92559c6-ed6e-11e3-8a1e-00144feabdc0.html#axzz3VDHZHA9w.
[7] A background on the natural gas pricing reforms is given here: http://www.platts.com/latest-news/natural-gas/singapore/chinas-oil-linked-natural-gas-prices-may-defy-26957322.
[8] An overview about the current state of the graft campaign is given by Wendy Leutert here: http://www.brookings.edu/research/opinions/2015/02/26-china-anti-corruption-leutert.
[9] India has raised tax rates on petrol and diesel in the wake of the falling oil price: http://www.ft.com/intl/cms/s/0/2bc594f8-6b26-11e4-be68-00144feabdc0.html#axzz3VDHZHA9w.
[10] Indonesia cut fuel subsidies early this year: http://www.reuters.com/article/2015/01/06/indonesia-economy-subsidies-idUSL3N0UH0MD20150106.

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