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China slashes natural gas prices by 30%

LNG exporters will welcome the return of a major buyer, while domestic producers will be less happy with the change.

City-gate gas prices for non-residential users will fall from $11.55/m British thermal unit (Btu) (yuan 2.51/m³) to $8/m Btu from 20 November, according to the National Development and Reform Commission (NDRC), China’s top economic planner.

China will also improve the market mechanism by allowing buyers and sellers to negotiate prices within a 20% range of the base price. But for the first year only downward revisions will be allowed. This flexibility could result in overall cuts as large as 50%, said Neil Beveridge, an Asian-focused gas specialist at research house Bernstein.

The NDRC also plans to improve the transparency of non-residential gas prices by encouraging sellers and buyers to use the Shanghai Petroleum and Natural Gas Trading Centre to carry out deals over the next two to three years. This should lead to greater price discovery in the market as prices more accurately reflect supply and demand. The trading centre came online in July 2015 but the market has been too illiquid to allow price discovery.

Expected for the last few months, the cuts show Beijing is serious about reducing its reliance on coal, which is causing widespread problems to the nation’s health.

Analysts said the move will be positive for gas consumers, gas distributors and liquefied natural gas (LNG) exporters. But the price cuts could slow domestic exploration and production of shale. Netbacks for marginal domestic gas producers, such as tight gas, coal-bed methane and shale gas will drop below $5/m Btu, challenging project economics.

The drop in gas prices should also help revive demand. After double-digit expansion for much of the past decade, China’s gas industry witnessed a surprise collapse in growth in 2015. LNG imports fell for the first time on record too. With LNG demand falling and long-term contracted supply expected to double over the next few years, investors have been increasingly concerned that China could default on its LNG obligations, especially as exports start to ramp up from Australia.

Those fears should start to evaporate, as the root of the problem has been the government’s mispricing of gas.

With oil at $44/barrel, alternative fuels such as fuel oil, liquefied petroleum gas and LNG, are trading close to $7/m Btu, slightly lower than the average industrial city-gate gas price of $8/m Btu. But the new regulated gas prices effectively align with LNG spot prices when oil prices are over $50/b, assuming LNG is tied to crude benchmarks.

The big winner in this is the China gas market, where growth has ground to a halt this year. China is the most important gas market globally and the LNG industry will breathe a sigh of relief on this announcement”, said Beveridge.

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