--Clyde Russell is a Reuters market analyst. The views expressed are his own.--
By Clyde Russell
LAUNCESTON, Australia, July 3 It's not often that increasing the price of something will boost demand, but China's reforms to its natural gas markets are an exception.
While much of the focus on China's energy markets is on crude oil and coal, major changes have been happening in gas markets and these could have a profound impact in coming years.
After three years of unchanged prices and mounting losses for state-controlled energy giants such as PetroChina , the government has finally raised gas charges.
The National Development and Reform Commissioned last week said that gas prices would rise by 15 percent to 1.95 yuan (32 cents) per cubic metre from July 10. The increase is for non-residential users, with households, which account for one-fifth of total demand, continuing to receive cheaper supplies.
It's also likely that the next jump in prices won't take three years to arrive, given the government's goal to establish market-linked pricing for gas supplies.
Even the latest hike won't eliminate the losses incurred by PetroChina in supplying gas, but it will cut the unsustainable $6.83 billion loss the company made selling gas below cost in 2012.
The logic behind raising prices is that this will encourage increased supply, which in turn will first alleviate pent-up demand, but then go further and start to promote the expansion of gas consumption.
Currently gas only meets about 5 percent of China's energy needs, and the government target is for that to rise to 8 percent by 2015.
However, it will have to rise substantially from that level to reach the international average of 24 percent, meaning there is substantial scope for gas markets to grow.
And grow they will, as the best way for China to cut its carbon emissions and lower the pollution that chokes cities, including the capital Beijing, is to boost gas-fired electricity generation and industry use far faster than that for coal.
The trick is to get the kind of momentum going that makes the process self-perpetuating, and the key to this is to make prices conducive to increased supply, without being too high as to render gas massively uncompetitive with coal, or even renewables and nuclear.
Getting this balance right will be key for China, as much of the additional supply will have to be met by increased domestic production of unconventional resources such as coal-bed and shale, or by pipeline and liquefied natural gas imports.
PRICE GAP TO IMPORTS NARROWS
The latest price increase isn't enough to make pipeline and LNG imports profitable, although the gap has narrowed substantially.
China paid an average $8.79 per million British thermal units (mmBtu) for pipeline imports from Turkmenistan and Uzbekistan in May, and an average $9.07 per mmBtu for LNG cargoes, with major suppliers being Qatar, Australia, Indonesia and Malaysia.
The new domestic price translates roughly into $8.76 per mmBtu, and while this looks close to pipeline costs, it must be remembered that the domestic cost is retail, while the pipeline and LNG costs are landed and still have to incur storage, transport and other charges.
A further factor is that China's LNG costs are going to rise in coming years as cheaper deals with Indonesia, Australia and Malaysia expire.
China paid Qatar $18.77 per mmBtu for LNG in May, compared with $7.98 to Malaysia, $3.87 to Indonesia and $3.54 to Australia.
Also, the seven LNG plants under construction in Australia will also be selling at higher, oil-linked prices, when they come on stream.
Any deal to buy pipeline gas from Russia will also most likely be at oil-linked prices, meaning China faces higher import costs for gas.
It's also unlikely that cheap domestic shale gas can come to the rescue, with the gradual realisation that tapping the nation's enormous reserves of 25 trillion cubic metres is going to be far more difficult than it was in the United States.
China's reserves are deeper and more scattered, meaning that exploration wells costs more than double to drill compared to the United States.
China also lacks the pipeline infrastructure needed to transport much of the shale production, and it also has relatively small storage capacity.
Storage capacity is currently around 3 billion cubic metres, equivalent to 2.1 percent of last year's consumption, according to the June edition of Asia Gas & Power, published by Argus Media.
By comparison, Japan's storage capacity is 7.2 percent of annual demand and the European Union's 21 percent.
While China has started to expand its gas storage, this will take time to come on stream.
Increased storage will allow China to buy LNG when prices are seasonally lower, rather than be locked in buying when demand, and therefore the cost, is high.
The increase in gas prices is a significant step in the process of increasing the share of the cleaner-burning fuel in China's energy mix.
Further price increases and investment in gas infrastructure will show if China, the world's biggest polluter, is willing to pay the price of higher energy costs in exchange for cutting emissions from cheaper coal.
(Editing by Michael Perry)
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