Industry Trend Analysis - Quadrupling Of Gas Power To Have Limited Power Mix Impact - OCT 2017

BMI View: We expect gas-fired power generation in China to quadruple over the next decade, in line with the government's push to reduce urban centre pollution by instigating coal-to-gas power switching. The nascent state of the gas sector nonetheless means that coal-fired power will remain the dominant source of power generation in China by some margin over the next decade.

We have an upbeat outlook towards growth in China's gas power sector over the coming decade - and forecast total gas-fired power generation to quadruple between 2016 and 2026. This expansion will be instigated by the government's push to improve air quality by lowering the country's reliance on inefficient and polluting coal-fired facilities. As such, we forecast the share of gas in the Chinese power mix to increase from less than 3% over 2016 to almost 8% in 2026 - with coal's share set to decline from 66% to 52% over the same timeframe. This decline will also be driven by robust power generation growth in the nuclear, hydropower and non-hydropower renewables sectors.

Power Mix Decarbonisation Progress, But Much More To Be Done
China - Technology Share Of Total Power Generation In 2016e (LHS) And 2026f (RHS)
e/f = BMI estimate/forecast. Source: EIA, NBS, BMI.

Government Push For Decarbonisation To Drive Coal-To-Gas Switching

The most important factor underpinning China's gas power push is the fact that the technology offers a cleaner alternative to coal-fired power generation. China ranks 179 th out of 180 countries ranked by Yale University's Environmental Performance Index in terms of air quality - and tackling pollution by closing coal facilities and encouraging coal-to-gas switching in urban areas is a key government priority. In line with this plan, the city of Beijing closed its last coal-fired power plant in March 2017 and now utilises natural gas instead - in accordance with the Chinese Capital's 5-year Clean Air Plan, which was laid out in 2013. Crucially, natural gas is relatively clean and more flexible than coal, making it an ideal replacement source of generation in cities (see chart below).

Lower Carbon Footprint To Support Gas Uptick
Carbon Emmissions By Fuel Type Pounds/mnBTU
Source: EIA

The Chinese government aims to increase the share of gas in the primary energy mix from the current 6% to 10% by 2020, and to 15% by 2030, with coal-to-gas switching for industry and heating forming an important part of this strategy ( see 'NDRC Guidelines Support Gas Outlook', July 5 2017) . We note that the Chinese government aims to have 100GW of gas-fired capacity installed by 2020, and 200GW by 2030.

Supportive Policy to facilitate Gas Growth

The Chinese government is implementing a number of policies in order to help stimulate gas-fired growth in an attempt to reduce pollution. These include:

  • Increasing Provincial Support For Coal-To-Gas Switching: On the back of the successes registered in Beijing, the NDRC stipulated in July 2017 that local government officials will be judged on their ability to instigate power generation switching. Local governments are also urged to offer financial incentives for gas power projects, as well as pipeline construction, LNG filling stations and the expansion of LNG import terminals. We also note that the government is seeking to reduce pipeline transmission fees in order to reduce the cost for the end-user.

  • Gas Price Reduction: China has reduced domestic gas prices over 2015/16 and cut the value added tax (VAT) from 13% to 11% (as of July 1 2017) in order to support an uptick in consumption. The government is also mulling providing direct subsidies for gas-fired power in order to stimulate more growth.

  • Carbon Trading Mechanism: China's carbon trading market is expected to be launched in late 2017, under which a carbon dioxide limit will be set annually. Companies would then be issued permits that would be equivalent to a set amount of emissions. Companies with cleaner power generation sources could sell their permits to more polluting coal generators - making the former more profitable and the latter less profitable. The effectiveness of such as mechanism is still reliant on the carbon limit that is set, and the amount of permits issues, and we will contemplate revising our forecast when more firm details on the mechanism are available.

The broad direction of such policy points to robust government support for gas-fired power - and informs our forecasts for a quadrupling of gas generation over the next decade.

Gas Expansion To Have Limited Power Sector Impact

However, given the nascent state of the gas-fired sector, we do not believe supportive gas power policy will trigger a contraction in coal power generation over the next decade; just accelerate the move of coal-fired generation away from urban centres. While China's ambitions for the gas power sector are high, we still question whether the sector can make a substantial impact on the overall Chinese power mix over the coming decade. If anything, the resurgence of coal over 2016/17, in response to the electricity consumption surge following fiscal stimulus, highlights coal-fired power's continued importance to the Chinese power mix.

Coal Still Key To Meeting Electricity Demand Surges
China - Net Generation Additions For Natural Gas And Coal, TWh (LHS) And y-o-y % Electricity Consumption (RHS)
e/f = BMI estimate/forecast. Source: EIA, NBS, BMI.

For example, in order to offset closing coal-fired power plants in Beijing, the city now imports electricity derived from coal-fired facilities from the surrounding Hebei province (which has seven of the most polluted cities in all of China). We believe the issue of meeting rising power demand will remain an issue, and our expectation that power consumption will grow by an annual average of 3.3% between 2016 and 2026 means that coal will remain the key component of Chinese energy security. While the gas sector will quadruple its output, new gas-fired power generation will only meet a bit more than a fifth of new consumption. This feeds into our view that coal will continue to expand at an equivalent 0.6% between 2018 and 2026 (after the 2.2% spike in 2017).

Gas Surge Must Accelerate To Dent Coal
China - Gas And Coal Generation, TWh (LHS) And y-o-y % Growth (RHS)
e/f = estimate/forecast. Source: EIA, NBS, BMI.

Upside And Downside Risks To Forecast

We highlight that there are a number of risks to our forecast. Risks to the upside include weaker than expected electricity consumption. The relative surge in consumption over 2016/17 is down to fiscal stimulus, which our Country Risk team believes will slowly wane of over coming quarters. Should post-stimulus power consumption underperform, gas-fired power would play a more important role in the power mix, as we would expect coal-fired generation to get hit first by weakening demand. In terms of gas-fired generation, the implementation of a stringent carbon emissions scheme coupled with additional generation subsidies for the sector would also lead us to revise up our forecast. We currently forecast gas generation to grow by an annual average of 14.7% between 2017 and 2026.

Risks to the downside centre around the elevated costs of gas feedstock in China. Despite 2015/16 price cuts, gas feedstock costs in China remain amongst the highest in the world. Our upbeat growth outlook for the sector is based on price reform progressing further, and should it fail to do so, our outlook for the gas power sector would deteriorate. We also stress that the Chinese gas transmission infrastructure will require further upgrades to facilitate the increasing flow of gas, and gas grid bottlenecks could lead to gas power generation underperforming our expectations.