Pipeline divestitures push China's state oil companies into city gas distribution

Singapore — China's pipeline divestitures have weakened the profitability of the three main national oil and gas companies -- PetroChina, Sinopec and CNOOC -- forcing them to expand into the downstream city gas distribution business across the country to boost their income.

The three state-owned energy companies, who sold off the bulk of their midstream pipeline assets to PipeChina in exchange for cash and equity, are rapidly acquiring stakes in local city level and provincial city gas distribution companies, or creating new companies, to make up for lost revenue.

This is expected to increase competition as well as lead to the consolidation of smaller gas distributors. The five biggest city gas distributors in China are Kunlun Energy, China Gas, China Resources Gas, ENN Energy and Town Gas, which are estimated to have a total share of more than 60% in the city gas market, according to market sources.

Infrastructure facilities used to be the core assets of PetroChina, Sinopec and CNOOC, allowing them to dominate the domestic pipeline transportation market, as well as sell gas by bundling them with transportation services. The pipelines were a steady revenue source.

For instance, PetroChina's pipeline transmission business posted a profit of Yuan 36.6 billion ($5.56 billion) in 2019, compared with a net loss of Yuan 30.7 billion in its imported natural gas business in the same period, the company's 2019 annual report showed.

But the asset transfer has deprived the three NOCs of monopoly advantage over the midstream gas transportation market. Market participants said expanding into the downstream market will allow the companies to build an integrated gas supply chain that links up with their upstream business, which is still dominated by them.

City gas distribution, which comprises of the use of gas for households and urban consumption, is a lucrative business. It was the strongest driver of China's domestic gas sales, accounting for 37% of total gas demand and posting a year-on-year growth of 14.7% to 113 Bcm in 2019, data from PetroChina showed.

City gas expansion

In October, PetroChina Kunlun Gas, a subsidiary of Kunlun Energy, signed agreements to acquire shares of 49%-51% in 10 city gas companies affiliated with Shanghai-listed Xinjiang Xintai Natural Gas for around Yuan 682 million, the seller said in a statement. PetroChina holds a 54.4% share in Kunlun Energy.

In the first half of 2020, Kunlun Energy had developed 31 new city gas projects, taking its total projects to 373 in 31 provinces, autonomous regions and municipalities, the Hong Kong-listed PetroChina subsidiary said in its half-year report.

In September, Sinopec Changcheng Gas, one of Sinopec's natural gas subsidiaries, acquire a 29.99% share in Hong Kong-listed Binhai Investment.

As one of the first foreign-funded enterprises to enter China's city gas market, Binhai Investment has 38 gas subsidiaries in Tianjin and Beijing municipalities, and Hebei, Shandong, Jiangsu, Zhejiang, Hunan, Jiangxi and Hainan provinces, and a total pipeline gas sales volume of 1 Bcm in 2019, company data showed.

Earlier in July, Sinopec Natural Gas, another Sinopec subsidiary, started Guangxi Gas Group, a joint-venture with Guangxi Guangtou Energy, focused on the downstream gas market.

CNOOC has also sped up its deployment in downstream city gas by cooperating with city gas distributor China Gas.

China Gas-CNOOC, a joint-venture between CNOOC Gas & Power Group and China Gas, signed a cooperation agreement with CNOOC Fujian New Energy and Fujian Futou New Energy Investment to jointly invest in the existing city gas projects of Fujian New Energy, according to a Nov. 3 announcement from Hong Kong-listed China Gas.

Fujian New Energy has agreed to restructure its city gas projects and set up five subsidiaries to operate the city gas business, China Gas said.

Fierce competition from upstream suppliers in the downstream market means that small city gas companies will find it increasingly difficult to survive due to few resources and outright acquisition by the large players.

The large city gas distributors are fighting for their own turf as well. The private Hong Kong-listed ENN Energy acquired 12 city gas projects in the first half of 2020, while Hong Kong-listed China Resources Gas signed on 14 more city gas projects in the same period, according to their half-year reports.

City gas has emerged as a resilient source of gas demand amid the pandemic and as one of the biggest drivers of demand gas growth across countries, not just China, but also in countries like India, boosting margins for city-gas operators.

China's GDP growth in the third quarter is a sign that economic activity is recovering, albeit at a slightly slower pace than years past. However, gas demand was still quite strong and S&P Global Platts Analytics estimates LNG imports grew by 15% over 2019 levels during this period.

Even at a relatively slow pace, with economic activity resuming growth and with conversions continuing from coal to gas in the heating sector, Platts Analytics expects Chinese natural gas demand to continue to grow this winter.