China’s pipeline reform: expect higher gas prices in the short-term
New research from Wood Mackenzie indicates that the creation of a national pipeline company in China is a step in the right direction but will result in higher end-user prices in the short-term as the country tries to balance institutional reform with implementation risks.
Government and industry discussions on the creation of China’s national pipeline have been ongoing since 2014. Regulatory change gained momentum last year as the National Development and Reform Commission (NDRC) focused on increasing gas demand and maximising China’s oil and gas output.
Wood Mackenzie consultant Xueke Wang said: “There are two main factors supporting pipeline reform. Firstly, existing infrastructure is insufficient to meet China’s energy demand growth. Pipelines are already running at maximum capacity during peak seasons, and we expect gas demand to rise 2.5 times from 2018 to 673 billion cubic metres (bcm), accounting for half of Asia’s gas consumption by 2040.
“Secondly, not everyone has fair access to infrastructure. Independent upstream producers face difficulties accessing takeaway capacity at competitive tariff rates, restricting the pace of upstream development, just when the government needs it most.”
Wood Mackenzie assumes the following pipelines to be included in the initial phase of the reform:
- Onshore gas trunk pipelines owned by PetroChina, Sinopec Group and CNOOC;
- Onshore oil pipelines owned by PetroChina, Sinopec Group and CNOOC;
- China-Myanmar domestic oil and gas import pipelines, including associated compression units;
- Suburban natural gas pipelines above 4 million tons per annum.
Using the price-to-book methodology, Wood Mackenzie believes the valuation of the new pipeline company could be in the range of US$80 billion - US$105 billion. The company will likely seek a public listing after two to three years of operation to access funds necessary for infrastructure investment.
“Post-reform, we think the three national oil companies (NOCs) could collectively hold up to 70% ownership of the national pipeline, with PetroChina taking pole position at just under 50%,” Wood Mackenzie senior analyst Maxim Petrov said.
“The remaining ownership should be held directly by the government or state-owned financial institutions, promoting mixed-ownership reform. The steady cash flow from midstream operations is generally well suited for institutional investors with predictable outflows, such as insurance companies and pension funds,” Petrov added.
While the move is unlikely to have material impact on Sinopec and CNOOC, the midstream business is significant to PetroChina’s financial performance, accounting for 25% of operating earnings over the past five years. The company operates the largest pipeline network in the world, accounting for 63% of China’s total network.
Petrov said: “Wresting these assets from PetroChina means it will partly lose its operational leverage and financial strength. Operating cashflow and income will be weaker, potentially putting the company’s future dividend at risk as PetroChina’s payout policy is based on earnings. But the pipeline reform will also have some positive implications for shareholders.”
As China aims to double its pipeline infrastructure to over 240,000 km by 2025, PetroChina’s midstream spend could hit up to US$20 billion a year. Pipeline reform means the company will no longer be liable for this spend, freeing up funds for domestic investment and overseas expansion.
Uncertainty around midstream reform has also driven PetroChina’s share price down. A revaluation of the pipeline assets at a higher multiple than current valuations will be positive for shareholders, particularly after a public listing, as it unlocks value from undervalued assets.
In addition, as China’s dominant upstream producer and gas importer, PetroChina has an interest in a gas price that better reflects its cost of supply. While it takes time for a market-based price to emerge after third-party access, this midstream reform is a step in the right direction.
Wang said: “However, we believe the end-user price is more likely to rise in the short term, as the NOCs will continue to seek breakeven prices to offset import losses and reduce the immediate financial impact of unbundling. This is one of the inevitable costs of market transition. The short-term pain is a step towards long-term progress.”
Wood Mackenzie believes the success of China’s national pipeline should be measured on three main criteria: new capacity investment, third-party access and operational efficiency. While the first measure is within the pipeline company’s control, the other two factors could face significant implementation challenges and will require additional reform initiatives.