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UNCLAS SECTION 01 OF 05 GUANGZHOU 000418 
 
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USPACOM FOR FPA 
 
 
E.O. 12958: N/A 
TAGS: ENRG EPET ECON EMIN SENV CH
SUBJECT: Natural Gas in South China (Part 1 of 2): Delayed LNG Plans 
Getting Back on Track 
 
REF: 
 
(U) THIS DOCUMENT IS SENSITIVE BUT UNCLASSIFIED AND INCLUDES 
BUSINESS SENSITIVE INFORMATION.  IT SHOULD NOT BE DISSEMINATED 
OUTSIDE OF U.S. GOVERNMENT CHANNELS OR IN ANY PUBLIC FORUM WITHOUT 
THE WRITTEN CONCURRENCE OF THE ORIGINATOR.  IT SHOULD NOT BE POSTED 
ON THE INTERNET. 
 
¶1. (SBU) SUMMARY: Recent progress in negotiations with Indonesia and 
other LNG suppliers suggest that the Chinese government has adjusted 
its expectations and renewed its interest in putting LNG projects 
back into the energy mix in South China. The government's 
unwillingness earlier to adjust negotiation strategies and conclude 
supply contacts in response to higher prices and shifting market 
conditions resulted in delays of most LNG projects.  The Chinese 
government still requires CNOOC to purchase a portion of the rights 
to the fields from which it sources gas and this means that CNOOC 
will continue to pursue oil and gas fields in places where many 
major Western oil companies are unable to do business and in 
locations where government-to-government influence can be better 
used to the company's advantage.  After years of planning 
discussions and negotiations, on September 28, 2006, the Dapeng 
Liquefied Natural Gas (LNG) terminal in Shenzhen became the first 
LNG terminal in China to start commercial operations.  Although one 
of at least 11 announced LNG projects spanning the coast of China, 
only two other terminals, one in Fujian Province and one near 
Shanghai, have broken ground. This is the first of two cables 
looking at natural gas in South China.  END SUMMARY. 
 
LNG in South China, A Brief History 
----------------------------------- 
 
¶2. (U) After research in the early 1990s showed Guangdong Province's 
electric power usage was going to exceed its capacity to generate, 
provincial government discussions focused on ways to meet the rising 
demand for energy.  Early solutions focused on building nuclear 
power plants and importing power from western provinces.  However, 
in 1994 proposals began to surface about ways to bring LNG into the 
energy mix for the province. 
 
¶3. (U) The following sequence of events is illustrative of the time 
it takes to bring a project to the fore: 
-- 1998: Guangdong Province won State Council approval for a pilot 
LNG project to be located in Shenzhen. 
-- 2001: British Petroleum was chosen as the foreign partner to work 
with the China National Offshore Oil Corporation (CNOOC) on the 
project. 
-- October 2002: a supply purchase agreement (SPA) was signed 
between the Guangdong LNG project and Northwest Shelf Australia LNG 
- a partnership which includes BHP Billiton, British Petroleum, 
Chevron, Japan Australia LNG MIMI (A 50-50 joint venture between 
Mitsubishi and Mitsui), Shell, and Woodside Energy - for supply. 
-- Late 2003: Construction on the terminal began 
-- May 2006: the Dapeng LNG Terminal received its first shipment of 
LNG. 
The terminal is currently the only operating LNG terminal in all of 
China and capable of processing 3.75 million tons per year (MMt/y) 
of LNG.  An additional LNG terminal in Putian, Fujian, wholly owned 
by CNOOC, is under construction and will be in operation by the end 
of 2008. 
 
For Dapeng, The Finances Work 
----------------------------- 
 
¶4. (U) Dapeng LNG negotiated its SPA in October 2002 at a time when 
the LNG market favored buyers.  Many countries had large offshore 
discoveries and were seeking to finance development projects by 
signing long-term SPAs.  In the case of Dapeng, the Chinese 
government received multiple supply offers and bidding became very 
 
GUANGZHOU 00000418  002 OF 005 
 
 
competitive.  The deal that was ultimately signed with the Northwest 
Shelf Australia LNG partnership was a 25-year take-or-pay contract 
with a ceiling price linked to $25 per barrel of oil (BBL). 
Correspondingly, Dapeng sold its entire supply to 11 customers: four 
new gas-fired power plants, one plant that converted from oil to 
gas, and six municipal local distribution companies (LDC) including 
Hong Kong at the same 25-year take-or-pay terms with prices that 
guaranteed supply and operating costs plus a profit. 
 
¶5. (U) Given the seeming no-lose situation of Dapeng and government 
support for a network of LNG terminals and pipelines up the coast, 
CNOOC quickly tried to replicate its success in South China 
announcing similar plants in Fujian, Zhejiang, and Shanghai as well 
as a second Guangdong terminal in Zhuhai.  In an effort not to lose 
out on LNG entirely, the two other Chinese oil majors, Sinopec and 
PetroChina, announced plans to open LNG terminals of their own. 
PetroChina won initial government approval for terminals in Jiangsu, 
Hebei, and Lioaning provinces and Sinopec for Shandong and Tianjin. 
An eleventh project located in Guangxi province is also under 
consideration.  All projects initially announced first phase 
capacities of between 2.5 and 3.5 MMt/y and with the exceptions of 
the Liaoning, Tianjin, and Guangxi terminals, all were originally 
Qcted to be in operation between 2008 and 2010.  Additionally, 
the second phases of the Dapeng and Fujian terminals, doubling their 
initial size, were also announced for completion by 2010. 
 
Slow to Adjust to Higher Prices 
-------------------------------- 
 
¶6. (SBU) The Dapeng terminal was not the only project to win an 
early supply purchase agreement.  The Fujian terminal also secured a 
25-year deal for 2.6 MMt/y from the Tangguh field in Indonesia at 
what was originally to be a ceiling price of around $26/BBL.  After 
the terms were agreed to, world oil and gas prices rose 
substantially and Indonesia sought to renegotiate the price of the 
deal.  This new uncertainty about supply caused CNOOC to delay 
construction and has pushed back the opening of the terminal by 18 
months.  On March 16, a representative from the Indonesian Consulate 
confirmed that CNOOC has agreed to a 50% price increase to $39/BBL 
for the SPA and the terminal should get its first shipment in 2009. 
With the exception of the CNOOC Shanghai terminal, none of the rest 
of the initially announced terminals has signed an SPA and all will 
be delayed indefinitely until LNG supply is secured. 
 
¶7. (SBU) After successfully reaching the first two agreements which 
included price ceilings and sub-market prices, the Chinese 
government instructed CNOOC to sign future deals only at the same 
terms.  When prices quickly rose and LNG supply began to tighten in 
the Pacific, buyers from Japan, Korea, and the United States reacted 
much faster to the changing conditions.  With sellers now in control 
of the market, ceiling prices have been replaced in deals with 
escalator clauses and prices for long-term SPA do not carry the 
discount they had in the past.  CNOOC could not agree to such terms 
and in places like the Australian Northwest Shelf, where CNOOC hoped 
to also supply Dapeng Phase II from, all new production was sold to 
other parties.  Fields in Australia will not likely be able to 
accommodate any new SPAs until 2012 at the earliest. 
 
Customer Mix Not Optimal 
------------------------ 
 
¶8. (SBU) The Chinese response to higher gas prices is due to a 
distorted mix of customers.  According to Mr. Thomas King, President 
of Guangdong Dapeng LNG Company, 64% of the Dapeng terminal's gas is 
going to power producers.  Even with contract prices capped at 
$25/bbl, the power generated from LNG fired plants is between two 
and three times the cost of power generated from domestic coal fired 
plants.  Mr. Shi Enzhe, General Manager of CNOOC Gas and Power, 
confirmed that the Fujian LNG terminal will supply 70% of its LNG to 
 
GUANGZHOU 00000418  003 OF 005 
 
 
power plants as well.  Moreover, all but one of the power plants 
supplied by the two LNG terminals are newly built.  Only one, the 
Meishi power plant in Shenzhen, is being converted from heavy fuel 
oil to LNG. 
 
¶9. (SBU) Due to the over-weighted proportion oQer generators as 
purchasers, a move in gas prices from under $4 per million British 
thermal units (MMBtu) to approximately $6/MMBtu, as has recently 
occurred with the renegotiated SPA for the Fujian terminal, has had 
a drastic effect on the economic viability of projects without 
government financial support.  Mr. King stated an ideal customer mix 
for Dapeng would be 33% power generators, 33% industrial and 
commercial customers, and 33% residential customers.  A heavier 
weighting of industrial and residential customers makes LNG projects 
feasible at far higher prices because the fuels these users 
substitute are propane, liquefied petroleum gas (LPG), heavy fuel 
oil, and diesel, all of which have prices closely correlated to the 
market price of oil as opposed to cheap domestic coal. 
 
¶10. (SBU) Both Mr. Shi and Mr. King commented that industrial and 
commercial users' desired adoption rate is faster than Dapeng can 
currently handle.  Due to supply issues, Dapeng is currently 
operating at only 30% capacity and much of the current supply is 
taken by the power customers and Hong Kong.  There is a waiting list 
for industrial users to convert to LNG and hook up to Dapeng. The 
wait is further compounded because the six municipal LDCs supplied 
by Dapeng must work with the city governments to convert and expand 
the existing gas distribution systems.  The cost of conversion for 
industrial customers must be paid for by the customer.  The average 
conversion project so far has cost 200,000 RMB ($25,873 USD).  Since 
Dapeng's LNG price is a 30% discount from current LPG or fuel oil 
prices, the average payback for conversion projects has been just 
three months time. 
 
¶11. (SBU) For residential customers, the wait may be longer.  Mr. 
Yan, Junfang of the Shenzhen Municipal Development and Reform Bureau 
said that Shenzhen has currently converted 130,000 homes to LNG. 
Mr. Wu Hong, Deputy Director of the Guangzhou Municipal Development 
and Reform Commission, stated that Guangzhou has only converted 
40,000 homes but should complete 200,000 more homes this year and 
finish converting the cities entire network by the end of 2008.  In 
the majority of these conversions, lines for LPG already existed 
that were capable of supplying LNG as well.  The LDC and government 
pay the cost to install one new LNG stove and water heater for each 
residence. 
As few new gas lines are being built, the reach of LNG in both 
cities will likely top out at less than 10% of the total 
population. 
 
Recent Trends Suggest LNG an Option Again 
----------------------------------------- 
 
¶12. (SBU) While CNOOC and Dapeng representatives were very reticent 
to discuss pricing issues, Professor Zeng Lemin from the Guangdong 
Techno-economy Research and Development Center, a government think 
tank associated with the Guangdong Department of Science, spoke 
openly about pricing issues.  Mr. Zeng is Chief of the Institute for 
Energy and has consulted on many LNG project feasibility studies. 
Zeng estimated the price to Dapeng at 0.8 RMB/cubic meter ($3 
USD/MMBtu). Representatives from Meishi power plant confirmed they 
pay 1.6 RMB/cubic meter ($5.79 USD/MMBtu) including distribution 
costs.  Zeng stated residential and industrial customers pay 3.8 
RMB/cubic meter ($13.76 USD/MMBtu).  Zeng continued that in China 
today LNG prices above 2 RMB/cubic meter ($7.24 USD/MMBtu) to the 
terminal would be unable to compete.  Yet the Chinese government has 
given CNOOC greater flexibility to negotiate new deals with a new 
contract cap of approximately $6 USD/MMBtu, not coincidentally the 
ceiling price of the renegotiated Indonesia-FQian deal and the 
reported contract price of the Malaysian SPA between Petronas and 
 
GUANGZHOU 00000418  004 OF 005 
 
 
CNOOC to supply the Shanghai LNG terminal. 
 
¶13. (SBU) At $6/MMBtu, the Chinese have moved much closer to the 
world price for long-term gas contracts but the desire for ceiling 
prices still remains an issue in new contract negotiations.  Zeng 
stated as long as the LNG market is tilted toward sellers, ceiling 
prices will either be unavailable or significantly higher.  Zeng 
speculated that China might enter into deals with higher ceiling 
prices once infrastructure to currently oil-dependent industrial 
users is further developed.  These customers could still view 
market-priced LNG as a less expensive and cleaner alternative to 
fuel oil and diesel. 
 
But Where will The Gas Come From? 
--------------------------------- 
 
¶14. (SBU) One thing that emerged from the Dapeng LNG deal was CNOOC 
and the Chinese government's frustration in dealing with a large 
Western joint venture.  Northwest Shelf Australia LNG has six main 
partners from five different countries.  CNOOC, perhaps feeling it 
could deal better with one partner directly and better leverage 
government-to-government involvement in deal negotiation, has since 
negotiated mainly with other national oil companies and government 
organizations such as Pertamina and BP MIGAS in Indonesia and 
Petronas in Malaysia.  Zeng said that new LNG supply deals are being 
explored with both of these countries as well as with Brunei and 
Qatar. 
 
¶15. (SBU) The Chinese government still requires CNOOC to purchase a 
portion of the rights to the fields from which it sources gas.  With 
the market currently favoring LNG sellers, there is little 
motivation for large Western integrated oil companies to sell pieces 
of profitable fields.  As such, CNOOC will continue to pursue oil 
and gas fields in places where many major Western oil companies are 
unable to do business and locations where government-to-government 
influence can be better used to the company's advantage. 
 
And How Will it Move? 
--------------------- 
 
¶16. (SBU) Pipelines are another issue. As part of phase one of 
Dapeng, a 379 km series of pipelines was built to transport gas 
between the cities of Shenzhen, Huizhou, Dongguan, Guangzhou, 
Foshan, and Hong Kong.  The pipeline primarily runs east-west and 
traverses rivers 14 times.  The chosen routing goes through 
minimally populated areas where possible.  CNOOC's Putian terminal 
also will include a pipeline that will span the coast of Fujian 
province from Fuzhou in the north to Zhangzhou in the south also 
supplying the cities of Quanzhou and Xiamen.  There is currently 
neither a plan to link the two pipelines together nor to link either 
pipeline to existing pipeline systems such as West-East pipeline 
that flows gas from Xinjiang to Shanghai. 
 
¶17. (SBU) Both Mr. King of Dapeng and Mr. Shi of CNOOC Gas and Power 
commented that linking of pipelines would likely be covered in the 
12th five year plan.  The long term goal is a nationwide network 
linking all of the coastal LNG terminals and offshore production 
with domestic supplies from Xinjiang and Sichuan.  King further 
stated that difficulties will arise without technical management and 
broad accommodation for the different qualities of gas found inland, 
offshore, and the varied imports from overseas sources through the 
LNG terminals. 
 
¶18. (SBU) Mr. Zeng was not as optimistic about the pipeline network, 
stating that current delays in LNG terminal construction would push 
completion of the Pearl River Delta's gas infrastructure to 2015. 
In his estimation, a coastal pipeline network linking Guangdong and 
Fujian would not be completed until well after 2020. 
 
 
GUANGZHOU 00000418  005 OF 005 
 
 
Comment 
------- 
 
¶19. (SBU) Guangdong's stated goal to raise natural gas use from the 
current level of about 3% of all energy to 10% by 2010 will not be 
met.  Even the most optimistic projections for natural gas supply 
and LNG terminal construction would struggle to meet this goal by 
¶2015.  Furthermore, the desire to add LNG as a fuel for power 
generation solely to diversify from domestic coal or to improve the 
environment seems misplaced.  Imported LNG will not be able to 
compete with the cost of Chinese coal and at current prices large 
scale investment in anti-polluting technologies for coal-fired 
plants would be more economically feasible.  Until promising 
domestic gas sources (onshore, offshore, and alternatives such as 
coal-bed methane) are further developed, imported LNG is best used 
as a competitor for dirtier, higher-priced, imported energy sources 
such as fuel oil, LPG, and diesel.  Unfortunately, without completed 
terminal networks and long-term guaranteed supplies, South China 
looks unwilling to invest much in expanding its currently limited 
distribution channels to these potential users. 
 
Note of Conversions 
------------------- 
 
¶20. (U) In this cable, the following conversion factors were used in 
computing equivalents: 
 
1 cubic meter natural gas = 35.3 cubic feet natural gas 
1 MMBtu = 27.993 cubic meters of natural gas 
1 ton of fuel oil = 6.66 barrels 
1 ton of crude oil = 7.33 barrels 
1 USD = 7.73 RMB 
 
GOLDBERG