Since Russia attacked Ukraine in late February, prices of crude oil and natural gas have jumped as sanctions on the major energy exporter have left many countries scrambling for alternative sources of fossil fuel.

If the war lasts more than six months, crude prices may top the record high seen during the global financial crisis in 2008, Sun Renjin, secretary-general of the expert committee at the China Petroleum Circulation Association, predicted at a mid-April conference.

China is already feeling the pressure. In March, its producer price index — which gauges changes in prices of goods circulated among manufacturers — recorded a month-on-month increase of 1.1%, the fastest pace in five months. The country’s consumer price index — which measures changes in prices of a select basket of consumer goods and services — climbed 1.5% year-on-year in March, the fastest pace in three months.

Experts at the April conference estimated that China — the world’s largest importer of oil — may pay nearly $100 billion more for the crude oil imports this year. Those costs would ripple through its economy.

Ironically, some say this could slow progress on the country’s “dual carbon” goals — peaking emissions by 2030 and achieving net neutrality by 2060. Beijing has been promoting the use of natural gas — which burns more cleanly than coal — as part of its transition away from fossil fuels. Volatility in the global gas market may push many Chinese industrial users to rely on coal.

Surging costs

From late February, Brent crude futures set to for delivery in June jumped from $90 to well over $100, peaking at nearly $120 per barrel. A natural gas benchmark, Dutch TTF natural gas futures that expire the same month, swung from under 90 euros at a day before the conflict to around 105 euros now, peaking at 211 euros per megawatt hour.

Additional costs involved in importing liquified natural gas (LNG) have also increased, ratcheting up pressure. On April 24, the most recent date for which data is available, China’s comprehensive import price index for LNG was up 171% year-on-year.

China is heavily dependent on energy imports.

In 2021, China imported over two-thirds of the crude oil it used, according to the CNPC Economics & Technology Research Institute. That year, the country imported 121.4 million tons of natural gas, 20% more than the previous year, customs data show. Imports accounted for some 44% of total gas consumption, according to the China Petroleum and Chemical Industry Federation.

Overall, coal still accounted for more than half of total energy consumption, compared to just 8.4% from natural gas and 18.9% from crude oil, figures from the 2020 China Statistical Yearbook showed.

Figures from the General Administration of Customs showed that China’s LNG imports were down 6.7% year-on-year in January and 11.8% in February. March brought a 12% drop compared to last year, according to 315i.com.

Kevin Jianjun Tu, the managing director of Agora Energy Transition in China, said that in a short term, coal will play an even bigger role in China’s energy market.

Many parts of China suffered a severe power crunch between late September and mid-October of 2021, as a manufacturing boom led to high demand while the coal supply was constrained by Beijing’s emission-reduction campaign. In China’s latest five-year plan for its energy system published in March, the authority didn’t cap the country’s consumption and output of coal. Instead, it emphasizes the essential role of coal in ensuring the stability and safety of the country’s energy supply.

End customers

Price hikes may cause China’s growth in natural gas use to slow to 6% from last year’s 12.7% expansion, says Yang Jianhong, chief researcher at Beijing BSC Energy Consulting.

And this is an “optimistic” prediction, Yang added, as major industrial consumers like those in engineering, power generation, and transportation companies are particularly sensitive to price changes.

He gave trucks running on LNG as an example. From 2018 to 2020, annual sales of such vehicles in China jumped from 71,000 to 147,000 units. However, that declined to just 50,000 units in 2021 due to high LNG prices. This year, sales are expected to dip to 30,000 units, according to Yang.

“When customers switch to other energy sources, they don’t switch back easily,” cautioned Yang, adding that natural gas may be marginalized.

Oil refiners are also feeling the pain from high oil prices, even as the price of their products rises to new highs.

Beijing raised the prices of gas and diesel seven times from the start of the year to early April, though they’ve fallen back slightly since. At the end of March, the government-set upper price limit for a liter of standard gasoline was over 9 yuan — a record — in 27 of the Chinese mainland’s provincial-level regions.

In mid-April, gas and diesel prices fell for the first time this year, but about two weeks later authorities raised them again, in the eighth such increase within four months.

But even though drivers will be forking out more at the pump, refiners won’t be celebrating. A source at a state-owned refiner told Caixin that the increase in refined oil prices is smaller than the growth of crude oil prices, leading many refiners to stop production or reduce output to prevent losses.

Sinopec Shanghai Petrochemical Co. Ltd., a unit of one of the country’s big three oil giants, said in its annual earnings call on March 24 that profit margins are narrowing as it cannot pass costs on to downstream customers.

Liu Bingjuan, a senior oil product analyst from research institute Oilchem.net, told the aforementioned April conference that some privately owned refiners in Shandong province lost money in March because of higher prices and the impact of Covid-19 flare-ups.

LNG power generation

Power generators are also hurting, as they are locked into a long-term supply contracts and face widespread shortages.

“Currently, energy prices are way above electricity prices, and power generators are definitely losing money,” a source at a state-owned natural gas power plant in Guangdong province told Caixin.

As of the end of 2021, Guangdong had 159 million kilowatt-hours of installed natural gas power generation capacity, accounting for nearly 20% of the country’s total, the most of any province.

Based on the April 13 spot price, the cost of burning gas to generate power in Guangdong was about 1.5 yuan ($0.23) per kilowatt-hour while the provincial price ceiling for electricity was just 0.55 yuan per kilowatt-hour. In other words, for each kilowatt-hour of electricity sold, the generator would lose 0.95 yuan.

A senior industry insider suggested that the government could allow electricity prices to fluctuate more above the government-set price point, to prevent such losses when commodity prices spike.

According to the source, his plant’s contracted suppliers could only provide natural gas to cover one-fourth to one-third of projected electricity demand in 2022.

Another source from a smaller local power generator said that they could not even get a long-term contract signed. A source from a Shenzhen power plant added that their contracted supplier simply stopped providing natural gas due to shortages.

The most essential prerequisite of a long-term contract is sufficient supply. If there is not enough supply, the contract will become invalid, said the senior industry insider.

Although China overtook Japan to become the world’s largest LNG buyer in 2021, many major Chinese buyers resell much of their LNG to other countries, rather than using it themselves, according to commodity market information provider 315i.com.

“If they sell LNG to domestic power plants, they could only earn $500 per ton at most. But if they resell it to Europe, they could make up to $1,875 per ton,” a source from a state-owned oil and gas company told Caixin.

Zhang Mianrong, chairman of Guangdong Electric Power Trading Center, told a conference on March 24 that the province is expected to see a tight supply this year, especially in the second quarter.

Currently, China is trying to allow market forces to play a bigger role in the natural gas sector. Domestically, major resources are held by the big three state-owned oil producers — China National Petroleum Corp., China Petrochemical Corp., and China National Offshore Oil Corp. (CNOOC). Midstream, the cost of pipeline transportation is controlled by the State Grid. And finally, end market prices are guided by the government.

Marketization will help companies pass costs along the production chain. But multiple sources told Caixin that rising LNG prices could hinder this process, as the market will become sluggish due to less import and consumption volumes.

The sluggish market will then push smaller players out of the game. A senior industry source sighed, “if many companies die out amid the volatility, how can we hope to achieve marketization?”

Reporters: Zhao Xuan, Luo Guoping, Chen Xuewan and Manyun Zou.

This article was originally published by Caixin Global. It has been republished here with permission.

(Header image: A employee fuels up a car at a gas station in Yueqing, Zhejiang province, April 15, 2022. VCG)