σ2 commodities

Coal vs Gas: The battle to power China

What do potential gas developments in LNG and Chinese energy policies mean
for the long term future of the seaborne thermal coal market?
September 2013
Disclaimer

This presentation (the “Presentation”), is being provided solely for the purpose of discussion at Coaltrans East Asia Networking Forum, a
conference hosted by Euromoney Institutional Investor plc between 25-26th September 2013. Save as specifically agreed in writing by Sigma
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2
An introduction
σ2 commodities are pleased to present our thoughts on natural gas, with reference
to the Asian seaborne thermal coal market, at Coaltrans Japan

o Seaborne thermal coal volumes are experiencing a cyclical adjustment, following

excess supply, coupled with lacklustre demand
o Concurrently, a series of LNG export projects are being developed, which will unlock
vast reserves of natural gas, in what could revolutionise the energy sector
o As China is a pivotal consumer of thermal coal, could this new “gas-age” inspire
developments within the Chinese gas industry that jeopardise future coal demand?

o To answer this question, this presentation will seek to:

– Summarise current developments in LNG export capacity
– Evaluate the current coal versus gas dynamic taking place within China, which
will include:
– Examining the coal policy environment in China
– Reviewing developments in Chinese gas infrastructure
– An overview of developments in Chinese unconventional gas
– Quantifying what this means for the seaborne thermal coal market

3
An introduction to σ2 commodities
Overview of σ2 commodities
Based in Hong Kong, σ2 helps resource firms in Europe and North America connect with entities
in Asia, acting as an “on the ground” representative
Founded in Hong Kong

σ2 WHAT SERVICES DOES σ2 PROVIDE? in mid-2013 by Karim

Awad, σ2 aims to
connect non-Asian
entities to firms in
Connections to Asia-Pacific entities:
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Hong Kong, Japan,
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‒ Identify suitable companies with short profiles ‒ Ferrous metals
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5
Developments in the supply of LNG
An overview of new sources of LNG supply
Australia will become the largest exporter of LNG, whilst significant unconventional
gas resources exist elsewhere without considering Russian / Chinese potential
SUMMARY OF NEW LNG EXPORT SUPPLY POTENTIAL Australia should
become the largest
exporter of LNG by the
end of this decade.
Areas where LNG export terminals have
Canada been proposed or under development
This could be
superseded by North
United States Significant unconventional resources American supply, if a
Algeria
Israel awaiting exploration / development and series of proposed
Mexico suitable for export terminals are
approved.
PNG
Mozambique Note: Size of bubble illustrates potential. Total 2012 gas
Australia
Argentina, Mexico and Algeria already produce consumption was
natural gas from conventional reservoirs
Argentina Ignores sizable resources in China or Russia c.117tcf. Taking those
shale gas resources
defined alone, these
ESTIMATED GAS RESOURCES (2013) could support c.35
1,161 Proved gas reserves
years of 2012
707 802 Shale gas resources consumption, before
TCF

573 545
300
437 considering the sizable
159 133 70 reserves in China and
15 - 13 11 10 - 5 -
Russia.
US Algeria Australia Canada PNG Mexico Argentina Israel Mozambique
Note: Proved gas reserves does not capture upside from deposits that are technically recoverable, and are considered to primarily reflect conventional gas reserves, though may
include unconventional gas resources. Shale gas resources are those considered technically recoverable. Source: EIA / BP

7
Summary of Australian developments
At least an additional 60mtpa of LNG capacity could come online by 2017, though it
is unclear if further capacity will be developed beyond this point
OVERVIEW OF DEVELOPMENTS LNG TERMINALS BEING DEVELOPED Australia currently
o Australian LNG has been beset by delays, Terminal
Capacity
(mtpa) Status
Year of
Operation
produces c.28mtpa
cost-overruns, and also issues in securing gas Queensland Curtis T1 4.3 Under development 2014
from its North West
feedstock Gorgon T1 5.0 Under development 2015 Shelf, Darwin, and
Australia Pacific T1 4.5 Under development 2015 Pluto projects.
– This has led to Pluto T2 being delayed Darwin T2 1.0 Proposed 2015
Gladstone T1 3.9 Under development 2015
– It has also seen the Browse project Gorgon T2 5.0 Under development 2015
An added c.60mtpa is
Pluto T2 3.0 Under development 2015 expected to come
restructured as a floating LNG project Queensland Curtis T2 4.3 Under development 2015 online by 2017.
o However capacity has benefited from being Australia Pacific T2
Gladstone T2
4.5
3.9
Under development
Under development
2015
2016
mostly off-taken, on crude-oil based pricing Gorgon T3 5.0 Under development 2016
A further c.50mt of
projects are proposed.
o This has led to doubts about future projects, Wheatstone
Prelude
4.5
3.6
Under development
Under development
2016
2016 It is unclear if these
with buyers applying pressure to have US Fisherman Island 3.0 Proposed 2017
will materialise,
Queensland Curtis T3 4.3 Proposed 2017
Henry-Hub based pricing Wheatstone T2 4.5 Proposed 2017 particularly given cost-
Ichthys T1-2 8.4 Under development 2017 overruns on current
EXPECTED LNG CAPACITY Gorgon T4 5.0 Proposed 2018
Australia Pacific T3-4 9.0 Proposed 2018
projects and the desire
70 to secure oil-linked
Gorgon 5 5.0 Proposed 2018
60 Browse T1 4.0 FEED 2018 pricing
Cumulative LNG
Capacity (Mtpa)

50 Cash Maple 2.0 Proposed 2019

40 Browse T2-3 8.0 FEED 2019
30 Scarborough 5.0 Proposed 2020
Bonaparte 2.0 Pre-FEED 2020
20
Arrow
10 Greater Sunrise
- Total Under development 59.9
2012 2013 2014 2015 2016 2017 2018 2019 2020 Total 112.7
Source: Quant group; Macquarie

8
Summary of North American developments
At least 40mtpa of US capacity is likely to come online by 2019, which will be linked
to Henry Hub gas prices
OVERVIEW OF DEVELOPMENTS LNG TERMINALS BEING DEVELOPED At least 40mtpa should
come online within the
o These capacities represent initial stages and Capacity Year of
Terminal (mtpa) Status Operation US by 2019, though
have scope for further expansion Canada this number could be
o If all developed, this would represent c.65% of Kittamat T1
BC / Douglas Channel
5.3
1.8
FEED
Export licence approved
2017
2018
higher if other projects
2012 LNG demand LNG Canada (Shell) 12.0 Proposed 2018 are approved for non-
o Current concerns surround pricing / securing Pacific Northwest T1 12.0 FiD expected in late 2014 2018 FTAA exports.
Prince Rupert 14.0 FiD expected in 2016 2020
off-take: WCC LNG (Exxon) 10.0 Proposed 2022
This would have the
US
– Canadian projects are still aiming for Sabine Pass T1-2 8.0 Under development 2015 potential to alter the
JCC*-linked pricing Freeport T1-2 9.0 Non-FTAA approved 2016 pricing dynamics of
Lake Charles T1 5.0 Non-FTAA approved 2017
LNG, as prices would
– US projects, though Henry-Hub linked, Cove Point T1-2 5.7 Non-FTAA approved 2017
be linked to Henry Hub
Cameron T1-3 12.0 Proposed 2017
may not all come online in time for Golden Pass T1 7.8 Proposed 2017 gas prices, rather than
current import terminals planned Sabine Pass T3-4 8.0 Non-FTAA approved 2018
crude oil or JCC prices.
*Japanese Crude Cocktail Lake Charles T2-3 10.0 Non-FTAA approved 2018
Elba Island 4.0 Proposed 2018
EXPECTED US LNG CAPACITY Golden Pass T2 7.8 Proposed 2018 Canada could also
50
ELS 10.0 Proposed 2018 contribute a significant
Pangea T1-2 8.0 Proposed 2018
export LNG Capacity

amount towards global

Potential non-FTAA

40 Jordan T1-2 6.0 Proposed 2020

Corpus Christi N/A Proposed N/A capacity, though there
30
(Mtpa)

Gulf Energy N/A Proposed N/A is insufficient visibility

20 Gulf Coast N/A Proposed N/A at this point in time.
Oregon N/A Proposed N/A
10
Total Canada 55.1
0 Total US 101.3
2012 2013 2014 2015 2016 2017 2018 2019 2020 Total North America 156.4
Note: Canadian capacity excluded given lack of development visibility. Source: Quant Group ; Macquarie

9
Summary of other LNG developments
PNG capacity development is most advanced, though almost c.40mtpa+ capacity
could be commissioned prior to 2020
PAPUA NEW GUINEA Almost c.40mtpa of
o Up to 3 LNG trains being developed additional capacity
Indonesia
– Trains 1-2 will total 6.9mtpa and enter operation by H2 2014 could potentially come
online prior to 2020.
– FiD to be taken later this year on Train 3 (3.45mtpa)
o Trains 1-2 will cost an estimated US$21bn These projects are
o Sinopec, Tepco, Osaka gas and CPC Taiwan will off-take LNG likely to have most
Australia
o ExxonMobil is the largest shareholder with a 33.2% stake output contracted on
crude oil pricing
MOZAMBIQUE
formulas.
o Plans for up to 20mtpa from 4 trains, which could be expanded to 50mtpa
— Based on estimates of 65tcf of recoverable gas with additional gas PNG LNG will naturally
being discovered (e.g. ENI discovery of 5-7tcf in Agulha – Sept 2013) be most competitive
o First train could start operation from H2 2018 within the Asian
o FEED contract awarded to Bechtel in early 2013 market, with
o Anadarko is the largest shareholder with 26.5%, and recently sold 10% to Mozambique exports
S.Africa
ONGC of India for US$2.64bn also feeding through
ISRAEL into India / SE Asia.
Turkey o Two LNG plants expected to be commissioned in next 6 years: Israeli / Cypriot exports
o Tamar FLNG – 3mtpa expected by 2017 with FiD by end-2013 are more likely to
o Leviathan – 5.5mtpa expected by 2019 though could be complicated by “swing” between
Tamar
FLNG
uncertainty surrounding Woodside’s commitment pricing arbitrages in
o Israeli exports recently capped at 40% of production Europe vs Asia
Leviathan
o An initial 5mtpa LNG plant is also being developed in Cyprus at a cost of US$5bn,
Egypt with the prospect of adding at least two trains

10
Coal versus gas:
The battle to power China
Current power fleet
China’s power fleet could grow 280GW by 2015 compared to 2012. Coal may account
for over c.40%, though is this credible, and will it lead to higher seaborne demand?
OVERVIEW PROJECTED GROWTH IN POWER CAPACITY Coal remains a key
component in
o Though demand for coal is expected to grow 1,500

Total Power Capacity GW

Other China’s fuel mix at
in markets like India, Japan, and South Korea, 1,250
Solar present.
China will remain pivotal to determining price 1,000
trajectories Wind However how could
750 these changes
o Chinese demand for generation capacity will Gas
500 impact the thermal
continue to grow Nuclear
seaborne market –
o Though its power fleet is dominated by coal, is 250 Coal both in terms of
it fair to expect continued growth in coal 0 Hydro substituting
power consistent with the past decade? Source: HSBC
2012 2013E 2014E 2015E towards domestic
coal production, or
o There are 3 factors that could impact this: PROJECTED COAL VS GAS POWER CAPACITY to other fuel
– Internal changes within the Chinese coal sources?
50
and power market
40 Though gas is not
– Developments in gas infrastructure and
New build GW

yet anticipated to
domestic policies 30 grow by much, are
– The pace of growth in Chinese Coal there grounds to
20 Gas suspect otherwise?
unconventional gas sources
o Examining the extent and impact of these 10
factors will guide judgements on the long run 0
viability of the seaborne coal market 2013E 2014E 2015E
Source: HSBC

12
a) Chinese coal and power market
developments
Chinese railway infrastructure
Railway improvements have the potential to reduce coal transportation costs by 2/3
relative to haulage levels, enhancing domestic competitiveness relative to imports
PLANNED ADDITIONAL RAILWAY CAPACITY BY END-2015 COMMENTS
Though thermal
o Cumulatively up to 900mt of capacity coal will have to
should be added by the end of 2015 compete with other
North-east commodities (e.g.
Heilongjiang
o Though rail quotas will need to be met coal; consumer
Provinces
secured, it is likely thermal coal will and industrial
63mt dominate transit from Xinjiang,
Jilin goods; etc) for rail
Xinjiang Northern Northern and North east Provinces quotas, it is difficult
Provinces Liaoning
160mt
Xinjiang
o This could crudely lead to: to envisage this
Inner
300mt being problematic
Mongolia – At least 100-150mt of thermal in Xinjiang, and the
Hebei
Ningxia
coal being transported directly Northern / North-
Shanxi Shandong
Qinghai to port east provinces.
Central
ShaanxiHenan
Provinces – A further minimum of 200-
Tibet Jiangsu This means a
275mt Anhui
300mt of coal partly being significant
Sichuan Hubei
transported by rail proportion of coal
Zhejiang

Hunan Jiangxi
o As rail costs are expected around will at least partly
Guizhou Fujian RMB0.15/km relative to haulage be distributable by
Southern rail, reducing the
Yunnan
Provinces costs of RMB0.55-0.60/km, this could
GuangxiGuangdong Taiwan
represent a substantial saving internal price of
130mt thermal coal.
o This could affect the competitiveness
Hainan of seaborne thermal coal

14
Chinese transmission infrastructure
Up to c.140GW of UHV capacity could come online between 2013-15 – providing an
alternative to coal through wind and hydro, or saving on coal transport costs
IMPACT FROM INCREASED TRANSMISSION CAPACITY COMMENTS
China has
o At present there is at least 45GW of embarked on a
Ultra High Voltage (“UHV”) in multi-billion US$
operation with at least 80+GW under plan to build out its
Heilongjiang
development transmission grid.

Jilin
o This is aimed at transferring power Beyond saving on
from new hydro or wind projects coal haulage, this
Liaoning permits the use of
Xinjiang
o This can crucially enable mine-mouth indigenous coal
Inner
Mongolia coal plants to transfer electricity from which can be burnt
Hebei less populated sources (e.g. Xinjiang, away from
Ningxia
Qinghai Shanxi Shandong Inner Mongolia) rather than populated cities.
transporting coal across long distances
ShaanxiHenan This could
Tibet Jiangsu
o These developments could lead to: therefore
Sichuan Anhui
Hubei
– up to 27GW in UHV transmission significantly
Zhejiang
lines dedicated to coal power enhance the
Hunan Jiangxi
Guizhou – a further 42GW of UHV competiveness of
Fujian
Wind capacity China’s coal
Yunnan transmission lines where coal
GuangxiGuangdong Taiwan industry whilst
Coal capacity power can support wind supporting
Hydro capacity
o σ2 estimates at least c.165m tonnes of competing fuel
Hainan coal could thus be saved from being types.
transported

15
Environmental policies
There is growing policy activity in reducing particulate emissions, in recognition of
increased population sensitivity to pollution risk, bringing coal use into focus
COMMENT PM 2.5 EMISSIONS ACROSS TOP 10 CHINESE CITIES It seems unlikely that
250 coal fired power plants
o Maintaining social stability is of paramount

Average PM 2.5 during Q1

Interim WHO Recommended limit: 25 can be built with

2013 (micrograms/m3)
importance to the Communist Party 200
relative abandon as
o There has been growing unrest surrounding 150 over the past two
pollution and particulate emissions which 100 decades.
government has sought to address: 50 There also seems to be
– Led to a 2GW coal plant being more effort to reflect
0
abandoned in Shenzen in August 2013 the cost of externalities
o It has also seen a series of policy initiatives (e.g. Pollution) in
introduced: power prices
Note: No data was available for Shantou. Source: Deutsche Bank
– A ban on building new coal plants in Given these
Beijing, Shanghai and Guangzhou SOURCE OF EMISSION CONTRIBUTIONS
PM 2.5 Sulphur dioxide
sensitivities, especially
– A trial carbon trading scheme in Coal Electric in populated areas, at
burning and heat a minimum, it is likely
Shenzhen 49% production
Other 50% 50% coal generation will
– Increased power tariffs to subsidise 51% Other
move away from
clean energy coastal cities to more
Nitrogen oxide Smoke emissions
– Subsidies to encourage de-nitration and inland areas.
Electric Electric
to reduce dust emissions and heat and heat This will increase the
o Coal emissions from power or industrial use 38% production 32% production
station gate cost of
62% Other Other
contribute materially to current pollution 68%
thermal coal imports.
levels Source: Deutsche Bank

16
b) Chinese gas infrastructure and
policies
Chinese gas landscape
The government is aiming for 10% of total energy consumption to be gas based by
2020, in efforts to address environmental concerns surrounding coal
OVERVIEW CHINESE PROJECTED GAS SUPPLY AND DEMAND The government’s
aspiration to
o The government is actively encouraging gas 300 Total
encourage more gas
consumption, representing a reversal of its 250 Consumption
consumption rests on
prior approach, with a view to achieving 200 having sufficient
environmental benchmarks Total Domestic

BCM
150 infrastructure capacity,
o This is notable within the areas of power Production along with
100 (DP) incentivising domestic
and transportation, whilst the NDRC* is
targeting 10% of China’s energy mix to 50 Total DP with production.
comprise gas by 2020 0 conventionals
at 2012 levels Though upstream gas
o An import deficit of c.50bcm is expected by 2012e 2013e 2014e 2015e
Note: 2012 consumption values are estimated. Source: CICC supply is controlled by
2015, though could be larger if domestic state-owned entities,
conventional production does not increase EXPECTED COMPOSITION OF GAS USAGE the pricing and
2011 GAS SPLIT regulatory backdrop
o Domestic gas prices are set by the NDRC will play an important
25% Residential Commercial
and based on “city-gate” pricing reflecting 19%
role in determining
average residential / non-residential use 5% Industrial Chemcial
how quickly and
12%
– This is problematic as import costs 26% Transportation Electricity successfully it achieves
13%
exceed the price set – causing state these aims.
2015e GAS SPLIT
owned entities to incur losses 18%
Residential Commercial
31% 5%
Industrial Chemcial
16% 23% Transportation Electricity
7%
Note*: National Development Reform Council Source: CICC

18
Chinese gas infrastructure
China has made significant progress in building out both LNG import terminals and
its pipeline infrastructure, and could add over 200bcm/year of capacity by 2020.
POTENTIAL CHANGE IN PIPELINE AND LNG IMPORT CAPACITY
Gas is now being
450 encouraged as an
400 alternative to coal
power, given the
350
developments in
Speculative gas
300 infrastructure.
pipeline projects
BCM/year

250 Gas pipelines Should such

200 substitution occur,
Speculative LNG it could further
150
terminal projects undermine the
100 LNG Terminals viability of imports.
50
Around 20-30GW
-
of gas fired plants
2012 2013 2014 2015 2020
Source: Daiwa are expected to be
commissioned by
o There is c.130bcm/year of capacity currently being developed 2015 – however a
o A further c.110bcm/year of capacity could come online depending on: further 40GW could
be supported if all
—Successful Chinese negotiations with Russia that could lead to two pipelines being built that these infrastructure
can transport up to 68bcm/year plans come to
—Sinopec and CNOOC planning c.40bcm/year of LNG projects yet to be formally proposed fruition by 2020
o Assuming 1/3 of these volumes are used in power generation, this could lead to c.50m tonnes of
coal being saved by 2015, and between 150-185m tonnes saved in total by 2020

19
Chinese gas pricing
Recent price reforms are positive, but may not be sufficient to fully stimulate
domestic gas exploration
Recent policies have
OVERVIEW ESTIMATES OF DELIVERED GAS PRICES
sought to encourage
o Recent reforms have been introduced to link 18
16
c.15-18 domestic gas production,
city-gate prices to fuel oil and LPG 14
c.12+ c.12
particularly of
c.12 unconventionals.

US$/mmbtu
12
– Average non-residential prices will rise by 10
c.15% to RMB1.96/m3 (US$0.32/m3) on 8
6
c.5+ However such an
existing gas supply 4 increase will simply offset
2
– A ceiling price on incremental gas varying 0 losses from import
by Province between RMB1.99-2.73/m3 Domestic Central Myanmar LNG imports Revised city- contracts and subsidised
conventional Asian imports (e.g. Qatar / gate price
gas imports Australia) residential gas supply.
– Residential prices will remain unchanged Note: LNG contracts reflect those predominantly agreed by PetroChina, which will
o These measures were intended to: come into being over the coming years. CNOOC has cheaper LNG contracts (e.g. US$6-
9/mmbtu) owing to its first-mover advantage. Source: Deutsche Bank
It could dis-incentivise
fuel switching from coal,
– Stimulate unconventional gas exploration
DOMESTIC GAS SUPPLY BY COMPANY (BCM) without support to
– Incentivise more efficient consumption specific sectors (e.g.
by penalising additional usage Power) or raising other
o However as PetroChina supplies most of 29 fuel costs (e.g. coal; etc)
PetroChina
China’s gas needs, this will more likely offset
Sinopec These measures could
losses made from LNG / central Asian imports 17
support a limited capex
CNOOC*
– In 2012 PetroChina lost 41.9bn Yuan 101 programme – but will
(US$6.8bn) on imports this be focused on
– Apparently contracts have been signed unconventionals vs
cheaper conventional
that will see 93.5bcm of gas imported (vs Note: *Breakdown not provided though CNOOC produced at least 11bcm domestically
with the remainder assumed to comprise imports from their LNG terminals. gas?
36.6bcm of imports in 2012) by 2020 Reflects distribution during 2012. Source: Associated Press

20
c) Chinese unconventional gas
developments
Chinese gas potential
China’s resources extent beyond conventional gas production, with significant shale
gas potential, along with existing production from CBM and coal-to-gas techniques
CONVENTIONAL GAS RESERVES UNCONVENTIONAL GAS RESERVES China has reasonable
proven reserves of
Daqing Junggar basin conventional gas, though
Tarim basin Songliao Basin significant shale gas
Jilin Tarim basin
potential.
Dadang Liaohe North China / Bohai Basin

Changqing China consumed c.5tcf of

Shengli Ordos basin
Zhongyuan gas during 2012, with
Jiangsu this exceeding
Sichuan basin
Offshore gas production of c.4tcf.
fields in the
yellow sea, This divergence is
East and South
China sea
expected to continue,
highlighting the allure of
ESTIMATED GAS RESOURCES (2013) FORECAST DOMESTIC GAS PRODUCTION its shale gas resources.
14.0
Coal to Gas However despite some
1,115 12.0
Shale Gas production, shale gas
10.0 Coal-Bed Methane represents a small
tcf

385 8.0 Conventional Gas

component, and it
tcf

109 6.0 appears unlikely if

4.0 government targets of
Proved gas Shale gas Recoverable 2.0 6.5bcm by 2015 (0.2tcf)
reserves resources CBM are attainable, let alone
0.0
Sources: BP / EIA. Recoverable CBM resources from China Energy Research Institute as 2012 2013E 2014E 2015E 2020E
60bcm by 2020.
of 2012 – total reserves are around 36tcm (1,260tcf)
Source: CICC / BP

22
Shale gas: the challenges so far
The technical aspects entail significant complexities beyond those experienced in
the US
GEOLOGY
o The Tarim and Sichuan basins are considered good Though Chinese shale
Junggar basin
prospects, given the likelihood of encountering deposits are vast, they
Songliao Basin entail a series of
Tarim basin less clay and existing conventional gas production
operating and technical
North China / Bohai Basin o Other basins may be more clay-rich (not as good complexities.
Ordos basin
for hydraulic stimulation)
In particular, a lot of
o Most deposits are located deep underground – deposits are found at
Sichuan basin even Tarim prospects could be >4.5km substantial depth, which
Considered suitable for o US deposits are relatively shallow requires considerable
development drilling expertise.
Likelihood of increased clay
o Chinese deposits therefore require skilled
/ greater drilling depths operators in horizontal drilling, etc Issues in securing
DISTRIBUTION OF WATER RESERVES sufficient water supply,
and in overcoming
o With the exception of the Sichuan basin, most environmental concerns
amongst communities,
North –east projects are located in areas with comparatively
North –west can easily delay or
8% limited water reservoirs potentially scupper
7%
o Though water availability will vary within these projects.
areas by each project, environmental concerns
Central (e.g. groundwater contamination; salinity; etc)
South –west
18%
50% South-east could hamper developments
16%
Location of known
unconventional gas resources

23
Shale gas: the challenges so far (cont’d)
The sector has been unable to attract sufficient investment, with regulatory as well as
technical hurdles, dis-incentivising interest beyond China’s state-run oil companies
COMMENT CRUDE COST PER EXPLORATION WELL The operating and
technical environment
o There have been a series of other issues that 20
13-16 makes well drilling
have stalled developments:
15 more expensive

US$m per well

– Lack of survey data compared to the US.
– High well costs 10 4-8
This underlines the lack
– Inability to stimulate skilled, private 5 of development, and
sector interest accounts for only a
– Infrastructure constraints (e.g. road 0 fraction of wells being
China US drilled, relative to
access; pipeline access; equipment) Source: Associated press
those targeted by the
– Community concerns NUMBER OF SHALE GAS WELLS government.
Comparison of shale gas wells Breakdown of Chinese wells
– Competing tenement issues (vs existing
9,000 As the government has
coal and conventional gas licences) 7,500 failed to stimulate
No. of wells

o Chinese state-owned companies tend to own 6,000 106 sufficient private

the most viable prospects 4,500 sector interest, it is
3,000 likely State-owned oil
o The government has attempted to auction 1,500 18 6 companies will
licences to the private sector, but this has 0
continue to dominate
US China - To China - China - Drilled to date
attracted non-oil and gas opportunists Producing meet Drilled to development – which
Producing > 10,000cm/d
o An estimated c.US$15-20bn is needed in well wells 6.5bcm date Other Producing could further delay
investment to meet 2015 production targets Total exploration wells progress.
These numbers are crude estimates. For instance, some reports have indicated up to
13,000 producing US wells, and could include shale oil wells producing gas as a by-product
To meet China’s target, each well is assumed to produce 10,000cm/d

24
What about coal gasification?
Though there are complexities with developing plants, existing plans appear
reasonably credible, which could see capacity potentially reach up to c.70bcm by 2020
COMMENT PRODUCTION PROFILE These projects normally
cost up to US$950m for
o Coal to Gas (“CTG”) involves heating coal deposits 30
70 Total Capacity
25 each bcm of capacity.
and extracting the gas produced

Bcm/year
o This typically has a lower calorific content 20 Datang Fuxin Analysts expect these
compared to natural gas (i.e. < 50%) 15 projects could be
10 Datang Hexigeten profitable relative to
o Up to 15 projects are planned with the NDRC imported central Asian or
5 Xinjiang Guanghui
approving those only with sufficient water access LNG gas, though will
0
o Most projects found in Xinjiang and Inner Mongolia By end By 2015 By 2020 Qinghua China
depend on pipeline costs.
o There is currently 0.5bcm pa (17.5bcf) of capacity of 2013 Kingho However given their
operational with a further 4.5bcm expected to Source: SX coal and other public sources
complexity, delays are
come online by the end of 2013 DEDICATED GAS PIPELINES PLANNED likely to be expected.
o This could reach at least 15bcm (525bcf) by 2015, Access to infrastructure
and up to 70bcm (2.4tcf) around 2020 Horgos
will also be important.
Yining
o However these targets could be affected by delays City However with the
owing to project complexity Xinjiang exception of Sinopec’s
proposed pipeline, it
o It will also depend on pipeline capacity would appear CTG may
– Sinopec will build a 30bcm, 8,000km pipeline, Zhejiang merely displace new
though may not be finished by 2020 pipeline capacity
– CNPC has built a 30bcm dedicated CTG spur to intended for Central
CNPC Guangdong Asian gas imports.
connect to its 2nd West-East pipeline Sinopec

25
What about coal-bed methane?
CBM contributes the most gas from unconventional sources in China, and is
significantly easier to develop than shale deposits
COMMENT LOCATION OF RESERVES DISCOVERED 2007-10 Infrastructure
remains important in
o Coal bed methane (“CBM”) is methane helping to further
7%
trapped within existing coal deposits, and develop resources.
includes surface along with mined (“CMM”) 13% Shanxi
deposits There are some
10% Shaanxi estimates that
o Found at depths typically < 2km and is easier Xinjiang suggest CBM could
to extract relative to shale gas 70% account for
Inner Mongolia
o Primary areas of development are in the 40+bcm/year by
Qinshui basin (Shanxi) and the Ordos basin 2020.

o The National Development and Reform Source: NDRC

The sector is
Commission (“NDRC”) are forecasting NDRC PLANNED CBM / CMM OUTPUT dominated by CNOOC
24bcm/year (0.85tcf) of marketable output by 40 and PetroChina, with
CBM / CMM Expected Output a limited number of
2015
30 Expected Marketable Output smaller players
– There are considerable differences participating
bcm/year

between output and what can be sold (normally in

20
– Due to lack of pipelines / pipeline access partnership with the
above).
o Insufficient information available to gauge 10
feasibility of these targets, along with amount
0
of drilling and planned capex
2010 2011 2012e 2015e
Source: NDRC

26
Bringing this all together:
Quantifying the implications of these
developments
Chinese economics of LNG
Coal superficially remains competitive vs LNG imports – however it is unclear if this
remains the case if cost externalities from coal use are considered
PRICING OF LNG FORECAST LNG SUPPLY AND DEMAND The current LNG
400 20 landscape would remain
Demand (LHS) Supply (LHS)

LNG Supply / (Deficit)

LNG volume (Mtpa)
Surplus / Deficit (RHS) 10 supportive of higher
Canada 300
prices in the short term,
0
United States 200 barring a decrease in
-10 crude oil prices.
100
-20
PNG Even with US exports,
Mozambique 0 -30 this is unlikely to
Australia 2012 2013 2014 2015 2016 2017
Oil-linked necessarily lower prices.
Henry-hub (“HH”) linked Source: HSBC

COMMENT CRUDE POWER ECONOMICS OF GAS VS COAL Coal continues to remain

o Oil linked LNG will be between US$15-18/mmbtu 160 competitive but it is
Total Overnight Levelised Costs Marginal Costs unclear how this could be
assuming oil prices of c.US$100/barrel 140
affected by other cost
o HH-linked LNG is cheaper but will be sold at similar 120 externalities (e.g.
levels, with marketers capturing the margin Range of coal
100 cost
pollution; new-build
US$/MWh

o Current spot prices are around US$15/mmbtu, but 80 externalities restrictions; etc), or if
could ease in future if supply increases as planned there are incentives to
60
encourage gas power
o PetroChina is expecting delivery of LNG cargoes in 40 beyond offering peaking
future which will cost c.US$18/mmbtu capacity.
20
o Coal remains cheaper than gas, but neglects any
0
subsidies from gas use, nor any cost externalities Coal Gas City-gate Gas Gas
with coal – which could narrow this difference (5,250kcal/kg) (US$18/mmbtu) (US$12/mmbtu) (US$5/mmbtu)
Source: σ2 estimates based on available public information

28
Domestic coal vs imported coal transport costs
Making a series of crude estimates would suggest upon planned railway upgrades
being concluded, it could improve the competitiveness of Chinese coal
ESTIMATE OF DISTANCES INVOLVED ESTIMATED 2010 CASH COST Though these figures are
40 quite crude, they suggest

2010 Mine gate

30
that if Chinese producers

(US$/t)
can secure railway
20
capacity, then it could
Urumqi 10
challenge the seaborne
c.1,000km 0 coal market.
c.3,400km Ordos Qinhuangdao (“QHD”) Xinjiang Inner Shanxi Shaanxi
Mongolia
Taiyuan
c.800km However this may vary
c.1,400km
ESTIMATED TRANSPORT COST amongst coal CV types,
Xi’an 400 given blending and
Rail
producer requirements.

US$/tonne
300
Key coal producing area Haulage
200
This also needs to
Significant coal reserves 100
consider that new coal
0 plants are likely to be
COMMENT Xinjiang Inner Shanxi Shaanxi
located away from the
Mongolia
o Average Chinese coal quality is c.5,000-5,500kcal/kg coast, creating additional
o Contrasting with current spot 5,500kcal/kg QHD FOB coal, CRUDE CASH COST USING RAIL costs with importing.
120
would suggest improvements in railway capacity could
FOB cash costs(US$/t)
100 QHD spot price The key question will
provide a domestic cost advantage 80 come down to how much
o These figures need to allow for mine cost inflation along with 60
railway capacity coal
40
whether railway capacity can be secured 20
producers can access?
o However upon these railway upgrades being completed by 0
end-2015, it could improve Chinese coal competitiveness Xinjiang Inner Shanxi Shaanxi
Source: Data drawn from Macquarie, Wood Mackenzie Mongolia

29
Substitution of imported coal
Continued growth in coal imports will heavily depend on the speed and utilisation of
new rail and UHV capacity that comes online
CRUDE ESTIMATE ON ANNUAL CHANGE IN DEMAND FOR IMPORTED COAL (2013-15) These numbers, though
rudimentary and
700 somewhat speculative,
Coal import / (exports) (mt)

600 suggest that imports

500 are likely to continue.
400
300 However whether these
200 grow or decline will be a
100 function of access to
0 railway infrastructure,
2012 Chinese 120 GW of new Impact from UHV Minimum use of Total before Additional Overall Net and the distance of new
Thermal Coal coal plants (2013- transmission new Railway additional railway Railway Use Import / (Export) plants from coastal
Imports 15) capacity use ports.
COMMENT
Gas, though
o Access to railway capacity and its associated costs per km will prove critical to determining import environmentally cleaner
demand between 2013-15 and better suited to grid
– If this is constrained, then we could still see some import growth management alongside
– If a third of expected new rail capacity is used, this will lead to exports falling from 2012 levels renewable energy,
appears insufficient to
o We neglect the impact of unconventional gas and associated pipeline / LNG developments dislodge coal from its
– It is also unclear how much unconventional gas will substitute pipeline imports dominant position,
– Assuming 1/3 of total gas production (conventional and unconventional) is used for electricity, unless providing peak
this could support c.75GW of additional gas plants by 2020 (vs 2015). This does not consider capacity
potential shale gas output, but will likely need to be supported by other baseload generation

30
Conclusions
Conclusion

o This presentation concludes that: It will be

– Despite the increase in LNG available for export over the coming years, this is developments in coal
transportation and
unlikely to challenge coal’s competitiveness within China transmission capacity
– Yet there could be other factors (e.g. environmental concerns; gas policies; grid that will weigh more
on the seaborne
management), which could incentivise gas use or increase the cost of coal power market this decade,
rather than
– Unconventionals appears to offer some potential, with the most promising
unconventional gas
developments in CBM and Coal-to-gas production, rather than shale gas. production.
– Given the lack of further pipeline infrastructure, it is unclear if such gas will This could also be
merely act as a substitute to imports, rather than being in addition affected if more
renewable energy is
– Even if it is additional, unless more gas is devoted to power consumption beyond substituted for new
1/3, this will only support a further c.75GW above expected 2015 levels. This will coal plants.
therefore require more baseload capacity (e.g. coal; nuclear) Only a massive spike
– A “shale gas boom” is unlikely this decade in China, given technical issues and a in unconventional gas
investment could
lack of investment, ruling out cheaper gas that can sustain baseload power change this. Even
then, this will not
– New railway capacity however could significantly alter demand for seaborne
affect present plans
coal over the coming years, and potentially reduce imports from current 2012 for coal plants, given
levels, especially with new coal plants potentially being located inland current energy needs

32
How can companies position / profit
from these developments?
Contact details

o To hear more about what actions can be taken, or to get a copy of this presentation,
please contact:

Name: Karim Awad

Address: 9B Amtel Building, 148 Des Voeux Road, Central, Hong Kong
Email: Karim.awad@sigmacommodities.com
Website www.sigmacommodities.com

34