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Zhao Shurong, Chen Jing
Government Functions in Working out Natural Gas Pricing Mechanism in China
1. The Current Situation and Problems in China’s Natural Gas Price Mechanism.
In China, the price of natural gas is developing in certain environments. At present, China's natural gas pricing policy can be summarized as followings: the price is determined due to the cost and market demand; ex-factory price is made by the Government, and the price of pipeline transportation mainly depends on the government’s policy divided into the prices of the old pipeline and the new prices for the new line; the distribution price of city gas is determined by the local governments. That is to say, the ultimate prices of natural gas consist of the ex-factory price, the price of transportation and the price of distribution. Ex-factory prices are the same nationwide, while the price of transportation and distribution are somewhat different due to different gas, different pipelines, and different cities. [1]
With China's accession to WTO, the internal and external environment in China’s oil and gas enterprises has been tremendously changed; in this case, the present price mechanism of natural gas is still directly controlled by the government, which has been unable to meet the requirements for the development of China’s market-oriented economy. On the one hand, the right for the enterprises to make their own decisions has been weakened, so that it is hard for them to adapt to the changes of the market; on the other hand, the government has to consider the interests of all social relations, it is difficult to promptly grasp the changes of the market and readjust the interests of all parties. Due to our specific two-track pricing mechanism which is controlled by the government to great extent, the price mechanism of natural gas cannot come into being market-oriented, [2] in this sense, there are still lots of problems in China’s natural gas pricing mechanism as I state in the following:
First, in the developing period of the natural gas industry, the price of the natural gas is not a true reflection of costs and demand and supply, as the pricing models in the times of planned economy have been used by now [3], hence, the impact on the development of natural gas industry and the effective use of natural gas is notable. In China, the price of natural gas is mainly decided by National Development and Reform Commission (except the price of services), and the central
government and other functional departments have the right to make final decisions, while local government and the enterprises can only observe. By this way to decide the price of natural gas, this price does not reflect the cost of production and the supply and demand of market. What is more, due to the low prices of natural gas, those enterprises cannot gain enough benefits to cover the basic costs, only some simple production and day-to-day costs can be kept, and are never going to make the technical innovation and in-depth exploration without financial support. As a result, it cannot stimulate the enterprises to be actively involved and cannot help open up gas market as well as expanding the consumption areas, and cannot help expand the exploration of natural gas either. Therefore, this pricing mechanism cannot fully reflect the evolving relationship between supply and demand, and the enthusiasm of our local government and enterprises cannot be fully played, which will affect the development of the natural gas industry.
Second, China’s current wellhead prices of natural gas are united. In this situation, the geographical distribution of natural gas resources, geological features and the changes of costs on collecting gases in the different production stages have not been considered. [4] We know that the number of resources, the distance between consumption areas and the location of gases the geological conditions of buried gas, the costs on collecting gases in the initial stages and latter periods are closely connected. Such as, in the area of Xin Jiang Tarim, natural gas is abundant, but it is located in a remote area, under such poor circumstance, it would not be easy to transform the resources into economic benefits; in the region of Sichuan-Chong Qing,
despite the fact that the exploration location is not far from the consumer areas, the geological conditions of gas reservoir are complex, so the production rate is low while the mining cost is high. Therefore, the united wellhead prices of natural gas in China cannot reflect the cost of production and it is not conducive to explore the resources rationally and make full use of it by this approach. In addition, the final price of natural gas to the users includes the wellhead prices, purification costs, pipeline fees and services fees, which does not reflect the economic value of natural gas, so on the one hand, it easily wastes the resources; on the other hand, it is likely that some customers cannot afford it.
Third, the price of natural gas is not linked to the market price of alternative energy resources. Currently the world's conventional natural gas price is connected with the price of alternative energy resources on the basis of market net return. [5] China's oil prices have been integrated with the international prices, and the prices of coal and electricity have gradually speed up the market prices, but the calorific value of natural gas to other alternative energy has been very low, furthermore, the environmental benefits are not considered, compared with the prices of coal and oil. Although National Development and Reform Commission has adjusted the prices of natural gas recently, the price of natural gas is still too low, compared with the prices of coal, oil, liquefied petroleum gas and other alternative energy sources.
Such a way to manage the price of natural gas is temporary, which only happens in the transitional period from a planned economy to a market economy. In the short term, it is conducive to the country's macro-regulation and control, but such pricing mechanism is a disadvantage in boosting the enthusiasm of local governments and enterprises as well as displaying the market function.
2. The behaviors of the Chinese Government in the current pricing mechanism of natural gas
2.1. Regulation Theory. "Gui Zhi" derived from the English word "Regulation" or "Regulatory Constraint", was first proposed by a Japanese economist. In general sense, the regulatory system (regulation) refers to restricting the behaviors of individuals and economic bodies on the basis of certain rules. Economic regulation is one of the most important regulatory systems of government to regulate the behaviors of enterprises, which refers to the government regulating the behaviors of enterprises by means of legal authority in the field of natural monopolies and information deviations, such as regulating the behaviors of enterprises to enter and exit, price, the quantity and quality of services, investment, financial accounting, etc. [6] Mainly to prevent the inefficient allocation of resources and to ensure the equitable utilization of resources. The earliest study on the Regulation Theory and experience focused on the prices and access control of some special industries. These industries include: public utilities (electricity, pipeline transportation), communications, transport (road freight, rail, and air). This regulation is known as the "old" system of regulation. Until 1970, [7] most of the early literature about Regulation focused on the regulation on the natural monopoly industry. Oliver Kahn (Kahn, 1970) even considered the natural monopoly industry as the “indescribable economy in the model of competitive market” in his classic textbooks. Traditional natural monopoly industries mainly refer to the industry with the characteristics of scale, scarcity of resources, network, the wide range of economic benefits and fixed costs. Later, Baomoer (Baumol, WJ and WE Oats, 1975) [8] and other scholars proposed the concept of the Subadditivity in the natural monopoly industry, which enriches the connotations of the natural monopoly industries further. For a long time, the Government imposed strict economic regulation on the natural gas industry based on the understanding of its monopoly, but such regulation resulted in the lack of fair competition in the market environment, as well as independent, unified, transparent and fair legal framework (Jiun-Hao Wang, 1999). [9]
Regulation resulted in the market failure. Hypothetical perfect market in the MicroEconomics can be adopted to reduce the production costs of enterprises by competition
mechanism, so that enterprises are able to innovate the production methods and develop the new products with the purpose of making profits. However, in practice, such a perfect market is non-existent, even if a purely competitive market mechanism dominates the entire market, which enables to achieve fruitful results on efficient allocation of resources, good productivity and technological innovation and so on, but for judging the market achievements of the overall economy, there are still several issues of the so-called "market failure":
- the income redistribution due to monopoly pricing, price discrimination and differential treatment;
- the market mechanism would have economic system instability in the reaction to the delayed recovery mechanism of the extreme volatility of economy;
- public nature;
- external economy;
- natural monopoly;
- imperfect competition;
- asymmetric information, etc.
These issues cannot be resolved within the market mechanism itself, and therefore government intervention is required, that is to say, to make regulation.
2.2. Government Regulation. "Government Regulation" means public bodies regulate and constraint the micro-economic behavior by means of using policies, laws and regulations. In modern economics, it means the government regulates the activities of micro-economic bodies by using laws and regulations. Specifically, the government regulation is that the government makes the direct and indirect specific legal limitations, restrictions as well as some actions and measures which comply with those legal restrictions to conduct the economic entities, in order to achieve certain socio-economic objectives. The essence of the Government Regulation is to govern the government failure, maintain normal operation of the socio-economic order, raise the efficiency of resource allocation, and enhance social welfare. Government Regulation in the modern economic life has the following characteristics:
- the main body to regulate is the government;
- the object to be regulated is the economic bodies which are involved in the activities of market economy, including enterprises and consumers, etc;
- regulation has the direct impact on the activities of market economy;
- the implementation of regulation will cost money.
According to different classifications, government regulation can be divided into direct regulation and indirect regulation. However, government regulation of the price is an important way for the government to intervene the economy. A price regulation system is that the Government regulates the price of some products (the scarce products) and services (monopoly characteristics) in the point view of increasing the efficiency of resource distribution and fair distribution of social welfare, aiming to prevent monopoly pricing and reduce the net loss of social welfare. Government Regulation has kin linked with economic policies which can stimulate and realize the efficiency of the resources distribution; meanwhile, it has a direct relationship with maintaining the survival of enterprises and their sound operation alike. [10]
Therefore, the government regulation has a significant impact on encouraging and restricting the price of natural gas of the end-user, the competition among the fuels and market participants.
2.3. Our Government's Regulation on the Price of the Natural Gas. In China, the Government plays an important role in the natural gas pricing mechanism. National Development and Reform Commission is the main body to decide the price of the natural gas, mainly determining the price of wellhead and pipeline. According to the number of plans, exfactory prices of natural gas are divided into two types, prices of planned gases and self-sale gases. The prices of the planned gases are made by the State Council department which is in
charge of formulating prices, and this type of gases is used as fertilizers, for daily life, commercial use, etc; while, the prices of the self-sale gases of enterprises have to comply with the price made by the Government, in which the State Council department in charge of formulating prices makes the benchmark prices and its fluctuation range, but the specific prices should be determined by the two sides, supply and demand, within the range of fluctuation. Natural Gas Pipeline Transportation prices are made by the Government. Furthermore, Valve Commodities prices are determined by the local government and the final sale price of natural gas is priced by the provincial departments which are in charge of price formulation.
Gas industry is a kind of industry with characteristics of a natural monopoly, which is the political and economic lifeline of every country, so it is under the control of the government in general, which is understandable. China's natural gas industry is at an early stage; the price of natural gas is decided and guided by the government, within this two-track pricing model, the behavior of government plays a dominant role, but it also has a lot of drawbacks, such as, the government’s behavior of complete control has impeded the development of natural gas industry so that the enterprises with monopoly operation would lack vigor to compete necessary to introduce a competition mechanism and coordinate the behaviors of the government with the market mechanism.
3. The policies and measures to regulate the price of natural gas in the western developed countries. From the United Kingdom to the United States, the natural gas market has gone through the stage of immaturity to maturity, in this process, the government regulation presents a kind of feature that gradually evolves from strict control to the current deregulation and now the market competition pattern has come into being under the supervision of the government. Therefore, analyzing the characteristics of government regulation in the western natural gas industry has a significant meaning for our country. The experiences of government regulation on the natural gas industry in the United Kingdom and the United States will be introduced in the following.
3.1. The Experience of the Government Regulation of the UK’s Natural Gas Industry. British gas market is Europe's largest natural gas market, and the third one in the world after America and Russia. [11] The Britain natural gas market is going through a developing process from immature to mature. At this time, government regulation and law systems on natural gas have played a tremendous role in developing its market. British natural gas market has been able to develop such a degree of perfection, which is inseparable with the rational regulation of government and law systems.
Generally speaking, Britain has experienced two phases to develop the natural gas industry. First, before 1979, natural gas industry was nationalized, and the national natural gas was controlled by the Gas Department, a typical government management. [12] After 1979 Lawson, Britain Energy Sources Minister, thought that the only mission of the government is to establish a suit of system, so as to increase the investment benefits of energy and its use efficiency. Thereby, the British government established a series of laws and regulations, which aimed to lead the market of natural gas into a more active market, in this sense; the government plays the role of policy-making rather than the executive. So the government has more time to make policies, which increases the work efficiency of the government as well as the enterprises. At present, the British government to supervise the natural gas industry mainly concentrates on the prices of gas transportation and gas keeping, while, the prices of production and sale are automatically adjusted by the market, which gives full play to the role of the market. [13]
In the United Kingdom, the price of natural gas is determined by the cost-plus method, and the prices in the traditional shore supply contracts and the contract with end-user have a stronger association with the oil prices, though this association is not as strong as in other European countries. With the competition in the natural gas supply, such an association
gradually disappears. The price in many new contracts is not on the reference of oil prices or other alternative fuel prices. Under these circumstances, the price is more a result of the market competition rather than regulation. [14] In Europe, Britain's gas price is the lowest, which proves that effective competition and higher degree of transparency for prices are the important factors of reducing the cost and improving the economic efficiency.
The supervision model of the British government has a huge force to promote the development of the natural gas industry, that is to say, on the basis of the legal systems of the natural gas, government’s functions to make policy and supervise are divided. Such supervision mainly focuses on the long-distance network and city gas distribution system with the characteristics of natural monopoly, and adopts the model that supervises the specific project. [15]
3.2. The Experience of the Government Regulation in the USA’s Natural Gas Industry. After nearly 80 years’ development, the natural gas industry of the United States has undergone a complete cycle of government regulation, from the limited control to full control, and then to the later deregulation, which leads the development of the natural gas industry step by step. [16] In the early development of the natural gas industry, the United States held a view that "the way of gas distribution is a monopoly, and we must engage in direct control of prices in order to prevent the monopoly interests, so as to achieve the purpose of safeguarding fair competition and improving the efficiency of the entire national economy.” Therefore, the United States established a regulation system of natural gas prices: the consumption price of natural gas was dually controlled by the federal government and state governments; Interstate gas price is managed by the federal government, and state gas price is managed by the state government; the price of gas production was dually controlled by the Federal Government and state governments too. After 1978, the United States Government began to abolish the "dual market" price management, and the price of natural gas has gradually liberalized, and eventually realizes the full market of the natural gas industry.
The reason why the prices of natural gas in the United States are divided into two types, namely pricing by market and by controlling, is to distinguish the competition part and the natural monopoly part. Introducing the competition system to the suitable part and promote the maturity of the natural gas market; controlling the natural monopoly so as to make the pipeline companies reduce the LDC costs, thus reducing the terminal prices of the natural gas, the interests of consumers are protected eventually. There are many natural gas producers in America. Due to the introduction of competition mechanism, the price of wellhead is determined by the market; hence, the cost of producers can be reduced through market competition. Because gas transmission and distribution belong to natural monopoly areas, there must be regulations, or LDC and pipeline companies may use market forces to develop high prices against the interests of users, and then damage the development of the whole gas industry. [17]
In addition, the United States has specialized agencies to supervise the natural gas industry, [18] the regulatory system is independent, objective, transparent, and can be accepted by all stakeholders. The contents of supervision are in the following aspects: the access of the exploration and development of state-owned resources; avoiding waste in the process of exploring oil and gas resources; health, safety and the protection of the natural environment; the prevention of abusing dominant position in the natural monopoly areas.
4. Learning the experience of Britain and the United States; discussing the role of the Chinese government in the natural gas pricing mechanism. The natural gas market in Britain and the United States has been shaped by more complete laws and regulation systems, more reasonable pricing mechanism and more open competitive market environment after the transitional period from strict control to appropriate control. Of course, there have been phenomena of over-regulation and market confusion. These experiences and lessons are both
worth leaning. Since China has just started its large-scale development and utilization of natural gas, the government still has some problems on natural gas’ price control. For that, some advice and suggestions are proposed below:
4.1. The Government Should Establish and Perfect the Natural Gas-related Legal Systems. Many countries in the world have enacted laws related to natural gas, such as the natural gas laws of United States, the United Kingdom, Australia, and Canada. China has enacted 244 items of various laws since 197В; however, there has no one complete law for petroleum and natural gas. Even if a small number of existing laws and regulations are related to petroleum and gas, it is also with problems of narrow coverage, more expedient measures, fewer long-standing legal provisions and lack of inclusive, forward-looking and authoritative laws. Therefore, to ensure a healthy and orderly development of petroleum and gas industry, the government should establish a sound legal system on the exploration and production, transport and distribution, contract management, asset management, taxation, land use and other aspects of petroleum and natural gas, such as the establishment of an independent Petroleum Law or Natural Gas Law.
4.2. The Government Should Suitably Loosen Regulation and Actively Introduce the Competition Mechanism. Many countries in the world have basically control combined with the market. For example, the United States has decontrolled wellhead price; the sale price of natural gas is determined by the market in Britain while the government has strict supervision for the midstream pipeline and wholesale retailers and there are not too many restrictions for producers and downstream users. However, there is more stringent control on natural gas in China; the government regulates the natural gas’ production and sales prices, and they set a very low price, which is one of the reasons for the basically loss state of petroleum and gas fields’ operations of major natural gas pipelines across the country. Strict controls have restricted the development of the natural gas industry. The government should open up the price control of natural gas and set up the competitive market under government regulation to promote the development of natural gas industry. Government control and the role of the market must be complementary and reinforce each other, as both are indispensable for the development of the natural gas industry. Even if the natural gas industry has developed to a higher degree and entered the relatively mature stage, the transmission and local distribution of natural gas will still have to be supervised by the government. Nevertheless, the intensity and extent of control should be controlled well according to the development of natural gas industry, and not too much or too strict.
4.3. Proper Government Supervision. As natural gas is the basic item of livelihood for ordinary residents, it has a small price elasticity of demand and weak selectivity for consumer; therefore, consumers will be involved in huge passive situation if it unconditionally depends on the market. Furthermore, considering the absence of the competition mechanism in market structure, prices decontrol will simply strengthen the pricing power of monopoly departments, and these giant enterprises that have got rid of the government controls to price will be genuine market monopolies, execute monopoly pricing and gain high monopoly profits from the overwhelming consumers. Therefore, it still requires the government’s proper supervision in the resource market related to the lives of ordinary people. On the aspect of Government's regulatory policy, revenue-based performance monitoring can be adopted, [19] such as the ceiling control on price and income. The prices ceiling control mainly refers the government regulates certain ceiling prices of products or services in certain natural monopoly industries, so as to control the profit of monopoly enterprise and protect the interests of consumers. [20] These two performance monitoring policies could stimulate enterprises to reduce costs and boost profits. Price ceiling control prompts enterprises to increase sales and in turn increase revenue. Income ceiling control cuts off the link between sales and profits, prompts enterprises to be more active in raising
efficiency of energy utilization, in this way it can protect the consumers’ interests as well stimulate enterprises to improve efficiency and reduce costs.
4.4. The Government Should Price Differently. The government may consider the discriminatory pricing when it prices natural gas in natural monopolistic market. Discriminatory pricing will enable enterprises to improve their profits, expand the market and enhance their competitiveness and viability, while natural monopolies have a certain market forces and qualifications for discriminatory pricing. Natural monopolies could set different prices according to the different affordability of consumers. The differences of end-user prices in United States and British reflect the different cost of serving different users. China should set the gas price based on different cost for various users and reduce cross-subsidization. Pricing scientifically is the key point to develop the natural gas market. China should properly proportion the price of natural gas according to its various uses, such as for power generation, industry and commerce and for livelihood.
4.5. The Government Should Determine the Wellhead Price on the Basis of Supply and Demand. The wellhead price of natural gas is the base of the whole price system, and it should fully reflect the ownership and scarcity of resources when it reflects the cost of the exploration and production. [21] The natural gas industry is facing the external competition, because natural gas, coal, petroleum, nuclear energy, electricity and other energies are alternatives to each other. In China, coal prices have been liberalized, and oil prices are also aligned with the international prices, what is more, the competitive internet mechanism is being introduced to the power industry, however, the price of natural gas is still determined by the government, which lags behind changes of the actual demand. International natural gas prices are linked to oil prices, which fluctuate with oil price, the Government cannot control prices in the international markets, in such circumstances, if the price in the domestic market deviates too much from the international market due to wrong policies, which would affect the development of the natural gas industry. If domestic prices are too low, it will affect the enthusiasm of domestic producers, being not conducive to the effective use of domestic resources; while, if domestic prices are too high, it will affect the interests of consumers. Therefore, wellhead price of natural gas cannot be decided by the government only, it should be determined by supply and demand. Some Chinese scholars have put forth that the determination of wellhead price of natural gas should carry out the full-cost principle, in addition to considering the cost of production and the average profit, it must also consider mining risks and the time value of money. Here presents a dynamic formula for calculating the estimated cost, which is an average incremental cost (AIC):
AIC = I (invest capital + cos t ) q )
I production
While wellhead prices of natural gas should be:
P = AIC (1 + average profit rate) (2)
The method considered the production cycle to grow up and decline, so it is a reasonable method. However, this method does not take the characteristics of procurement market of natural gas into account. Different gas quality would have different AIC, if the wellhead price is made on the basis of their own AIC, and then the price of good quality gas would be lower than normal prices; while, the price of bad quality gas would be higher than normal prices, this is unreasonable and unacceptable. The key to determine the wellhead price by full-cost method is to decide the AIC. Therefore, when determining the AIC, we can pick up the different gas from different field size individually to count the AIC and then do weighted average, namely,
n
AIC= I AIC i x r,. (3)
i=1
mi mi
Here, AIC,=I(I, + C, )/I Q, is the average incremental cost in the gas field i,
j=1 j=1
I tj is the present value of the investment in the gas field i; CiJ is the value of production cost in the year of j ; Q, is the production value in the gas field i in the year of j; in this formula
mi n mi
r =I Q,/1 I Q„; n is the number of gas field selected; is the years from beginning to
j=1 i=1 j=1
explore the gas to cease collecting. This way to determine the wellhead price can reflect the
actual cost of gas, average profit as well as the time value of money; furthermore, it reflects
the competition in the procurement market of natural gas. [22]
4.6. Government Should Build the Natural Gas Pricing System Related to the International Market Price as soon as Possible. Similar to the oil, the international market of natural gas has become the integrity of international spot market and futures market. At this stage, China should introduce the futures products of natural gas when we are ready to actively develop the spot market, with a view to use futures contracts to circumvent the price risk in the process of developing spot market. In addition, in the process of developing the
market system of natural gas, we should strive to perfect the relationship among the natural
gas market in order to make the price relationship among the natural gas, petroleum, and other energy products more rational. [23]
5. Conclusion. In short, to promote the development of China's natural gas industry, the function of the government must be converted, and the government supervision has to be improved. With the continuous perfection of China's socialist market economy, natural gas enterprises should be gradually brought to the market, and the existing national pricing mechanism should be gradually transformed into market-regulated pricing mechanism, so that the prices of natural gas can be consistent with the law of value, and comply with the law of supply and demand; meanwhile, it is good to mobilize the enthusiasm of production and sale enterprises, and promote consumer’s positive attitude towards consuming gas, which eventually promotes a sustainable development of the natural gas industry.
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