Three years ago, the gigantic west-east gas pipeline project was overwhelmed with doubts over whether there was enough demand for gas.

Now, the project, which delivers gas from the deserts of western China's Xinjiang Uygur Autonomous Region to East China's Shanghai through a 4,000-kilometre pipeline, has become a hot issue in the market.

As oil and coal prices continued to surge over the past three years, gas demand quickly rose to the same level as the project's designated production capacity.

Three years ago, PetroChina, the operator of the project, was saddled with the problem of how to find more customers.

Now, the company is happy to find itself with the opposite "problem" of how to increase its production capacity to meet robust demand.

It seems to be a happy ending for everyone involved.

Customers, including chemical plants, power firms, gas distributors and residents, get clean and efficient natural gas; the better-than-expected gas demand helps the project make a profit this year, far ahead of PetroChina's schedule. For the government, the project contributes to its western development strategy. It also fulfills the government's plan to increase natural gas consumption to reduce heavy reliance on oil imports and help protect the environment.

But analysts warn that the champagne corks should not start popping yet, as daunting challenges lie ahead, analysts said.

Above all, it remains questionable whether customers would observe long-term gas purchase contracts once the prices of alternative energy fall, analysts said.

In particular, power plants, which account for one-third of the total gas consumption of the project, have not yet received prime-pumps to support them to replace the cheap coal with the natural gas for fuel.

Prices of natural gas are twice as much expensive as that of coal. Without incentives, such as favourable electricity tariffs, power plants may have to face fat losses, analysts said.

Dream comes true

Last week was a landmark in China's embryonic gas industry.

The US$17 billion west-east natural gas project commenced official commercial operation on December 30 after months of trial operation.

"The project marks a new era for the gas industry," said Xu Dingming, director of the Energy Bureau of the National Development Reform Commission, at the press conference last week.

"Gas consumption is expected to experience rapid growth in the coming 15-20 years," Xu said.

The project is China's first long-distance gas transmission project, and is among the largest gas projects in the world.

It would deliver 12 billion cubic metres of natural gas a year for more than three decades, increasing the country's gas consumption by a third.

It is part of the government's plan to increase the gas in the total energy consumption mix to 10 per cent by 2010 from the current 3 per cent.

But there has been widespread suspicion over the project's profitability ever since it was approved in 2001.

Negotiations over the gas sales were stalemated as PetroChina and customers could not agree on the gas prices.

PetroChina offered an average 1.29 yuan (15.6 US cents) per cubic metre depending on the distance of the trunk line. The company insisted the price was the bottom line for the project to make economic sense.

Most industrial gas users, however, said that they would only afford to use the gas at around 1-1.1 yuan (12.1 US cents - 13.3 US cents) per cubic metre.

Should the price not drop, customers could shift to alternative energy such as coal and oil which are much cheaper.

The project was at risk when it started construction in 2002 without any legal take-or-pay contract.

Under take-or-pay contracts, customers pledge to buy a certain amount of gas at a certain price range for more than two decades, no matter how much they use actually.

It is rare in international practice that a gas project takes off before enough customers are secured.

Bowing to the pressure, PetroChina agreed to lower the price by 0.02 yuan (0.24 US cent) per cubic metre to 1.27 yuan (15.3 US cents) per cubic metre in September 2003.

Still, customers were reluctant to commit to gas consumption.

Things turned around in late 2003 when the prices of alternative fuels, such as coal and oil, started to surge.

Coal prices have more than tripled since 2002, while oil prices have increased from US$30 a barrel to round US$50 a barrel.

"The price increase of alternative fuel spurred the demand for the gas from the west-east project," said Ren Suxing, a senior consultant with China International Engineering Consulting Corp, in a telephone interview.

"And people start to acknowledge the benefits of natural gas as the market develops," said Ren.

With better-than-expected gas demand, Su Shulin, senior vice-president of PetroChina, said the project will start to make a profit this year.

Consumption is expected to reach 4.0 billion cubic metres this year.

By 2007, consumption is expected to reach the designed capacity of 12 billion cubic metres annually, one year ahead of the original plan.

So far, 40 companies have signed take-or-pay contracts, committing themselves to consume 12 billion cubic metres a year.

PetroChina's executives maintained that the price of the gas is lower than the international level.

The average city gate price, which refers to the prices of gas delivered to the designated cities before it is purified, is 1.27 yuan (15.4 US cents) per cubic metre. The city gate price at Shanghai, the major destined market, is 1.32 yuan (16.0 US cents) per cubic metre.

It is cheaper than the average gas price of 1.89 yuan (22.9 US cents) per cubic metre in the Netherlands,1.8 yuan (21.8 US cents) in France, 1.62 yuan (19.6 US cents) in the United States, or 1.61 yuan (19.5 US cents) in Mexico, according to Su.

"Now many of the customers demand natural gas," said Su at the press conference. "It demonstrates the price is not high."

Customers said they are satisfied with the gas.

A manager surnamed Chen from Changzhou Gas Thermodynamics General Company, said the gas is competitive compared with coal gas.

Coal gas is a major energy source for residential and commercial users in Changzhou, in East China's Jiangsu Province.

The gas price for commercial users, such as restaurants, hotels and department stores, is 3.4 yuan (41.1 US cents) per cubic metre, as compared with 2 yuan (24.2 US cents) per cubic metre for coal gas.

But the thermal value of coal gas is two-fifths that of natural gas. It means five cubic metres of coal gas generates as much heat as two cubic metres of natural gas.

When the thermal value is factored in, the price of natural gas is 15 per cent lower than that of coal gas, according to the manager.

"It is even cheaper for industrial users such as power plants," said the manager.

"And the gas is much cleaner," he added. "More and more customers demand to use it."

The manager said the gas has provided the company with an opportunity to expedite the development.

In the past, the company was afflicted by insufficient capacity to produce coal gas.

It had to first meet the demands of residential customers, but was incapable of satisfying the demands of commercial users who would afford higher gas prices.

Now, the west gas has provided enough supply, said the manager.

The company hopes to increase the commercial and industrial users in its consumption mix to 40 per cent in 2004 from the previous 25 per cent.

This year, the proportion of commercial users would further increase to 60 per cent.

In addition, it is cheap to adapt the production facilities to the gas, according to the manager.

"The investment can be recovered as early as in half a year," he added.

Challenges

But the project continues to face daunting challenges.

For one thing, the power plants, which account for one-third of the total consumption of the project, have not secured long-term power purchase agreements (PPAs).

While the power plants have to commit to a certain amount of gas consumption, they could not lock the electricity sales.

Without PPAs, the power plants may find it difficult to sell the electricity to grids as the government is encouraging generating firms to compete to sell the electricity, analysts said.

Typically, the price of natural gas is as much as double coal prices for power generation.

As the result, the gas-fired power plants may suffer from high costs in the competition, if the government does not grant favourable policies.

"Certainly, the government would give incentives for power plants. But the problem is when and how," said an industry observer who refused to be identified.

"Now the risks are all on the side of the power plants."

The analyst said the ideal PPA should guarantee the amount of power generation, and ensure the proportion of power generation during peak and low consumption period.

The price of electricity in peak consumption period is much higher than in the low consumption period.

The electricity prices should also be allowed to float in line with the gas price changes, the analyst added.