OREANDA-NEWS. Fitch Ratings says today that the Chinese government's announcement that it will reduce gas prices and launch further natural gas price reforms for non-residential end-users will foster greater usage of natural gas in China.

The National Development and Reform Commission's (NDRC) said on 18 November that non-residential gas prices will be reduced by CNY0.7 per cubic metre (pcm) from 20 November 2015. In addition, from 20 November 2016, city gas price policy will be adjusted, so that buyers and providers of gas, such as China National Petroleum Corporation (A+/Stable) can agree on prices that are as much as 20% above the NDRC-determined reference price with no floor.

Fitch has been expecting the reduction in non-residential gas prices due to the fall in gas procurement costs following the drop in global oil and gas prices, as well as lower coal and oil prices, which make gas in China uncompetitive. The average cost of China's gas imports had fallen by about 25% since early this year; the CNY0.7/cubic meter (about 28%) reduction in non-residential gas price is in line with the fall in import costs.

China relies on imported gas to satisfy around 30% of its total annual gas requirement, but has been historically making losses on such imported volumes. We think the lower gas prices will help lift near-term demand in China; overall gas demand growth in the country has decelerated to a decade low of 2.5% in 2015.

The gas price cut will narrow the profitability of CNPC's natural gas and pipeline division from the levels seen in the first nine months of 2015, but we expect the division's profitability to remain much healthier than that in 2013 and 2014. The profitability of this segment improved substantially in the first three quarters of 2015, with the fall in average cost of gas.

The lower gas price will also benefit provincial energy companies, such as Beijing Energy Investment Holding Co., Ltd (A+/Stable) and Zhejiang Provincial Energy Group Company Ltd. (A/Stable), which use natural gas for power generation and district heating.

The additional pricing freedom to be implemented from November 2016 will help boost gas usage during peak demand periods, and moves China towards greater liberalisation of gas prices in China over the long-term. Gas prices have been closely controlled by the state via NDRC. Fitch believes the greater flexibility to determine prices will provide an incentive to natural gas suppliers to source additional natural gas during price peaks. The current reference city-gate natural gas price does not reflect natural gas procurement costs for the natural gas providers during peaks.

Fitch also expects the cost pass-through mechanism for non-residential end-users to be timelier with the implementation of the announced reforms. Arrangements between city gas operators and their non-residential customers, however, can vary from region to region. While many arrangements now incorporate clauses of automatic cost pass-through, there are certain areas where local authority approval is still needed to raise tariffs. We believe regulators will seek greater freedom for city gas distributors to automatically adjust prices, if the November 2016 changes are to be fully implemented. A successful implementation of this will support the growth of natural gas sales for city gas operators such as Binhai Investment Company Limited (BBB-/Stable), China Resources Gas Group Limited's (BBB+/Stable) and ENN Energy Holdings Limited (BBB/Stable).

Over a much longer term, Fitch expects natural gas prices to be increasingly more marketised, especially when the newly operational Shanghai Petroleum and Natural Gas Exchange (SHPGX) is able to establish a natural gas price reference that is relevant for the Chinese market. However, Fitch does not expect a fully marketised natural gas price in the immediate future because the central government still needs to maintain substantial control over the price-setting mechanism to ensure high natural gas prices do not curb the growth of natural gas usage in China, and to ensure the mechanism does not result in significant volatility in gas prices.