China Energy Overview

The growth in China's economy since 1980 has resulted in a sharp increase in demand for energy. In 1996, China became a net oil importer for the first time and it now imports over 40% of its crude requirements, consuming over 6 million barrels a day. Currently, China is the world's second largest oil consumer, although, on a per capita basis, China's consumption is still less than one tenth of that of the United States.

High international oil prices and environmental concerns have both served to increase the world's demand for natural gas. World gas consumption currently constitutes about 25% of the entire energy mix, whilst in China it is only about 3%. China's natural gas industry is still in the early stages of development but natural gas development and utilisation is a key government energy policy.

The Chinese Government has recently announced plans to raise this percentage to 5.3% by 2010. Total consumption in 2006 was circa 57 bcm so the proposed target represents a total of 122.9 bcm in 2010. Part of the China gas strategy is to encourage the transportation of gas from West China and other countries around China, including Russia and Central Asia, where there are significant resources, to East China where demand is highest and the energy shortage is most acute.

Completed in 2004, China's first major West to East Gas Pipeline was built by China National Petroleum Corp. (CNPC), parent company of Petrochina Ltd. (NYSE:PTR, www.petrochina.com.cn), now carries approximately 14 bcm of gas a year from the Tarim Basin along a 4,000 km pipeline which terminates at Shanghai. There were initial concerns that there would be insufficient demand for the gas but now demand exceeds supply and prices have increased.

In May 2006 the first of shipment of LNG was made to the first LNG terminal on the coast in Shenzhen. After less than one year of operation there is now a shortage of gas from the long term supply contract and so the terminal has started buying LNG on the spot market. The second LNG terminal in China is located in Fujian province which received its first shipment in May 2008. There are at least six other terminals currently under construction or being planned.

In order to respond to the increasing demand, there are now three new West to East pipelines planned for the near future, two of which will be able to supply gas to Zhejiang Province.

In August 2007, CNPC announced proposals for a second West to East pipeline with a capacity of 30 bcm per annum. The pipeline, which will be over 6,000 km long, is planned to run from Turkmenistan through Xinjiang to Guangzhou in Southern China, branching at Nanchang to run east to Shanghai and passing through western and northern Zhejiang Province. Approval from Central Government was granted in October 2007 and construction commenced in February 2008 with gas supply due to start in 2011/2012. CNPC signed agreements in July 2007 to import 30 bcm of natural gas over the next 30 years from Turkmenistan to supply this pipeline.

In addition, China Petroleum and Chemical Corp. (Sinopec, NYSE:SNP, www.sinopec.com.cn) has started laying a natural gas pipeline that will run from southwest Sichuan Province to Shanghai. This new pipeline, will have a total capacity of 17 bcm and is expected to supply 12 bcm per annum by 2010 to cities along the pipeline and will pass through northern Zhejiang Province.

In the past, the Chinese Government has held state-set gas prices below international LNG market levels but strong demand for gas, coupled with pollution targets, has forced it to obtain supplies from foreign sources at market prices. As a result, there has been significant upward pressure on prices and in November 2007 the Chinese Government announced increases in prices for all major gas pipelines which are now approaching international LNG prices. China is currently buying LNG on the spot market and CNPC and CNOOC reported late in 2008 signing long term LNG supply contracts at prices well above current North American gas prices.

These recent developments are clearly indicative of a maturing gas market with a more market-driven pricing system which will benefit the development of Block 25/34 in the long term. Further, it is apparent that a nation-wide gas grid is in the process of being established in China and that the East China region, as the most industrialised region of China, will be the frontrunner benefitting from this improved gas infrastructure.

Zhejiang Gas and the Zhejiang Provincial Grid

Zhejiang Province has a total population of circa 50 million and a land area of 101,800 sq km. It rates as the 4th largest provincial economy within China and has enjoyed double digit annual growth during the last 25 years. The 2007 total GDP was RMB1,846 billion or US$5,261 per capita. Its export size and growth is impressive, reaching US$128 billion in 2007. The Province has almost no primary energy supply except for its hydro-energy potential and about 91% of its energy needs have to be imported from outside the Province. In 2006, its energy consumption heavily relied on coal (62%), then oil (22%), with hydro and nuclear energy at 9.1% and natural gas at only 1.1%, way below the national level of 3% and miniscule compared with the international average level of 25% in the total energy mix.

Zhejiang Province currently has a small provincial natural gas grid of 330 km in the northern part of the Province, serving the major cities in the area, including Hangzhou, Huzhou, Jiaxin and Shaoxin, which is fed by the first West To East Gas pipeline. This gas grid is owned and operated by Zhejiang Gas. As part of the Zhejiang Province gas distribution policy, it is now intended that the provincial gas grid will be developed and expanded to connect other major cities within the Province, including Wenzhou, to the proposed Second West to East Gas Pipeline, to the Sichuan Gas to East Pipeline and to LNG imports. The planned annual throughput of the Zhejiang provincial grid by 2015 is estimated at over 6 bcmpa. It is intended that the gas from the Lishui 36-1 discovery will be sold into this provincial grid at a delivery point at Wenzhou.

The development of the Zhejiang Provincial Grid presents an exciting opportunity for Primeline in that, rather than endeavouring to create a gas utilisation market in a greenfield situation in Wenzhou alone, it will now be possible to supply to a rapidly developing market via the grid which is to serve all the major cities in Zhejiang Province and beyond. It is apparent from other natural gas grids in China that once supply has been established then there is rapid expansion of demand.