Prior to 2005 China operated under a dual-track pricing structure for natural gas with fixed prices for energy within state-set production quotas and flexible price on above quota production. After 2005 gas pricing was segregated. Major production areas such as, Chongqing, Changqing, Qinghai, Xinjiang (excluding the West-East line), Dagang, Liaohe, and in the central plains gas field used one fixed price. Remaining regions continued the dual track system.

In 2005, the NDRC instituted natural gas price reforms that allowed factory benchmark prices to reflect alternative energy prices. Gas producers could adjust pricing based on fluctuations in alternative energy prices once a year. The new government provisions allowed for natural gas prices to fluctuate 10 percent annually, whereas the previous year's range was less than 8 percent.

Yet, these averages reflect only domestic production and do not include the impact of natural gas imports. According to Deng Yusong, an authority at the State Council's Development Research Center, the future impacts of imported gas cannot be ignored and must be accounted for in pricing mechanisms. Deng believes domestic alternative energy pricing cannot substitute as a representative price for imports. According to Deng import prices are subject to supply and demand and each importer has different pricing standards. Not to mention, import prices are cyclical and at times unpredictable.

Cao Xiaoxi, an engineer with the Sinopec Research Institute, said that current domestic prices for gas are composed of production costs, transportation fees, and additional distribution fees, all coupled together to form the final consumer price. Transportation costs and charges for distribution are supposed to be subject to price controls and fixed benchmarks set by the NDRC. But the NDRC has shown little initiative in enforcing these benchmarks and instead has shifted the responsibility down to its local appendages. All in all the last two years have shown little progress in achieving the strict standards proscribed in the 2005 directive, said Deng Yusong.

Prior to 2009 the NDRC raised natural gas price ceilings two times. After December 26, 2005, the NDRC instituted natural gas price increases ranging between 50 to 150 yuan per thousand cubic meters, which were to be implemented over the following three years. In November 2007, the NDRC again issued price adjustments aimed at reflecting skyrocketing global energy prices. The 2007 provisions protected large industrial consumers of natural gas by awarding them preferential prices of 400 yuan per thousand cubic meters.

"When market prices are too low, manufacturing ambitions are also low. This is the age-old conundrum of natural gas pricing." said Cao Xiaoxi.

How High Can Natural Gas Prices Go?

Growing global demand for natural gas will be driven primarily by China and India. Forecasts from the U.S. Department of Energy foresee Chinese domestic natural gas production to increase by 3.1 percent annually through 2030 which is not enough to keep up with domestic demand which is expected to rise at 5.2 percent annually. By 2030, China could be dependent on imports for more than one-third of its total natural gas consumption.

According to 2008 BP energy statistics, natural gas import prices for the United States were 6.95 dollars per MMBtu (million British thermal units), 6.17 dollars per MMBtu for Canada and the European Union, and a remarkably low 5.34 dollars per MMBtu for China. Yet, the domestic prices for natural gas among the three regions tell a slightly different story. Natural gas prices for consumers in America averaged at 7.73 dollars per MMBtu, in Canada and European Union at 8.93 dollars per MMBtu, and in China at 7.82 dollars per MMBtu.

According to CITIC Securities analyst, Yan Xiao, China's fixed pricing structure for domestically produced natural gas has resulted in terminal production costs that are higher than in many overseas markets. Nonetheless, domestic consumer prices for natural gas remain in line with international prices, which means there is ample room for import costs to rise.