China has a goal of reducing carbon emissions. At the same time, China is currently targeting an increase in natural gas consumption as a part of broader national strategies to reduce the environmental (air pollution) impacts of the nation’s energy system, which at present is still heavily reliant on coal. Natural gas is also being promoted in residential sector as a way to improve living standards.

Chinese policy makers have recently launched nationwide gas pricing reform that links the natural gas price to oil prices to address natural gas supply shortages. My analysis of the pricing reform shows that it leads to a better predictability and transparency than the previous pricing regime. The reform also increased natural gas price that incentivized gas suppliers to produce and import more gas. However, there are also some limitations of the reform. First, it creates biased incentives that favor suppliers. Second, natural gas and oil have different supply and demand patterns and linking natural gas price to oil price may create distortions for natural gas use. The Chinese government should support a market-based natural gas pricing system because it will establish a better resource allocation system and improve welfare of China.

To assess natural gas scenarios up to 2050, I use the EPPA model, which is a global energy-economic model where China is represented as a separate region. Based on my updates to the EPPA model to represent China’s energy system and cost of technologies, three main policy scenarios are explored: the reference scenario, the cap-and-trade policy scenario, and the integrated policy scenario that coordinates the natural gas subsidy with economy-wide emission constraints.

The results show that a cap-and-trade policy will reduce natural gas consumption while enabling China to achieve its climate goals. The integrated policy uses a part of the carbon revenue obtained from the cap-and-trade system and promotes natural gas consumption. The integrated policy results in a further reduction in coal use relative to the cap-and-trade policy case. Both the climate objective and the natural gas promotion objective can be achieved with the integrated policy. The integrated policy has a very moderate welfare cost while leading to a reduction in air pollution. The results are tested for their sensitivity to excluding the household sector from the cap-and-trade scheme, the cost of natural gas-based power generation, the substitutability of fuels in final consumption, and the level of nuclear power generation in China.