BEIJING (Reuters) - China may raise natural gas prices as soon as September in its latest effort to normalize cheap domestic energy rates, but it treads a fine line in trying to bolster long-term supply while damping short-term demand.

A plant which will produce oil from coal, known as coal-to-liquid (CTL), nears completion in Erdos, in China's Inner Mongolia region, April 2008. REUTERS/Nao Nakanishi

A rise in domestic rates, which are half U.S. prices and less than one-third those of spot LNG imports, will be a boon for top producer PetroChina 0857.HK and peer Sinopec 0386.HK, whose regulated wellhead prices have risen only twice in the past three years.

But it is unlikely to resonate as loudly as last month’s sharp fuel price and rare power tariff increases, as natural gas occupies just 3 percent of China’s energy basket. Beijing aims to double the share of gas by 2020 as part of a high-profile effort to encourage greener economic growth.

To get there, it must increase prices enough to make it economical to produce domestic gas from remote areas or import it, and cut demand to avoid a short-term supply crisis that would force companies to seek other fuels.

At the moment, demand is galloping as natural gas looks an increasingly good choice compared to coal -- the price of which Beijing effectively liberalized last year before freezing again in June -- and to oil, which has surged to highs near $150.

“With coal prices already market driven and Beijing just raised fuel and power prices, people asked me what’s next? I said it should be natural gas,” said Yang Fuqiang of the U.S. Energy Foundation, which advises Beijing on energy policies including pricing.

“Possibly as soon as after the Olympics. Low gas prices are not conducive for demand control.”

Controlling demand without killing it is crucial for policy makers who want to ensure the success of huge projects like the $30 billion Central Asia pipeline.

GAS PUZZLE

China’s gas policy is the most complex and opaque piece of its energy pricing puzzle, as the sector is in its infancy and geared most toward the heavily subsidized fertilizer industry.

Natural gas makes up 3 percent of China’s overall energy use, versus a third in the United States and a quarter in Europe, Cambridge Energy Research Associates (CERA) said in a report.

A surge of enthusiasm for imported LNG has been dulled by escalating global prices and stagnant local rates.

China last raised wellhead gas by a third last November, after a 5-15 percent hike two years earlier, but it only affected industrial and commercial users, sparing more price-sensitive residential consumers and fertilizer makers.

Even after that increase, prices at around 1.40 yuan per cubic meter, or $5.6 per million British thermal unit (mmBtu), are well below U.S. levels <0#NG:> at $10 per mmBtu and versus long-term LNG contracts now hitting $15 per mmBtu.

The timing may also be right for policymakers to raise gas prices, as annual inflation for June was at 7.1 percent, easing

for two-straight months after hitting near 12-year highs.

“The current price level (for inflation) looks relatively modest and is acceptable to the government, which could create a favorable environment for further adjustment of resource and energy prices in the second half,” said Su Chang at China Economic & Business Monitor.

Few analysts were willing to estimate the scale of the next rise, but most agreed that any increase would be another small step towards a long-term market-driven pricing scheme.

A string of recent LNG import deals also seemed to point to Beijing’s growing acceptance of international prices.

PetroChina agreed on surprise LNG purchase deals with Shell RDSa.L and Australia's Woodside WPL.AX last year. CNOOC and PetroChina concluded deals with Qatar in April, likely at $10 per mmBtu or higher.

China had previously clung to hopes of repeating its first LNG import deal sealed in 2002 around $3 per mmBtu.

CHANGE VERSUS STABILITY

Gas producers like PetroChina and Sinopec have long asked the government for market-based pricing to hasten exploration and production, while regulators also hope to raise prices to reflect real value of the cleaner fuel.

But Beijing has yielded to broader economic concerns such as inflationary pressures, or worries that drastic price increases would hit vulnerable users such as farmers and the urban poor.

“The current decision-making process is propelled by a mixture of conflicting policy drivers and is expected to remain so at least in the medium term,” said senior China oil and gas analyst Yan Kefeng of CERA.

A revolutionary approach is not on the cards.

“Stability will be key,” said Catriona Scott, London-based gas analyst with Gas Strategies Consulting. “Prices will be rationalized and increased... But it’s not going to happen in the next six months, it will happen over years.”

Yet changes are underway, as more market-based supplies -- via pipelines from Turkmenistan and through tankers from Algeria, Australia and Qatar -- join the pool, and as expanding webs of pipelines boost gas producers’ pricing powers.

“It is clear that the new market elements are increasingly influencing policymaking.” said CERA’s Yan.

Lagging prices risk exacerbating shortages. The annual supply of 12 billion cubic meters (bcm) in China’s first West-East pipeline, a fifth of the country’s total output, was taken up faster than expected by users lured by low rates.

China started building its massive second West-East line in February, which will eventually pipe in 30 bcm a year of gas from Turkmenistan to China’s eastern and southern seaboards.

PetroChina, the country’s largest pipeline operator, has targeted urban users -- residential and commercial -- to take up over half of supplies from the second West-East line, industries some 28 percent and power about 16 percent by 2015.

“If the first West-East is any precedent, it’s a case of supply constraint,” said Gas Strategies Consulting’s Scott.

(Editing by Ramthan Hussain)