* PetroChina-dominated grid limits small gas producers
* Small producers forced to sell at discount
* Mandating access could encourage shale, coal bed gas output
BEIJING, Nov 22 (Reuters) - As China struggles to rid cities of choking smog, one of the early priorities for Beijing's economic reforms will likely be to force state-run PetroChina to allow private producers fair access to natural gas pipelines.
Without fair access to the distribution network, independent producers have no incentive to develop the country's vast gas reserves to their full potential. Already the world's fourth-largest gas user, China's leaders want to boost domestic output to accelerate the substitution of cleaner-burning gas for coal to fuel power and heating.
They included gas price reform and some curbs on the role of state monopolies in their boldest reforms in decades unveiled last week. Industry experts say both are needed to maximise gas output and ease annual winter supply crunches that have slowed the switch from coal in power plants and forced authorities to ration industrial gas use.
China's largest oil-and-gas producer, PetroChina, built and runs nearly three quarters of the 54,000-km natural gas pipeline system across China. It controls most of the large, long-distance trunk lines that pipe gas from far-flung fields to fast-growing cities. Other state energy firms - Sinopec and CNOOC - run the remaining trunk pipelines but are much smaller operators compared to PetroChina.
Some independent gas producers say PetroChina has imposed unfair conditions on them for access to the grid, erasing the profit-incentive for boosting output, and others are asking the state giant for better access.
"To have more access to the pipelines and more access to broader markets would bring more incentive to producers," said a senior executive with Asian American Gas, which pumps gas from China's coal seams in Shanxi province.
"We have a plan to access the trunk lines and serve the coastal markets along with our production growth in the near future. The recently proposed new policies are actually in line with the party's new policy of letting the market decide the allocation of resources."
Open access to pipelines was one of the key factors that enabled the U.S. shale gas industry to revolutionise the energy sector of the world's largest economy. China's shale reserves are potentially bigger than those in the United States, but the Chinese sector is undeveloped.
PetroChina demands independent producers sell the gas they want to move through the pipelines at a discount to the oil giant rather than charging a transit fee, said executives with independent producers. They declined to be named as both were unauthorised to speak to openly the press.
PetroChina declined to comment on the terms of deals it has made for third party access to its pipelines. Only a few independent producers needed access and they were able to negotiate terms, said company spokesman Mao Zefeng.
"It is unfair that any third party has unconditional rights to use our pipelines," the spokesman said. "As an integrated upstream and downstream oil company, gas pipelines are one of the components connecting upstream production with downstream operations. Our own oil-and-gas need pipeline capacity allocation."
PetroChina pays independent producers 70-80 percent of the retail value of the gas, the executives with independent producers said. It then sells the gas to consumers at the retail price, pocketing the difference and preventing independents from competing for customers.
To avoid selling at a discount, independent producers stick to pumping from gas fields to nearby retail markets they can reach without using PetroChina's pipelines.
That means small producers have no motive to boost output above a level that meets local consumption and counters Beijing's aim of boosting natural gas output nationally through encouraging private enterprise to develop unconventional energy sectors such as shale gas and coal-bed methane.
While conventional oil-and-gas fields are reserved for China's state-owned energy giants, Beijing has allowed private firms a role in the unconventional sector.
Production of gas from China's coal seams has been more successful than shale, but output would increase more quickly with better pipeline access, industry sources said.
"One of the boxes (investors in gas exploration) want to tick is access to market managed in a regulated and transparent way because there is access to a pipeline," said Beijing-based Gavin Thompson of energy consultancy Wood Mackenzie.
Beijing has introduced subsidies for shale gas and hiked gas prices this year as it looks to boost investment in the sector. Prices need to rise again to lure investors, industry experts say, with hikes of at least 15 percent a year for the next two to three years needed to make shale profitable.
As the role of gas in the economy grows, hiking prices so much may be difficult without fuelling inflation.
China's natural gas consumption is expected to grow to 250 billion cubic metres per year by 2015, up 70 percent from 2012. Imports will need to double to 80 bcm as domestic supply fails to keep pace, industry experts have forecast.
The country's top economic planner, the National Development and Reform Commission (NDRC), started work on a new policy for gas pipelines long before the government announced its reforms.
A policy draft seen by Reuters that the NDRC circulated in August for feedback from industry participants, calls for pipeline operators to provide non-discriminatory transmission services to third-parties.
Forcing state giants to allow access on an equal footing to independents would stimulate investment, while leaving the state-owned firm in control of the assets it has built. That may fit into Beijing's plans for slow monopoly reform.
A deeper, longer-term reform would be to establish a separate operator to run the pipelines. That reform is not in the draft, but industry experts say it would accelerate the expansion the grid needs.
Until then, China is relying on state energy giants to build the pipes. They are in the midst of a plan to nearly double the grid's size by laying 44,000-km from 2011-2015. Top gas consumer the United States, which burns five times as much as China, runs pipeline grids nearly 10 times those in China.
The government needs to ensure improved access to the pipelines does not jeopardise expansion of this hugely capital intensive sector.
"The balance the government is trying to seek is to incentivise third-party investment but at the same time to make sure the pace of the pipeline development is maintained," said Wood Mackenzie's Thompson.
The NDRC reform draft also seeks to introduce more transparent accounting of transport costs in a sector that has bundled transmission and gas sales together.
China has three tiers of pipelines: trunk lines built by the big state energy firms, intercity lines built by state firms together with local government-backed distributors, and city grids. The grids are run by distributors such as ENN Energy Holdings Ltd and China Gas Holdings Ltd.
(Addtional reporting by Judy Hua and Beijing newsroom; Editing by Simon Webb)