China is sitting on the largest shale gas reserves outside the United States. But can the world’s largest energy user get this valuable resource out of the ground?
On paper China has a tremendous opportunity to emulate the U.S. shale revolution, where it is fracking its way towards energy independence, lower energy prices and even a falling current account deficit.
According to the U.S. Energy Information Administration, China has 1,100 trillion cubic feet of recoverable shale gas. That means shale gas reserves are 10 times more than its current proven conventional gas reserves. China also has the world’s third largest shale oil reserves at 32 billion barrels.
Shale gas is also a critical resource for a country seeking to tackle a pollution crisis. China badly needs to increase the use of cleaner energy like gas, as the smoke from coal-fired power stations becomes a public health issue. Already China burns almost as much coal as the rest of the world combined. This September, the State Council, China’s highest governing body issued new guidelines setting a target for coal to be less than 67 percent of the country’s energy mix by 2017.
But for China’s economy to keep growing it needs to feed a huge energy appetite. This presents some tough choices says Neil Beveridge, analyst at Bernstein Research in Hong Kong. “If China does not do shale, is it going to do more coal or nuclear? If it just imports more, then you have uncertainty over pricing and energy security.”
The potential economic and environmental benefits present a strong case for shale. And mainland authorities appear to recognize its potential. In China’s 12th Five Year Plan, it set an ambitious target of producing 6.5 billion cubic meters (bcm) of shale gas by 2015 and 60-100 bcm by 2020. This would be part of a target to raise natural gas to 8 percent of total energy consumption by 2015, up from about 4 percent in 2010.
Despite this, shale in China has so far struggled to make it off the drawing board.
Indeed, the future of the shale gas industry in China is one of the key controversies in global oil and gas says Bernstein in a recent report. Shale wells so far have only reached a trickle, despite development permits being issued and official government support.
While there has been limited public information on progress, estimates are that China has drilled about 100 shale gas exploration wells over the past several years. This compares to the 8,000 shale gas wells drilled in the U.S. annually.
Gavekal Research says one hurdle is a more challenging geography for shale in China. Typically Chinese shales are deeper and structurally more complex, while the terrain can be more difficult to access. This all adds up to more expensive well drilling costs. The other major technical issue is water management given China has longstanding issues with water shortages.
Despite this, the bigger hurdles for shale in China appear to lie above, rather than below the ground.
Gavekal Research says technological and market barriers remain high with hindrances including a pipeline monopoly and state-set gas prices, which discourage expensive shale investment. Other issues include bureaucratic delays, a lack of technical expertise and, like in many countries considering shale, protests from residents worried about potential environmental damage.
China needs a regulatory environment in place that will encourage rapid development of its shale resource says Beveridge at Bernstein. He cites a lack of competition with state-owned enterprises PetroChina and Sinopec dominating the best acreage for shale development. And without the right incentives, these operators may choose to focus on developing cheaper coal, bed methane or additional conventional gas reserves first.
This is where the contrast with the industry structure that drove the U.S. shale boom proves instructive. The availability of private ownership of mineral rights was a key commercial driver behind the industry alongside small independent “wildcat” producers and supportive contractors with critical expertise.
Yet, there are some signs authorities are gradually moving to square the commercial challenge of exploiting shale in China.
In June of this year, Beijing announced a gas price hike to roughly U.S. $8 per million British Thermal Units. This likely brings the initial cost of shale gas development near or just over the breakeven level, estimates GaveKal.
Better incentives look essential. While China did expand shale rights in its second auction in 2012 away from major gas developers – with acquirers including a property developer and a grains trader – progress has still disappointed. So far reports suggest none of the 16 firms that won exploration rights had ever drilled a gas well. Meanwhile, access by foreign operators is limited as they are not allowed to directly buy these licences.
Given the large amounts of capital needed to exploit shale gas, better fiscal incentives look to be key for shale to become a viable commercial proposition. Much depends on whether the government can get its policy right. China’s target to reach annual production of 60-100 bcm of shale gas by 2020 may look ambitious, although it took the U.S. less than a decade to reach that level.
There has been some speculation China may include new policy initiatives at its plenum meeting in November 2013. Yet, shale might have been pushed down the agenda the industry grapples with potential reform and restructuring in the wake of the recent corruption scandal at oil giant PetroChina where four senior executives were arrested.
“Do I think they (Chinese leaders) are sitting around a table and discussing shale?” asks Beveridge at Bernstein. “No. I think at the moment there are bigger issues grabbing their attention.”