China Energy Flop: Beijing Slashes Shale Target For 2nd Time

Early this month, Wu Xinxiong, head of China’s National Energy Administration, cut the country’s 2020 production target for shale gas to 30 billion cubic meters.  The goal, immediately before the reduction, had been 60-80 bcm.

Despite the big drop, China will have a hard time reaching the goal.  At the moment, there is only one major area in operation, Sinopec’s Fuling field, in the Sichuan basin.  The state-run company projects production of 5 bcm by next year and 10 bcm by 2017 from Fuling, considered the most promising site in China.  Because all sites last year produced just 0.2 bcm from shale, it’s hard to see how producers will meet the 2020 target—or even the 2015 target of 6.5 bcm.

What is so significant about Beijing cutting its 2020 production goal and in all likelihood missing it?  Because the shale gas failure shows the limits of what China can do within its top-down economic system.

China has all the ingredients for shale gas glory.  The country, after all, has by far the world’s largest shale reserves, some 31 trillion cubic meters according to the U.S. Energy Information Administration, almost twice America’s.

As important, Beijing has the incentive to secure energy at home as its economy is now dependent on maintaining a flow of hydrocarbons from politically volatile regions and far-away locations, from the Middle East to Africa to Latin America.  China, of course, needs as much natural gas as it can pump: last year it became the world’s third-largest user of the commodity, trailing only the U.S. and Russia.  And if this were not enough, Chinese leaders need clean-burning natural gas because goupy skies have become a pressing political issue across the country.  Therefore, analysts as late as last month were talking about China fracking 100 bcm a year by 2020.

The National Energy Administration cited geology and high costs for cutting its 2020 target, but that is unconvincing.  It’s true that China’s reserves are in hard-to-reach locations, there is a lack of water in many of those places, the reserves are generally buried deep in the earth, and the shale has too much clay, but all of these factors were known when Beijing announced its initial 2020 goal of 60-100 bcm in the country’s 12th Five-Year Plan.

As for costs, that’s the name of the game when it comes to shale.  The technology of hydraulic fracturing—fracking—and horizontal drilling have been known for decades.  What produced the shale boom in the United States—now the world’s No. 1 gas producer and No. 1 pumper of hydrocarbons overall—is that Americans figured out how to make the extraction of gas economically feasible.

Don’t thank major oil companies for the cost reductions.  Progress was due to the independents.  Over time, small producers, applying their ingenuity and remaining patient, made mostly tiny improvements in processes and techniques.  For instance, they figured out how to replace expensive gels with water and determined the best angles to drill.  This was a matter of tweaking, not technology.

Beijing’s genius technocrats, however, have learned nothing from the experience.  Their approach is to reserve all the best blocks for the country’s gargantuan state oil companies.

It is no coincidence that a state firm—Sinopec—sits on the best site in China—Fuling.  The first auction of state shale blocks took place in 2011 and was open only to six state firms.  Forbes researcher Yue Wang called it “largely a staged play.”  The second round of bidding, held in 2012, was surreal, open to private enterprises, such as a home appliances company and a hardware business.  The third auction, originally scheduled for last year, has yet to occur.  The betting is that companies politically favored by the localities where the offered blocks are located will win.  At the moment, two state firms, Sinopec and China National Petroleum Corp., hold nearly 80% of awarded exploration rights.

State firms can do some things well, like sign up major deals abroad, but they don’t make good frackers.  They don’t, for instance, have the incentive to spend the time making adjustment after adjustment to optimize the return from each well.  They’re just not that interested in pumping a few cubic meters here and a few there.  Because of their size, shale is a minor sideline they would not participate in were it not for a directive issued from the Chinese capital.

They can, of course, buy technology.  That’s why Beijing permitted Halliburton and Schlumberger to enter into contractual arrangements that will result in know-how sharing and why it pushed China’s state companies to buy North American shale assets to obtain tech.  Yet that strategy has limited usefulness for shale.  China’s surface and subsurface geology is substantially different from North America’s and Chinese locations vary widely, so it will take time to adapt foreign knowledge to make it commercially useful in China.

via China Energy Flop: Beijing Slashes Shale Target For 2nd Time.