Stepping on the gas

Shale-gas production will pick up over the course of this decade, but nonetheless fail to meet official aspirations.

In March, China’s appalling air quality prompted its prime minister, Li Keqiang, to declare a “war on pollution”. In fact, China has been trying for a while to shift its energy mix away from reliance on dirty coal. One way it proposes to do so is by tapping China’s huge resources of natural gas caught in shale rock. The going has been slow, however, in the face of many obstacles. Domestic gas production is falling well short of surging demand, and import dependence has risen steeply. Whereas in the mid-2000s China barely imported any gas, by 2013 it was buying in one-third of its supplies. Yet optimists can point to encouraging signs that a Chinese “shale-gas revolution” is finally taking off.

Regulatory support is becoming firmer, as China chases an official target to produce 6.5bn cu metres of shale gas by 2015. Gas prices for non-residential users were raised from September 1st, while municipalities including Shanghai are introducing a tiered pricing mechanism for residential users. These moves should help incentivise domestic gas production. Previously, in late 2013, the government had elevated shale to the status of a “strategic emerging industry”, which will boost funding for related technology. In February this year, furthermore, it announced that all national and provincial oil and gas pipelines—which are generally run by the state oil companies, especially China National Petroleum Corp (CNPC)—will be open, on paper, to third-party access, albeit within certain constraints. Unprecedentedly, China’s Ministry of Land and Resources had already allowed private investors to bid for shale blocks.

Potentially the most encouraging evidence of progress came when state-owned Sinopec announced a breakthrough at its Fuling property in Chongqing earlier this year. Output at the field, which produced around 65% of the 200m cu metres of shale gas produced in China in 2013, expanded rapidly in a matter of months: the best well produced nearly 550,000 cu metres per day, over 30 times the average at Chinese shales. Sinopec plans to invest Rmb21.5bn (US$3.5bn) at Fuling in 2013-15. Encouragingly, it seems to be breaking even: production costs at Fuling are reportedly Rmb1.75/cu metre; given a sale price of Rmb2.8/cu metre and government subsidies of Rmb0.4/cu metre, this yields a net profit of Rmb1.45/cu metre. Flushed with success, the company says Fuling will produce 1.8bn cu metres in 2014, rising to 5bn cu metres next year.

Who’s Fuling whom?

The regulatory framework is thus improving, and production is picking up. Yet for every hint that momentum behind shale is building, more reasons exist to believe that progress will be less-than-revolutionary. Tellingly, in August China’s National Energy Administration (NEA) cut its 2020 shale-gas production target to 30bn cu metres from 60bn-100bn cu metres. This reflects the scale of the problems affecting China’s early-stage shale development.

Water supply is one oft-noted constraint. In China’s most promising shale play, the lush Sichuan Basin (where Fuling is located), hydrological concerns appear overhyped. But at its nearest rival, in arid Xinjiang, they are pertinent. A more universal reason for pessimism is that Chinese shales are generally deep and geologically complex, hence expensive to penetrate. This is the opposite situation to that in the US, which has led the shale-gas revolution.

The US boom was prompted by risk-taking, innovative private drillers. China, by contrast, lacks such companies; new shale outfits are being formed, but they face steep learning curves. Indeed, in China’s second shale-gas auction, which was held in 2012 and open to private companies, many of the winners had no oil-industry experience. (A third auction is long-delayed.) Entrepreneurial firms in the US drilled thousands of wells over a couple of decades before shale took off. Active fields in China number in the dozens still.

This leaves China’s shale-gas industry dominated by state-owned oil and gas companies, which hold over two-thirds of the acreage. They are betting heavily on shale in part to curry favour with the national leadership. Foreign majors such as Royal Dutch Shell (UK/Netherlands) are joining the fray. But they need to partner with Chinese state titans to gain access to the most promising plays and will be pressured to give up intellectual property and know-how. In fact, these foreign majors have a poor record in discovering new shale plays.

Evolutionary prospects

Despite these barriers, the pared-back 2020 production goal does not signal the government’s commitment on shale is wavering. The more realistic target could help discourage wasteful, unsustainable development by smaller companies. Recent changes to the regulatory framework, including price reforms and efforts to open the sector to competition, should all spur advances. Meanwhile, China’s state titans are gaining experience and earning a degree of success.

Still, it will take years, at best, before Chinese shale production reaches any scale. In the interim, the good news for providers of pipeline and liquefied natural gas (LNG) is that China will need them to help fill the gap.

via Stepping on the gas.