Shale Gas Blooms in China? Not So Fast

on April 09, 2014 at 12:00 PM

Chinese Labourers Work At Lunnan Oilfield In Xinjiang

When China released its 2015 targets of 6.5 billion cubic meters of shale gas a few years back (source, in Chinese), it looked like the goal was out of reach. At the time, the country had zero commercial shale gas production and domestic natural gas extraction was mainly in the hands of state-owned companies. But Sinopec’s recent breakthrough at the Fuling block in southwestern China is raising questions as to whether the country can reach its ambitious targets.

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 China is not the US

Conventional wisdom in China – shared at Chinese conferences, boardroom tables and over casual conversation – was that America’s success in shale gas was due to the highly distributed nature of production. Small, nimble companies ruthlessly competed to extract gas and laws ensured that companies holding titles to land kept producing, even when natural gas prices fell. Not to mention numerous additional harmonious factors and market dynamics.

China had none of that.

The vast majority land with oil and gas blocks are held by either state-owned PetroChina or Sinopec. Mineral and land rights aren’t held by private citizens as they are in the US. Market participants viewed blocks auctioned off in 2012 as second-rate (80% of unconventional gas resources are located in existing blocks held by state-owned companies). Many of those auctioned blocks wound up in the hands of coal producers or others without oil and gas know-how. Access to pipelines is almost non-existent, with PetroChina and Sinopec having a monopoly on the market. Competition is between a few large players and just a handful smaller ones, quite the opposite of the American model.

The landscape is more challenging than in the US, according to geologists; shale deposits are deeper, in some cases up to 8,000 meters, the rocks more structurally complex. Water is a key issue: many shale deposits are located in areas far from water reserves. China water resources are considered low on a per capita basis and the country is already undergoing a massive water relocation project (the south-north diversion project to ensure the arid north can meet local water demands). Shale reserves in China’s southwest sit on or next to China’s rice basin and are located in mountainous regions. Natural gas production will compete for land and water with the country’s agricultural development and collide with Beijing’s desire for self-sufficiency in food. The relevant expertise for drilling lies outside of China’s borders, as do the service providers. Even the Ministry of Land and Resources encouraged foreign partnerships for the blocks it auctioned off in 2012.

china shale gas map

* Map from Daiwa Capital Markets report

Beyond what China lacked in the unconventional realm, the country still had plenty of easier, conventional targets. Domestic natural gas production was growing quickly: in 2013 production reached 121 billion cubic meters, up 9.8% from the year earlier, according to the country’s top economic body the NDRC.  Pipelines from the west and south (Turkmenistan and Uzbekistan through the Central-Asia gas pipeline and Burma through the China-Myanmar pipeline) promise to bring more gas. Piped gas imports increased by 24.3% last year. LNG imports are growing as well, with a 27% increase in 2013.

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Declaring Success? Not so Fast

Despite all of this, Sinopec recently announced that the company plans to produce 5 billion cubic meters of natural gas by 2015 (and 1.8 billion cubic meters by the end of this year), almost single-handedly meeting the country’s shale gas targets from the Fuling shale discovery in the Sichuan basin. The basin is estimated to have reserves of 2.1 trillion cubic meters. It’s the first major step towards China’s goals, but analyst caution reading too far into the meaning.

“While drilling at Fuling has delivered promising results, it is not representative of the Sichuan basin as a whole. Other operators such as PetroChina, Shell and Chevron have reported less promising or more mixed results. Moreover, the Fuling area is structurally different to the rest of Sichuan, which means that it may not be reflective of the wider Sichuan basin as a whole,” writes Neil Beveridge of Bernstein Research in a report on Sinopec.

Furthermore, shale gas development is not a top priority for PetroChina, the largest shale gas landholder. The company devoted just 1% of its overall budget to shale gas production last year, according to Wood Mackenzie.

PetroChina plans to produce 1.5 billion cubic meters of natural gas by 2015 and 20 billion cubic meters by 2020, according to reports. That still leaves at least 40 billion cubic meters of shale gas to be developed by Sinopec and other domestic players for a 2020 goal of 60-100 billion cubic meters. The country is relying heavily on unconventional production to boost oil and gas output (see table). 

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The news from Sinopec shows potential, but Beveridge warns that prices in China remain high for shale gas development. A cut in capital expenditures this year means smaller budgets for exploration and development. China may very well be on its way to a revolution in shale gas, but it’s going to look distinctly different from that in the US.