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Sinopec spends big to hit shale gas targets

Figures from Bloomberg New Energy Finance reveal that the country's costs are higher than competitors

China is likely to hit its shale-gas production target next year, but it will come at a high price as costs in the country’s shale patch remain far higher than in the US, according to a new Bloomberg New Energy Finance (BNEF) report.

Beijing is keen to tap into its potentially world-beating shale gas resource to help cut its reliance on coal and boost energy security and it has set a series of production targets for its state-owned oil and gas producers. The government is targeting annual output of 6.5 billion cubic metres (cm) by 2015, around 3% of total consumption, with a quick ramp-up to 60bn cm to 100bn cm by 2020.

Both targets were seen as overly ambitious until a breakthrough earlier this year at Sinopec’s Fuling shale-gas project in southwest China seemed to put the 2015 target within reach. Sinopec says that it will produce around 5bn cm of gas from the Fuling gasfield in 2015 and 10bn cm by 2017, up from just 600 million cm earlier this year. But that production won’t come cheap. Wellhead costs at the project range from $11.20 per million British thermal units (Btu) at high producing wells to as much as $21.10/m Btu at lower producing wells, according to BNEF. US shale gas wellhead costs are as low as $3.40/m Btu.

While costs remain high, they are coming down and they are expected to continue declining. Sinopec was spending an average of $16m to drill a shale-gas well at the Fuling project in 2012, but that has fallen to around $10m more recently, according to the report. Still, well costs have some way to fall before they reach US levels. It costs around $6m to drill a well in the Marcellus shale, the largest shale-gas play in the US. 

Sinopec will struggle to make money on the project unless it can bring costs down faster, says Xiaolei Cao, an analyst at BNEF. Under the existing fiscal regime Sinopec gets between $8.10/m Btu and $10/m Btu on its shale gas sales, depending where it is sold. The company will have to invest $3.1bn by 2017 to reach its production target, according to the BNEF report.“Reforms along the gas value chain, from upstream market entry to third-party access and to the city-gate pricing mechanism, are required to improve the economics of shale gas development,” Cao said. “But reform takes immense time and effort.”

Sinopec and its compatriot China National Petroleum Corporation (CNPC), publicly listed PetroChina’s parent company, have pushed Beijing to raise domestic natural gas prices, which are controlled by the government, and offer more generous incentives for shale-gas production. Last year the government increased tariffs for non-residential users by 15% and analysts have expected another price increase this year. 

Beijing, though, has seen pushback from domestic manufacturers, the engine of China’s multi-decade economic boom. They have counted on cheap subsidised energy to keep costs low for years, especially more recently as labour costs in the country have risen sharply. The government has offered a subsidy of 0.4 yuan per million cm ($2.30/m Btu), but it would have to raise that to between 0.6-0.9 yuan per cm to make shale development profitable, according to BNEF’s calculations.

The poor returns on shale development in China has discouraged CNPC, by far China’s largest gas producer, from pursuing domestic shale more aggressively. The company has large holdings in China’s most promising shale plays, but it has done little to pursue development. Last year, less than 1% of CNPC’s total spending went towards shale as it focused on more profitable conventional and tight gas projects. In April the company increased its shale-gas production target for next year from 1.5bn cm to 2.6bn cm.

Sinopec, historically a refining-focused company that had little involvement in producing oil and gas, does not have the same deep portfolio of domestic gas projects to choose from, and it has emerged as the clear leader in China’s shale patch. 

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