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Cautious optimism over China's shale-gas plans

The country’s huge reserves are not living up to their promise

China could become the world’s largest importer of natural gas over the coming decades. But its extensive unconventional gas resource base could help stem its rising reliance on foreign energy supplies.

“Significant shale gas production could start taking the heat out of gas import growth around 2025,” Gavin Thompson, an Asian gas specialist at Wood Mackenzie, told Petroleum Economist.

The energy research firm forecasts shale output to hit between 120bn and 140bn cubic metres (cm) in 2035. But given China is pumping just 5bn cm per year (cm/y) now, the projection is “undoubtedly the single biggest risk factor in our China gas analysis,” added Thompson. It’s no secret that China’s shale gas resources are potentially prolific. Although estimates are uncertain, preliminary studies show that the country may have more than 670 trillion cubic feet (cf) of recoverable shale resources at prices below $12/m British thermal unit (Btu). Its technically recoverable shale-gas resources are estimated as high as 1,115 trillion cf, the largest in the world and nearly double the size of the US’ cache.

Yet there are still huge hurdles for the broad-scale development of Chinese shale.

Falling costs

Sinopec’s flagship Fuling shale gas project has been reasonably successful. Former chairman, Fu Chengyu, recently said that Fuling could give good returns. Drilling costs per well have fallen from 100m yuan ($16m) to 80m yuan and are set to drop to 60m yuan or less over the next two years, he added.

But Thomson is not convinced. He believes the returns are a “little bit marginal, probably around 15% and not great considering the costs involved”.

Robert Liou, a Beijing-based upstream specialist at consultancy IHS Energy, believes true costs are likely to be at least 30-50% higher than the average $10m shale well that Sinopec and CNPC claim to be able to drill, especially in areas of the prospective Sichuan basin outside of the Fuling play, he told Petroleum Economist.

It will be the repeatability of the Fuling project that will be crucial to making the sector open up. But for now, both Liou and Thompson, agree that the sub-surface understanding or homogeneity is not there to repeat it on a large scale. IHS estimates that Fuling can breakeven at wellhead prices of $8-9/m Btu, while CNPC’s Changning play needs prices of $14-16/m Btu. Other areas face much higher breakeven numbers on the back of higher well costs, but much lower initial flow rates. Reflecting the many obstacles facing the rapid development of Chinese shale Beijing reined in its previous goal of producing some 60bn to 80bn cm/y by 2020. Still, the ambitious plan, mapped out in 2012, epitomised China’s ambition.

It now plans to pump 30bn cm/y by 2020, which is seen as a more realistic target. That still pales in comparison to US shale-gas production, which after around 12 years of accelerated development is running at over 270bn cm/y. Still, China will become the world’s second largest shale-gas producer by 2035, behind only North America – and together they will produce 85% of the world’s shale gas, according to BP’s chief economist, Spencer Dale. But bringing in more private capital to the industry, which is dominated by national oil companies (NOCs), will be key to its future development. From 2025 to 2035, China’s shale gas production will expand by an average 33% per year, BP’s latest forecast showed. 

Nevertheless, there is a lot of work ahead. China’s National Development and Reform Commission’s (NDRC) Energy Research Institute reported that cumulative investment in shale gas development hit 15bn yuan with 322 wells drilled – including 96 horizontal wells – as of April 2014. Investment house Bernstein Research projected recently that China’s shale gas production will hit 6.5bn cubic metres (cm) this year, bolstered by some 25bn yuan ($4bn) of investment. 

It’s a feasible target, given state-backed Sinopec will pump 5bn cm of shale gas from its Fuling play, which is expected to reach 10bn cm/y by 2017. In parallel, compatriot CNPC plans to produce 5bn cm/y by 2017, up from 2.6bn cm this year, and rising to 12bn cm/y by the end of the decade. But boosting production fivefold to 40bn cm per year (cm/y) by 2020, China would have to drill more than 4,000 wells and spend more than $50bn, Bernstein said.

However, unlike the US, China arguably lacks some of the crucial ingredients that sparked the phenomenal leap in shale volumes. Its geology is more difficult, because the shales are generally deeper and more faulted; it lacks pipeline infrastructure to transport potential production; its oilfield services sector is too immature to support development; it has a high density of land use as well as mountainous terrain; and water supplies, crucial to the drilling process, are limited in some areas.

On the other hand China has some of the best source rocks, but technically it remains to be seen if developers can crack the code for optimal well productivity. So while the total organic carbon is good, the best way to fracture the shales has not been determined yet.

Similar technical issues have curbed China’s production of coal-bed methane (CBM), which after decades of commercial development is running at 3.6bn cm/y.

The naysayers blame sluggish progress on the domination of China’s NOCs – particularly CNPC and Sinopec – that control the best acreage, but lack the entrepreneurial zest that advanced the US plays. The NOCs, led by CNPC, hold about 80% of China’s unconventional gas blocks.

For their part, the NOCs have been reluctant to devote resources to shale gas after experiencing hefty exploration costs for low output during pilot drilling, preferring instead to focus on tight and conventional gasfields.

But in the Sichuan basin, neither funding nor technology appears to be the main problem, said Liou. It is the strict approval processes and difficult conditions for private companies to enter the industry, as well as lack of local and national policy support, which keep costs high.

“Private and foreign participation will be a crucial step in making shale gas economic, but this will be a slow process as the NOCs slowly reform and loosen their grip on the industry,” he added.

Indeed, investors will be in no hurry to commit a lot of capital until there is clarity around the fiscal terms, access to acreage, and pricing structures, all of which remain rather vague. And the recent announcement that government subsidies for shale gas development will be reigned in over the next five years may be another drag on China’s shale drive.

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