Shale Gas: A Game Changer for China’s Energy Consumption Pattern?

On Thursday, March 1, 2012, the Ministry of Land and Resources (MLR) of the People’s Republic of China announced the results of its official nationwide shale gas resources survey. The results show China’s onshore shale gas resources are 134. 42 trillion cubic metres, and exploitable shale gas reserves are 25. 08 trillion cubic metres (excluding Qingzang Plateau area). Although this official figure is lower than the figure of 31 trillion cubic metres predicted by the U. S. Energy Information Administration earlier, it confirms that China still has one of the largest shale gas reserves in the world.

So what is shale gas? It is natural gas trapped in shale rock deep below the Earth’s surface. China has identified several onshore shale gas regions: Northwest region, Qingzang region, Upper Yangzi (including Yunnan, Guizhou and Guangxi) region, Mid and Lower Yangzi and Southeast region, and East and Northeast region. In total, 180 shale gas areas from these regions are identified by MLR as suitable for priority development.

China began its shale gas study in 2004 and conducted its preliminary geological survey on shale deposits in 2005. From 2006 to 2007, MLR analysed shale gas prospects in China. During 2008, MLR conducted a comprehensive study on the geological conditions in the U. S. and China for shale gas deposits. The shale gas prospects in the Upper Yangzi Region were the focus of a follow-up study and a number of areas in the region were earmarked for trial development. In 2009, a number of blocks were listed as ‘priority shale gas development projects’ but at the time, shale gas was not listed as a type of independent mineral in China. It was only in December last year that shale gas was recognized as the 172th mineral asset which can be explored under an independent mineral right, and was listed by National Development and Reform Commission as one of the priorities in the 12th five year plan for further development.

In May 2010, China saw its first successful hydraulic fracturing exercise using U. S. fracturing technology. By March last year, another Sino-foreign joint venture drilled China’s first horizontal shale gas exploration well in Sichuan’s Weiyuan block.

A handful of China’s state-owned companies dominate Chinese shale gas development. As they are relatively inexperienced in shale gas exploration, the central Government has encouraged them to partner with international companies, in particular, with US companies that have developed advanced technologies and gained extensive experience in developing US shale gas reserves.

MLR launched the first round of bidding for China’s first commercial development permits in June 2011. Six state-owned energy companies were invited to submit bids. Only two out of four blocks put up by MLR for bidding received sufficient bids¹ and were licensed to two Chinese state-owned companies.

Originally, the market was hoping MLR would start the second round of bidding in the fourth quarter of 2011 and the third round in 2012. However, the second round of bidding was delayed. It is not clear whether MLR will resume the planned bidding in the first quarter of 2012.

Footnote

1. According to China’s bidding law, a bid process will be considered a qualified process only if no less than three bids are received.

China faces at least six major challenges to develop its shale gas reserves. Unless feasible solutions are found to tackle them, investors in Chinese shale gas are likely to face high development costs and significant commercial and environmental risks.

1. Policy vacuum
   China’s shale gas development outpaces its legislative progress. No single set of detailed rules have been promulgated to regulate the licensing, exploration and production of shale gas. The Government was urged to introduce preferential policies to support shale gas development (including tax breaks and price subsidies) but so far nothing was confirmed at the date of this briefing.
2. Complex geologic factors
   Shale gas resources in China are generally located in mountainous, rocky or desert areas and are buried deep underground. This variety of geological conditions makes transportation and installation of the heavy equipment essential for shale gas development a very complicated and costly exercise.
3. Lack of experience and tailored technology
   Chinese companies lack experience and technology in developing shale gas reserves. They heavily depend on US shale gas technology, attributed to the highly successful U. S. and China Shale Gas Resource Initiative endorsed by the leaders of the two countries in November 2009. However, because the geographic terrain for Chinese shale gas reserves differs from that in the US, the proven US technology solutions may not be a perfect fit for China. Innovations and improvements are required to adapt the U. S. technology to local conditions.
4. Water shortages
   Water shortages are another challenge. The hydraulic fracturing process in shale gas development consumes huge volumes of water. Many shale gas reserve areas in China are facing water supply problems. Large-scale shale gas development in these areas will only exacerbate these problems.
5. Environmental concerns
   Using shale gas could help reduce greenhouse emissions. However, during hydraulic fracturing a large amount of chemically treated water is injected through seams of rock at high pressure to force the gas inside to seep out so it can be captured. If the process is not managed properly, the process can cause serious contamination to waterways, which would be disastrous to drought-plagued China. The fracturing process produces cumulative noise, traffic and surface disruptions and may create problems for farmers or other residents living near the site. According to experts, shale gas in China contains high levels of non-hydrocarbon gasses, particularly hydrogen sulphide, a toxic and corrosive pollutant, which could lead to air pollution and corrode drilling equipment unless strict emission standards and advanced drilling and gas purifying technologies are implemented.
6. Infrastructure bottle-neck
   Most of the Chinese shale gas reserves are located in areas that are far from China’s existing pipeline network. Although China has stepped up its pipeline development in recent years, identifying new pipeline routes and building connections to China’s current pipeline network takes time. Bottlenecks in pipeline transmission, coupled with high development costs, could slow Chinese shale gas development.

Currently, shale gas development is only open to a limited number of Chinese state-owned companies which may or may not be in partnership with international companies (as minority shareholders). This may change soon. MLR said in its recent news release that the Government would like to see a ‘variety of investors’ to participate in shale gas development. This appears to suggest that private companies will be given an entry ticket to the game. Many major foreign oil companies are keen to leverage their technology and know-how to gain access to China’s shale gas market and to participate in future bidding opportunities.

As mentioned above, the Government is reviewing its energy policy as a result of calls from academics and industry players for preferential tax treatment, waiver of fees for shale gas mineral rights and the reduction of licence fees payable for shale gas exploration. We may expect further guidance and/or detailed rules on shale gas development to be introduced later this year.

When the Government announced its natural gas price reform pilot scheme in December 2011, it made liberalization of the prices for unconventional gas as one of its energy reform targets. Once the prices are liberalised, shale gas exploration companies will be able to pass on their development costs through the gas distribution chain, which will turn the shale gas business into a more attractive investment for more investors.

The oil and gas resources study centre of MLR has made a rather optimistic forecast of China’s prospective shale gas output by 2015 and 2020. According to its prediction, China’s shale gas output could reach 6. 5 billion cubic metres per annum by 2015 and 100 billion cubic metres per annum by 2020. Shale gas will constitute approximately 26% of China’s natural gas consumption by 2020.

If all goes as predicted, shale gas will become a game changer for China’s energy consumption pattern. A healthy development of the shale gas business will in no doubt reduce China’s addiction to coal and reliance on imported crude oil and gas, including liquefied natural gas.