Market outlook: China faces shale gas challenge

14 February 2014 00:00 Source:ICIS Chemical Business

The country has enough recoverable shale gas to last more than 240 years. But land ownership issues and water shortages pose huge obstacles to exploitation

A couple of friends might get together in, say, a bar in Texas one night and come up with the idea of making money out of shale gas. Within a few weeks, they could well be in business, having rented a rig and persuaded a farmer to lease or sell his land.

But in China, which, according to the Energy Information Administration, has 68% more recoverable shale gas than the States, life is very different.


China’s growing environmental movement is complicating shale gas development

Copyright: Rex Features

First of all, land ownership rules are very different than in the States – for example, residents in rural areas in China don’t have full title to their land. The only way to get access is to approach one of the Chinese oil majors, which already have exploration rights on a block, or bid for a block in the infrequent rounds of bidding.

There is also nothing like the same number of service companies in China as in North America and it can very difficult to secure the services of an experienced drilling contractor. Finally, one may find the block is in the mountains or desert with no road access.

A further problem is that the way China has managed its shale gas exploration. This hasn’t encouraged the kind of innovation essential for successfully exploiting reserves, and, thus, taking advantage of the country’s vast potential.

“Shale reservoirs are not usually homogeneous and there are unlikely to ever be any standard generic drilling rigs. Sophisticated technology including 3D seismic, CT scanners and advanced imaging solutions are necessary to map the reservoir and decide where to drill,” said Tony Regan, Singapore-based oil and gas consultant with the consultancy, Tri-Zen.

“Purpose-built specialist drilling rigs are required and the equipment and processes need to be adapted and tweaked for optimum development and completion of each well.

“Constant innovation is the norm in the US to improve well productivity and reduce costs. Chinese companies are only just beginning to acquire the capability for large scale horizontal drilling and lengthy, multi-stage hydraulic stimulation.”

There are only two ways to participate in shale gas development in China.

The first way is to approach one of the national oil and gas companies such as PetroChina, Sinopec or CNOOC, who have already secured exploration rights to a block from the National Development and Reform Commission (NDRC) or to bid for a block in one of the infrequent auctions held by the Ministry of Land and Resources (MOLAR).

The first round of bidding, which took place in 2011, involved no foreign companies, according to an October 2013 Macquarie Research report. Round 2 in November 2012 was slightly better in that more players were involved. Nine of China’s state-owned enterprises were allowed to participate along with two local private companies, but Regan points out that none of these companies had any oil and gas experience and one of these companies was a candle maker!

There has been very little exploration progress since the second round of bidding, added Macquarie in the same report.

What is also preventing China from sourcing the required technical skills is its famously lax intellectual property rights protection.

The US has, literally, thousands of highly-skilled shale gas providers, many of which remain very reluctant to provide cutting edge technologies to China in case they get stolen.

One long-standing Chinese government policy – “indigenous innovation” – is a big deterrent, as it encourages local companies to develop their own versions of overseas technologies in order to avoid paying licensing fees.

China also lacks sufficient gas pipelines. As a result, shale gas producers may need to build compression of liquefaction plants near to shale-gas fields so gas can then be transported to the market by truck.

Rising public anger over China’s industrial-pollution crisis is another problem. In the future, the oil and gas majors – such as Sinopec and PetroChina, which are involved in local shale-gas projects – may have to involve themselves in “hearts and minds” projects in order to convince people that fracking is safe.

Population density in Sichuan province might add to the difficulties in getting public support for fracking, added the Macquarie report.

Sichuan has China’s biggest shale-gas reserve and has a population per square mile that is 1.5 times that of Pennsylvania and 4.5 times that of Texas in the US. There are also major shale-gas fields in Pennsylvania and Texas.

The problems extend below ground, including, perhaps most importantly of all, China’s well-documented water shortage.

China‘s per capita water resources are 80% lower than those in the US, according to the UN Food & Agriculture Organisation.

“A typical multi-stage horizontal well requires 4-5m gallons of water, and would compete directly with agriculture, industry, and local residents,” said the Macquarie study.

Recycling water can help solve the problem, but Regan added: “You can treat and recycle water but that comes at a cost. It is not straightforward because the water needs a lot of treatment before it can be re-used as it can be toxic, and in some cases, it can even contain radioactive elements.

“You also cannot recover all of the water, as some of it is lost in the fracking process.”

Regan also highlighted the depth of shale gas resources in China. Some can be as much as five to 10 km below the surface and the more accessible shales are generally deeper than many being developed in US, where, for instance in Eagle Ford, drill depths of 5,000 to 8,000 feet (1.5 to 2.4 km) are the norm.

Greater depth substantially increases drilling costs and already drilling costs in China are proving to be about double those in the US.

And whilst US shale gas tends to be contained in brittle impervious layers of marine shale, some of China’s shale resources are in lacustrine-deposited shale reserves, which can be clay-rich and less favourable for hydraulic fracturing. But it is not all doom and gloom.

Total and Shell have, for example, managed to bypass the bidding process for shale gas reserves, which was run by MOLAR, by working with PetroChina or Sinopec in locations where these companies already have exploration permits issued by the NDRC. Shell has made significant progress and in March 2012 had announced that it secured government approval for the first and only shale gas Production Sharing Contract (PSC) with PetroChina.

PetroChina and Sinopec are developing blocks where they already have NDRC approval for foreign investment. This makes it much easier for these companies to bring in high quality overseas skills to deal with the technical challenges.

Nevertheless, major shale gas production in China is thought to be at least 10 years away.

Officially, the Chinese government remains very bullish about the future, as, despite all the above difficulties, it is sticking to an estimate of 60-100 billion cubic metres (bcm) of shale gas production by 2015-2020 from almost zero production today.

This compares with the Macquarie forecast of just 1.1-10bcm of production by 2015-2020.

China conducted its first shale gas study in 2004 and in 2009 a number of blocks were selected as priorities for shale gas development. The first shale gas well was drilled in the Sichuan Basin in December 2009 and completed in April 2010.

The first horizontal well was drilled in December 2010 and production began in August 2011. By the end of 2012 about 80 wells had been drilled and about 50m cubic metres of shale gas had been produced at an estimated cost of about $10bn.

China is therefore at a very early stage in the development of shale gas resources and still some way from having meaningful substantial commercial production.

Fast-track development is also hindered by the fact that no single set of rules exist to facilitate or regulate the licensing, exploration and production of shale gas and there are no preferential policies other than subsidies to support its development.

But a polyolefins industry source said: “Shale gas opportunities in countries other than in the US are making us feel very confident – for example, the huge reserves in Argentina and in China.

“All the experts keep saying the geology is difficult in China and China lacks enough water, but the Chinese government keeps telling us: ‘just watch us, we will make this work.’”

China has much bigger reasons than petrochemicals to put its foot on the shale-gas pedal.

Increased gas production would help China raise gas-fired electricity generation – a cleaner alternative to coal.

This would help reduce air pollution, which causes 350,00-500,000 premature deaths each year, according to research by the World Bank, the World Health Organisation and the Chinese Academy for Environmental Planning.

And the Macquarie reported said: “If China somehow achieves its 100bcm shale gas production target, our 60bcm [global] gas undersupply by 2020 base case flips into an oversupply position.”

This would increase China‘s bargaining power with Russia, which supplies pipeline gas to China, and with liquefied natural gas suppliers, said the bank.

And to further underline the scale of the opportunities, the EIA estimates that China has 1,115 trillion cubic feet (210bn bbl of oil equivalent) of technically recoverable shale gas, by far the largest in the world. This, potentially, gives it enough gas to last more than 240 years.

So often in China where is there a national will there can be a way.

But as one Beijing-base executive with a major Western bank said: “The technical challenges of shale gas are one thing, but I think the economic challenges are something altogether different – and bigger. You are talking about adapting the economic system to accommodate shale-gas development and that is no easy or quick task.”

By John Richardson