China’s Shale Gas Potential: Great Uncertainty Remains Despite Growing Optimism
One year has passed since China held its first auction of licenses for shale gas extraction. The second auction is due to be held this summer. In order to accelerate the assessment and exploitation of shale gas, the government has reclassified shale gas as a mineral resource rather than as petroleum.
This will allow a wider range of Chinese companies to participate in the auctions and provides greater flexibility in designing the contractual and fiscal terms. The second auction due to take place this summer may offer as many as 20 blocks. Although only Chinese companies may participate, the range of enterprises is likely to be much larger than in the first auction. Coal mining and electrical power companies and a range of other enterprises are likely to form consortia in addition to the three major national oil companies, PetroChina, Sinopec and CNOOC.
The main focus of activity so far has been the Sichuan Basin in the south-west of the country, which stretches across Sichuan Province into parts of Yunnan, Guizhou, Chongqing and Hunan. Potential exists in Shaanxi in the north, in Jiangsu and Anhui in the east, and in the Tarim Basin in the far north-west of the country. Other areas are also being assessed. Shell, BP and Chevron are already involved, and other foreign companies will be lining up to form joint ventures with the winning Chinese companies after the upcoming auction.
The production of coal-bed methane and other sources of gas is also set to rise dramatically. This massive growth of domestic supply of gas would greatly enhance China’s security of energy supply in the medium term, as it is doing in the USA. It might also reduce the total emissions of greenhouse gases, provided the additional supply of gas was used to replace coal in the energy mix rather than just supporting the unconstrained growth of energy consumption, and provided the leakage of gas from the fractured shale was constrained.
Despite this aggressive and optimistic strategy, many uncertainties and risks remain: geological, technical, economic, managerial, safety, environmental and social.
The first and most important of the uncertainties is geological. The geology of the potential shale gas basins in China appears to be much more complicated and less attractive than in the USA. As a consequence, recoverable reserves may not be as great as hoped, delays may occur as companies seek the right combination of technologies, and extraction costs may rise. Even if the geology is favorable, a range of challenges lie ahead to ensure that the technologies and skills are available in the quantity required to support the anticipated rapid growth of production. Contractual regimes for the extraction of shale gas must be stable and secure. New infrastructure will need to be built to deliver the gas to where it will be used and the industrial and commercial energy users will need new appliances to burn this gas. Gas prices, whether set by government or by the market, will have to be at levels which provide suitable incentives for both producers and users.
In this context it should be remembered that China first began systematic assessment of coal-bed methane resources in the early 1990s. Nearly twenty years later, annual production amounts to barely 10 billion cubic meters. Even conventional gas supply projects have revealed risks which were not anticipated by key actors. The gas pipeline from the Ordos basin in north China reached Beijing before the city gas company had prepared its infrastructure to receive the gas. The first stage of the west-to-east gas pipeline resulted in power companies building gas-fired power stations but receiving no gas. More recently, PetroChina lost US $ 2 billion in 2011 on its new import pipeline from Turkmenistan on account of the low level of government-controlled gas prices in China. In the absence of a coherent policy framework and of clear incentives, the rapid expansion of China’s shale gas production is full of risks for investors.
Yet more challenging will be the need to manage the safety, environmental and social aspects of shale gas extraction. The safety record of Chinese oil companies in gas production may have improved since the disastrous accident in Sichuan in 2003 which killed 243 people, but the recent experience of the high-speed rail network in China highlights the difficulty of maintaining safety standards in a rapidly expanding sector.
The greatest unknowns facing shale gas extraction anywhere in the world are the environmental impacts, particularly the depletion and contamination of ground water and the triggering of earthquakes. Both the USA and Europe have seen wide range of social and political reactions to these threats which range from indifference to outright bans on shale gas extraction. Not only is China very prone to earthquakes, it also has a range of water problems. The southern and eastern regions of China (including the Sichuan Basin) may be relatively well supplied with water in most years, but they are susceptible to drought and are densely populated in both urban and rural areas. They are also host intensive agriculture. Poor safety and environmental management could easily create strong local resistance to shale gas extraction. Northern and north-west China may be less densely populated, but they already have severe water shortages.
China’s enthusiasm for shale gas provides commercial opportunities for international oil companies and service companies, at least in the short-term whilst China masters the technologies. It also underpins the government’s continuing reluctance to reach a deal over future pipeline imports of gas from Russia.
With thanks to Transatlantic Academy