Natural gas production in North America surged over the past decade as drilling companies discovered ways to exploit the gas-rich shale rock that lies beneath much of the continent. Today, Chinese energy mandarins look to benefit from the American experience.
The technique of the moment is called hydraulic fracturing, or “fracking,” where a slurry of water, sand and chemicals is shot into a horizontal well at pressures of up to 8,000 pounds per square inch (psi) – about 800 times the pressure needed to demolish a concrete building. The blast splinters the shale in a radius of up to 1,000 feet around the well, freeing a sea of tiny gas bubbles from the rock matrix.
Drilling operations sprang up across North America as fracking made extracting shale gas profitable for the first time. In the US, shale gas production has grown eightfold in the past 10 years. This glut of new gas caused spot prices to fall to less than US$5 per cubic foot in 2010 from around US$10 in 2005, which encouraged big energy companies to move in and acquire smaller drilling entrepreneurs.
Chinese companies took part in this buying spree: PetroChina and China National Offshore Oil Corporation (CNOOC) snapped up stakes in North American shale drillers like Chesapeake Energy and EnCana with the intent of acquiring technology and ramping up production at home.
The case for unconventional energy in China is compelling: Domestic resources are abundant, burning gas generates half the carbon emissions of coal, and domestic production will be far cheaper – and diplomatically simpler – than imports.
But unlike in North America, production is likely to begin in China not with a bang but a trickle. The country’s unconventional gas industry may not take off until after 2020, when cheap conventional gas reserves begin to dwindle. Beijing has yet to officially distribute shale gas blocks, and Chinese producers need time to acquire technology, run pilot projects and build pipelines.
In addition, current extraction techniques pollute massive amounts of water – 4-5 million gallons per well, roughly equivalent to the daily water use of 200,000 Chinese people – and China does not have much water to spare. Even proponents of unconventional energy recognize the need to improve on the North American model of extraction by brute force, developing technologies to both increase profits and lessen environmental damage.
Regardless, in the short term China is likely to remain rhetorically bullish on unconventional gas, if only to promote chosen industries and facilitate haggling for long-term gas supply contracts with foreign trading partners. Over the next several decades, the project to bring difficult-to-extract gas into the domestic market will indeed change China’s relationship with its foreign trading partners. It will reorganize the roles of the domestic energy industry by bringing them into increasingly direct competition with one another. And it will provide fresh opportunity for foreign energy giants and smaller private firms on the cutting edge of research and exploration.
Sitting on a gas mine
Geologists have known for decades that China has little in the way of conventionally extractable natural gas, but it wasn’t until recently that the country’s vast unconventional energy reserves were revealed.
Unconventional gas, or natural gas that is locked in rock formations, already makes up some of China’s energy mix: The country produced about 3 trillion cubic feet (tcf) of gas in 2009, nearly one-third of which came from tight gas, which is trapped in sandstone or carbonate. Producers also pumped 35 billion cubic feet of coal-bed methane (CBM) out of China’s extensive coal reserves in 2009.
However, geological data indicate the real opportunity is in shale gas, which China does not yet produce commercially. According to information released by the US Energy Information Administration (EIA) in April, China has 1,275 tcf of technically recoverable shale gas resources, nearly 50% more than the US.
“To put it in perspective, the state of Qatar has 900 tcf of gas reserves, which represent about 14% of the world’s known gas reserves,” said Peter O’Malley, managing director of HSBC’s Asia-Pacific Resources and Energy Group.
The figures may be revised upward as research and drilling continue, said Anne-Sophie Corbeau, senior gas expert at the International Energy Agency (IEA). “If you look at the US, for example, the EIA revised drastically its views regarding shale gas,” she said. Last year, the agency more than doubled its estimate of technically recoverable but unproved resources.
Compelling economics
This wealth of lower-carbon energy is especially appealing in China, where coal generates more than 70% of power and many of the country’s famously smoggy days. But energy security and price are probably the most compelling arguments for ramping up unconventional gas production. Although setting up drilling operations and infrastructure will require a big initial investment, domestic unconventional gas should ultimately be much cheaper than imports.
David Hewitt, regional head of oil and gas for research firm CLSA, said liquefied natural gas shipped from Australia costs around US$13-14 per million cubic feet (mcf) by the time it arrives in Shanghai, compared with almost US$12.5-13 per mcf for gas piped from Turkmenistan. Shale gas shipped from Shanxi Province would cost half that price or less.
“For China, you either choose to buy from an import source, where you take the security of supply risk and a significantly higher price, or you try to accelerate domestic unconventional, and I think it’s a no-brainer. You go for your domestic,” said Hewitt.
In the US, shale production led to a sharp reduction in annual gas imports – nearly one-third between 2007 and 2010. The prospect of cheap domestic gas has undoubtedly sparked China’s interest. The country aims to derive 8-12% of domestic energy production from natural gas by 2020, up from around 3% currently. Shale gas, CBM and tight gas are projected to make up about one-third of the 2020 total.
However, most analysts see these figures as guidance rather than hard targets. “Neither the companies nor the government understand how [Chinese] shale is going to respond to drilling. Coal-bed methane targets in the previous five-year plan were nowhere close to achieved,” said Gavin Thompson, head of China research for energy consultancy Wood MacKenzie.
While Beijing has presumably tasked China’s national oil companies with advancing unconventional gas, the goal will undoubtedly take a backseat in the short-term to maintaining national energy supply.
This is especially true for PetroChina, the listed subsidiary of China National Petroleum Corporation (CNPC), which is the largest oil company in China and the fifth biggest in the world.
The company leads its competitors in capital and infrastructure, allowing it exert significant influence on the pace of unconventional energy development. Because of its traditional focus on upstream exploration, CNPC controls most of the country’s pipelines, giving it a natural advantage in commercializing remote unconventional gas. It also set up China’s first shale gas research institute in late 2010.
The company entered two high profile unconventional gas deals in the last year and drilled its first horizontal shale gas well in the Sichuan Basin in March, sparking expectations that it will ramp up commercial production quickly.
PetroChina joined Shell to acquire Australian CBM producer Arrow Energy for US$3.1 billion last March, and then announced its intention in February to buy half of EnCana’s western Canada tight gas assets for more than US$5 billion – the largest Chinese investment in unconventional gas assets yet.
PetroChina said that the EnCana deal represents a platform for entering the North American market. However, the field’s p
roximity to the Kitimat natural gas terminal on the Canadian west coast suggests there is the longer-term potential to ship gas back to China. The owner of Kitimat, Apache Corporation, began refitting the import terminal for export last year.
Although PetroChina is pumping money and resources into unconventional gas, the segment accounts for just a fraction of the company’s business. To meet China’s short-term demand for gas, PetroChina has sunk substantial investments into the construction and supply of cross-border pipelines for natural gas in the country’s interior as well as import terminals along the coast.
Given these holdings, developing unconventional gas would run counter to the company’s commercial interest, suggested Thompson of Wood Mackenzie. A surge in unconventional gas production would likely depress gas prices, as it did in the US.
“PetroChina has a significant volume of pipeline gas that is relatively expensive. It has to find a market for that gas, and it will need to sign additional contracts in 2011, 2012 and 2013. In order to find a strong market, the company wants gas prices to continue to rise,” Thompson said.
PetroChina declined to comment to China Economic Review when contacted for this story.
Though Beijing has set aggressive targets for developing unconventional energy, a recent IEA report stressed that profits, rather than government directives, steer the policy of China’s national oil companies, especially in upstream investments and operations.
“These are far from puppet companies operating under control of the Chinese government, as many have assumed,” said IEA analyst and report co-author Julie Jiang. “Their investments in recent years have been driven by a strong commercial interest, not the whim of the state.”
Talk the talk
But even if other commercial interests take precedence over unconventional energy, it may be in the interest of both the Chinese government and national oil companies to keep up the big talk about unconventional gas. Aggressive targets for domestic production can serve as a bargaining chip in negotiations for long-term supply contracts with Russia and other gas trading partners.
China is set to finalize terms in 2011 for natural gas piped from Russia’s Siberian Altai region. If it becomes clear that unconventional gas cannot meet a significant proportion of China’s aggressive gas consumption targets, the dynamic of negotiations with Russia could shift, said CLSA’s Hewitt.
“You hear two very different versions of the story, one where China says I don’t need any incremental significant pipeline gas up until 2015 – or towards 2020 I should say – whereas the Russian view is [that] they’re desperate, they’ve gotta buy. The reality is probably somewhere in the middle.”
Close contender
CNOOC, China’s smallest national oil company, has also boosted its exposure to unconventional gas through acquisitions. The company purchased shale gas acreage in Texas, Colorado and Wyoming from Chesapeake Energy and CBM blocks in Queensland, Australia from Exoma last year.
These acquisitions could arguably be aimed at increasing reserves and securing a supply for liquefied natural gas (LNG) imports. However, CNOOC also bought a 51% stake in the mainland’s largest CBM producer, China United Coal Bed Methane Corporation (a subsidiary of China Coal), a clear sign that CNOOC is quietly moving its business onshore and into competition with PetroChina and Sinopec.
“They didn’t hang a flag out and shout ‘Here I am!’ … But when you talk to them, they will say, ‘We are permitted to be onshore and the other two are permitted to be offshore.’ And that’s a slight change in rhetoric from what we were hearing before, even a few months ago,” said Hewitt.
CNOOC is smaller than its rivals but is far more profitable since it is insulated from China’s tightly controlled market for refined products. CNOOC has spent US$17.6 billion on foreign acquisitions since 2005, when it launched its famous failed US$18.5 billion bid for Unocal – a deal that would have doubled the company’s crude oil and gas production.
For CNOOC, the biggest hurdle to bringing its business onshore is its lack of infrastructure. To get gas to market, it would either have to form an agreement to pipe gas through the networks of CNPC or Sinopec, or shell out to build its own pipelines. The decision to take a majority stake in CUCBM may indicate that CNOOC has already picked the second option.
Forward thinking
Whether construction is led by CNPC or a new player, however, an extensive pipeline network could be built fairly quickly. “It took less than four years to build the Rockies Express Pipeline, one of the largest pipelines in North America, from start to finish,” said Samantha Santa Maria, associate editor of Platts’s Gas Forward Curve.
CNPC announced earlier this year that it plans to have 540,000 km of pipeline installed by the end of 2015, double the length it laid by the end of 2010.
With technology transfer only just begun, China’s oil majors are likely to continue snapping up stakes in unconventional plays abroad. Since technologies for extracting unconventional energy are still evolving, these companies are aiming at a moving target.
Sinopec, China’s second-largest national oil company, has lagged behind PetroChina and CNOOC in acquiring unconventional energy projects. But there are signs that it is catching up – it bought a US$4.65 billion stake in ConocoPhillips’ Canada oil sands venture in 2010 and a share of an Australian CBM venture owned by ConocoPhillips and Origin Energy in February.
For further acquisitions, the national oil companies will probably continue to look to North America, where projects are plentiful and prices are low. Buying upstream reserves and liquefaction points to ship gas back to Asia makes sense from a strategic perspective, according to Hewitt at CLSA.
One target could be Cheniere Energy, which recorded a net loss of US$76 million in 2010. The company is converting its re-gasification terminal on a deepwater port in the Gulf of Mexico into a liquefaction point, in hopes to send the majority of its LNG through the Panama Canal by 2014, when a new wider lane in the canal is scheduled to open.
Further investment could also target the American northeast, said Santa Maria of Platts. US billionaire Phil Anschutz recently sold 500,000 acres for a rumored price of US$3 billion to Chesapeake Energy, recipient of the aforementioned CNOOC investment. Anschutz’s plot has access to both the Marcellus shale deposit and a larger shale that lies below it, the Utica – often called America’s next big shale play.
Chinese companies will need to study the widest possible variety of shale deposits abroad to tackle the resources available at home.
“With unconventional gas, there’s no silver bullet, no one technology that really works for everything. The trick is in understanding the interplay between the technology and the resources to understand what works,” said Neil Beveridge, an analyst at sell-side research firm Sanford C. Bernstein & Co. in Hong Kong.
Shale on the auction block
Even as China’s energy companies amass shale gas experience, there is another roadblock: Companies are still waiting on the government’s go-ahead to begin commercial production at home. The Ministry of Land and Resources (MLR) continues to delay distribution of the country’s first official shale gas blocks.
The MLR originally planned to auction six shale gas blocks last November to four state-owned companies – PetroChina, Sinopec, CNOOC and Shaanxi Yanchang Petroleum Group.
November came and went. In January, the deputy director of the MLR’s oil and gas strategy research, Zhang Dawei, gave an update: Eight shale gas blocks would be auctioned in the first quarter, with three new private companies entering the bidding
Sinochem, Xinjiang Guanghui and China ZhenHua Oil.
Successive delays may have been related to a debate about whether private capital should enter the bidding.
“In our opinion, there is interest from the government in increasing the level of competition in the sector. What we don’t know is, what does this ultimately mean?” said Thompson of consultancy Wood Mackenzie.
Even if private operators win some bids, analysts say China’s national oil companies are likely to continue to drive development. Once the auction is complete, Chinese companies will begin seeking out foreign partners to help them develop the blocks.
A likely candidate is Royal Dutch Shell, which has cooperated with PetroChina on projects in Australia and Qatar. Shell said earlier this year that it plans to spend US$1 billion a year on shale gas in China if its current exploration in Shaanxi and Sichuan provinces is successful.
Statoil, Europe’s largest oil company, has also said that it is looking to tap Chinese shale reserves and is in conversations with Sinopec.
Foreign companies could be confined to the role of a temporary technology partner instead of acting as an equity participant for the duration of exploitation.
“The question is, would the foreign participants want to do it anyway? I think the answer is yes, because you see all of the foreign participants building yet stronger relationships with the SOEs [state-owned enterprises],” said Hewitt. For example, Chevron’s recent sale of a stake in an Indonesian deepwater gas project to Sinopec was clearly designed to curry favor with the Chinese company.
As China Economic Review went to press, no further news on the MLR’s auction had emerged, save for an announcement in mid-April by Che Changbo, deputy director of the MLR’s Oil and Gas Strategy Center, that China may begin producing shale gas before the end of 2015.
Even if the MLR allots its first shale blocks soon, China’s ramp up to unconventional gas production is likely to remain gradual. Though the country’s shale resources are even more extensive than those of the US, the time and investment needed to acquire technology, run pilot projects and build infrastructure will prevent China from replicating a US-style shale gas revolution any time soon.
“There’s a lot of excitement at the moment, but the industry is really in its infancy still. So we’re not going to see an incredibly dramatic near-term buildup,” said Thompson of Wood Mackenzie.
Insatiable appetite
Over the next several decades, however, the development of difficult-to-extract gas will alter China’s energy strategy both domestically and abroad. And development will begin picking up pace soon enough: Experts say production will likely grow rapidly after 2020, when cheaper conventional gas supplies are projected to begin to dwindle.
There’s a small risk that environmental concerns could sideline the development of unconventional gas. Critics say shale gas is not nearly green enough – it just delays the day of reckoning for renewable energy. But in a coal-based economy where energy needs are skyrocketing, China cannot afford to be too choosy. The EIA projects that China’s demand for coal, gas and clean energy will all grow in the coming decade.
Environmental effects are a lesser consideration than this urgent need for energy, said Zhang Jinchuang, a professor at China University of Geosciences. “In China, the priority for energy exploitation is whether there is energy or not.”
You must log in to post a comment.