China Awards More Shale Gas Blocks although Much Remains to be Seen

China has been increasingly focused on the production and use of natural gas as a key way of diversifying its energy sources and addressing growing environmental concerns. While demand continues to outpace supply, China’s annual domestic natural gas production more than tripled to 3.34 trillion cubic feet (tcf) within the first decade of this century. Under the current Five-Year Plan for Natural Gas Development, China hopes to establish a natural gas supply capacity of 9.18 tcf and a consumption level of 8.12 tcf by 2015. As reflected in the Natural Gas Usage Policies, released in October 2012, the country also intends to promote natural gas use in the power and transport sectors, as well as including unconventional gas resources like shale gas and coal-bed methane in the scope of its natural gas strategy.

China, which already imports piped gas and liquefied natural gas, is in the midst of determining the economic potential of its vast shale gas resources, which the U.S. Energy Information Administration (EIA) has estimated to be 1,275 tcf. According to the Shale Gas Development Plan, released in March 2012, China targets shale gas production levels of 229.55 billion cubic feet (bcf) per year by 2015, and 2.12-3.53 tcf per year by 2020, which is equivalent to the entire volume of natural gas that the country produces today.

Against this background, China offered 20 shale gas blocks spanning 7,811 square miles (20,239 square kilometers) across eight provinces last fall, mostly in central China, to companies with registered capital of at least $47 million, existing exploration and production licenses, as well as a good financial standing. The auction, which ran from September 10 to October 25, saw 16 of the 83 participating entities win acreage in 19 blocks (one block did not receive sufficient bids and was cancelled). While the auction is an important step forward, many questions remain about the future contributions of shale gas, including technology access, production characteristics, and pricing.

This was only the second time that the Chinese government has auctioned shale gas blocks. The first round was held in summer 2011, when six companies bid for rights to explore in four blocks (although two of the blocks were later cancelled as not enough bids were placed); the Nanchuan block was awarded to Sinopec Corp. and a provincial gas company while the Xiushan block was awarded to Henan Province Coal Seam Gas Development and Utilization Co.

The second auction was notably different from the first in both the size and profiles of participants. For example, the second auction saw over 80 companies submitting 152 bids as the Ministry of Land and Resources (MLR) urged participation from a larger segment of economy. The tender attracted bids from not only China’s powerful national oil companies (NOCs), but also listed electricity and coal companies. Machinery and equipment manufacturing, investment and real estate companies were also among the bidders.

On January 21, MLR released the official auction results. In short, the acreage awards were dominated by state owned entities and half of the winning entities represented coal and electricity businesses. For example, China Huadian, one of the largest state owned power generation companies in China, won four blocks in Hubei, Huzhou and Guizhou provinces while Shenhua Group Corporation, the largest coal producer and trader in China, won a block in Hunan province. Also, half of the winners were affiliated with local governments seeking to capitalize on a potential shale boom in China.

Out of the 32 non-state owned entities that submitted bids, only two won acreage: Huaying Shanxi Energy Investment Co. Ltd. and Beijing Taitanyongyuan Natural Gas Technology Co. Ltd. Notably, none of the NOCs won acreage, a result that reportedly reflects a lack of serious interest. The relative weakness of geological characteristics and the limited amount of geological information offered by the MLR appear to have discouraged the NOCs from fully engaging.

This auction signifies the latest step as China contemplates how to capitalize on its shale gas resources. While the development may be exciting, significant challenges lie ahead which are both geological and non-geological in nature. First, Chinese geology is unique in several significant ways. For example, the high clay content of most Chinese shale plays render them ductile and they deform rather than shatter during the injection process, lowering the productivity of these shale deposits. Chinese shale formations also lie much deeper than their American counterparts which can generally add to the cost of extraction.

Aside from geological challenges, the lack of technology and domestic expertise remain key obstacles to China’s ability to exploit its shale gas resources. Technological advancements in areas like horizontal drilling, hydraulic fracturing, and high quality three dimensional seismic readings have been essential in shale gas development in the United States. The ability to manage and apply reservoir-specific technologies, gained mainly through firsthand experience, is another fundamental ingredient for success. At this point, Chinese companies have neither. Consequently, the application of existing technologies may be less effective in China, requiring Chinese producers to modify or develop new extracting technologies.

In this light, greater involvement by foreign technology holders would be a rational pathway for assisting Chinese efforts to both develop shale gas potential and also improve the expertise of local labor. By allowing foreign entities to participate in the second tender, albeit through joint ventures as a minority partner, China may be a step closer to addressing its expertise bottleneck. Reportedly, six of the bidders were joint-venture companies. But it remains unclear if any involved a non-Chinese company. Auction winners with no ties to NOCs may be compelled to engage foreign technology holders to make up for their lack of expertise.

Furthermore, the natural gas pricing reform experiment in selected locales since earlier this year is a welcome step but the experimental reform must continue and expand if natural gas, whether from shale or conventional sources, is to capture a sizable share of the country’s future energy mix. Current controlled prices for natural gas have created a wide gap between domestic and international prices in natural gas, forcing companies to import gas at a loss. The expansion of the natural gas pipeline system would also significantly improve shale gas development in China. All of the nation’s gas pipelines are committed and, absent network expansion, newly found shale gas would remain stranded (for more details on shale gas development conditions in China, see Prospects for Shale Gas Development in Asia).

China’s shale gas industry is at a nascent state. Sinopec’s presentation at the 4th Annual Unconventional Hydrocarbons Summit 2012 described how China’s 12th five-year plan calls for drilling 50 exploration wells, 150 production wells, and 990 water wells to verify 35.3 tcf geological and 7.06 tcf recoverable reserves by 2015. Thus far, 39 shale gas exploration wells and 12 production wells have been drilled in China, compared to about 35,000 wells that were drilled in the United States in 2006 alone. Additionally, among the shale gas wells in China, only nine have a daily output level of over 350 mcf, which is three to nine times lower in productivity when compared to an average U.S. shale gas well.

In the meantime, there already are some indications that MLR is planning a third round of shale gas block auctions, likely in the northern part of China, and future rounds may include more resource-rich blocks. Today, nearly 80 percent of prospective shale gas deposits are said to be located at conventional oil and gas blocks that are owned by the NOCs and the current law allows them to develop shale gas in these blocks. However, the MLR provisions, issued on October 26 (one day after the close of second bidding round) require that the NOCs submit a shale gas development plan for each shale play they own within the next three months. The NOCs will presumably need to turn over to the MLR shale blocks that are outside the scope of their development plans.

Lastly, answers to several additional issues would help determine the pace and scope of Chinese shale gas development: Does the absence of private land ownership in China facilitate or hinder shale gas development? How does the control of resource rich acreage by Chinese NOCs affect the pace of shale gas development? Once implemented, how will natural gas pricing reform affect profit margins for shale gas vis-à-vis conventional natural gas and how would NOCs and non-NOCs respond differently, if at all? As for the technology challenge, how capable are the NOC service departments in developing shale gas fields?

The world will be closely watching how the auction winners, now obligated to invest over 12.8 billion yuan (US$2 billion) in the next three years, proceed in developing their blocks. Their activities will serve as valuable indications on how ready the Chinese shale gas sector may be in seizing an opportunity to exploit the country’s vast unconventional energy sources.

Jane Nakano is a fellow with the Energy and National Security Program at the Center for Strategic and International Studies in Washington, D.C. Ksenia Kushkina is a doctoral candidate at the World Economics and International Relations Institute at the Russian Academy of Sciences and was a visiting fellow at CSIS through the Yegor Gaidar Fellowship Program (2011-2012).

Commentary is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

© 2013 by the Center for Strategic and International Studies. All rights reserved.

Jane Nakano
Senior Fellow, Energy Security and Climate Change Program

Ksenia Kushkina