Shale Gas Revolution in China: Game Changer for Coal?

In his opening remarks on the potential of a shale gas revolution in China, Xizhou Zhou, Director of IHS CERA (China) commented that “there is a lot of exuberance about how fast it can happen. Many people, including some in the government, think it could happen in five years’ time.” Zhou subsequently offered a more conservative view saying that “China’s shale gale’ might not happen until the 2020s.”

On Friday, March 15, 2013 at a China Environment Forum meeting, two leading experts closely monitoring the shale gas industry in China and the United States, Zhou Xizhou and Briana Mordick, senior scientist at the Natural Resources Defense Council (NRDC), provided a comprehensive analysis on the potential of and challenges facing China’s shale gas development.

A Supply-Constrained Market
China’s rapidly growing demand for natural gas has outpaced its domestic supply. As a result, the government turns to expensive imports through pipelines and liquefied natural gas for about 30 percent of the country’s gas consumption. The high economic and strategic costs of these energy imports provide strong incentives for China to develop its own domestic shale gas resources. Based on IHS CERA’s geological and cost assessments and projections, Zhou asserted that China’s rich shale gas resources will be developed overtime. With China’s abundant shale gas resources, unconventional gas should become cheap enough to create a “revolution.” However, it is the timing of the “revolution” that is yet known.

The Long and Winding Road Ahead
The current development in China’s shale gas basins has been underwhelming. To date, only 60 horizontal wells have been drilled in the most developed Sichuan Basin. Zhou’s presentation, “The Long and Winding Road Ahead,” belied the immense investment and time as well as low probability of quickly finding the natural gas reserve “sweet spots.” Underdevelopment is also due, in part, to the limited number of shale gas players. Three national oil companies—in collaboration with international oil companies—are drilling most of the wells.  In the second round of bids for shale gas drilling permits, the Chinese government awarded leases to inexperienced companies from the power, mining, trading and city gas sectors. These companies lack expertise in drilling and operating upstream – even in exploring conventional gas – and have a significantly lower appetite for risk. Although potential profits are huge, Zhou said that these companies may very quickly lose interest once they realize the extent to which shale gas development is heavily capital-intensive with often a very slow timeline for investment returns (which in the short-term, are far from guaranteed).

Zhou also mentioned other key differences between U.S. and Chinese shale gas development:

• Nationally owned mineral rights create obstacles for companies entering the Chinese market.
• Regulated prices cause hardship for foreign investors to acquire price visibility. Price liberalization is very likely to meet opposition from strong interest groups in China.
• Pipelines in China are owned by national companies with regulated tariffs from the government. The pipelines are not yet nearly as extensive in China as those in the United States.
• Market structure is vastly different. There are only a few national oil companies who dominate shale development in China; in the U.S., the shale gas revolution was led by hundreds of independent companies innovating and competing to find the best solutions to geological and technical challenges. In China, non-nationally owned companies have limited experience in shale gas exploration and production. They are also less familiar with the internationally owned companies that could serve as partners and bring technical know-how.
• Terrain and geological difficulties raise the upfront cost for Chinese developers.

A Chance to Get Things Right from the Start
Speaking from the U.S. experience, Briana Mordick provided an overview of the environmental challenges in shale gas development and the regulations in place:

• Greenhouse gases can be emitted in many steps during shale gas production and transmission Regulations in both federal and state levels to keep up with the rapidly moving shale industry need to be updated and properly enforced. Well construction problems were the main cause of many high profile shale gas pollution cases around the United States.
• If not done properly, wastewater handling at shale gas wells can cause severe soil pollution that is tremendously difficult to remediate.
• New technologies are developing ways to reduce freshwater use in hydraulic fracking
• The U.S. has witnessed induced seismicity caused by fracking and wastewater disposal. Although these were relatively small and low-risk earthquakes, well-established methodology could evaluate the risk and prevent them from happening.

In most cases, these environmental risks are well understood, and existing technologies are capable of mitigating them. The fast pace of the shale gas development in the U.S. caught many people – including regulators – by surprise. There is an urgent need to update states and federal regulations to enforce the proper management of shale gas development.

Drawing on lessons learned in the U.S. experience, NRDC is working closely with the Chinese government, academics, and NGOs to encourage discussion of potential environmental risks associated with shale gas development. Mordick mentioned that China has a “unique opportunity to get things right from the start” by seizing the opportunity to put in place modern infrastructure and safety measures before extraction begins on a large scale.