7 Factors That Are Holding Back China’s Shale Gas Revolution

Published on 18 Aug, 2017

China’s aim to replicate the US shale gas revolution by 2020 has been stalled owing to multiple market, economic, and technological challenges.

Shale gas in China has been viewed as a potential solution for supplying a majority of the nation’s local energy needs.

According to the U.S. Energy Information Administration, China possesses around 1,115 trillion cubic feet (31 trillion cubic meters (tcm)) of technically recoverable shale gas, reserves almost that of the U.S and Canada combined. This makes China the top country with the largest reserves of (technically recoverable) shale gas across the globe. These shale gas reserves are distributed across multiple basins in China namely:

  • Sichuan basin (17.70 tcm),
  • Tarim basin (6.12 tcm),
  • Junggar basin (1.02 tcm),
  • Songliao basin (0.45 tcm),
  • Others (5.71 tcm).

China has invested billions of dollars in shale gas exploration and development, with about 200+ horizontal wells being drilled by shale gas producers.  Currently, of the two state-owned enterprises, China National Petroleum Corporation (CNPC) and China Petroleum Corporation (Sinopec), the latter has been able to commercially produce shale gas. The government has also been encouraging production of shale gas by investing in shale gas exploration, setting country-wide production targets as well offering subsidies for the manufacturers, with production targets of 6.5 billion cubic meters (bcm) by 2015 and 60-100 bcm by 2020 across the country. Additionally, the government had also offered subsidies at ¥0.4 per square meter to shale gas producers during 2012–15.

These efforts have been implemented with an aim to replace the usage of coal (by natural gas) for energy production, which has been eroding the country’s air quality. Energy produced through gas generates less than half the emissions of equivalent coal when utilized; making natural gas an integral aspect of the government’s push toward cleaning up China’s polluted cities. Although natural gas has been identified as a key industry, momentum hasn’t been unabated, and the Chinese government has been forced to cut its (production) target to 30 bcm by 2020 as well as reduce subsidies to ¥0.3 and ¥0.2 per square meter by 2016–18 and 2019–20 respectively.

There are several other major hurdles that are affecting shale gas exploration in China, some of which include:

1 — Geological / Natural factors

China’s shale gas reserves are situated deeper into difficult and structurally complex geological terrains, with some also being seismically active. Unlike shale deposits in the flat-lands of US, primarily buried in the range of a few hundred meters up to 3,000 meters, China’s shale gas deposits are buried much deeper ranging from 3,000-8,000 meters. Such complexities make horizontal drilling and infrastructure construction (pipelines, power lines, roadways, and so on) highly challenging and costly.

2 — Scarcity of Water Supply

The shortage of water has been one of the major constraints for shale gas development in China. The country as a whole faces a shortage of water resources on a per capita basis, while conventional gas mining techniques such as hydraulic fracturing requires tons of water. In the U.S. drilling and fracking consumes about 19,000 tons of water per well. Excluding the Sichuan basin in China, most of the country’s shale gas reserves suffer high water stress levels or arid conditions. Even in the Sichuan basin, water resources are at about 3,000 cubic meters per capita per year, which is significantly lower than 17,000 cubic meters per capita in the U.S. Furthermore, almost 80% of water in the Sichuan basin is utilized for agricultural purposes.

3 — Technology and Investments

Shale gas exploration and development in China is almost 2-4 times more expensive than in the U.S. During 2015, the cost of horizontal drilling in the Sichuan basin was estimated at about $11-13 million per well, far higher when compared to the average cost of $4-6 million per well in the US. This is primarily because the kind of technology utilized in the US may not be a perfect match for the geological conditions prevalent in areas that hold China’s shale gas reserves, not to mention the complications that arise due to the unique configurations of each well/reserve. Additionally, a lack of necessary technology has compelled Chinese companies to rely heavily on foreign enterprises, especially from the US. A few Chinese companies have also formed strategic partnerships with firms based in the US to gain knowledge on shale technology, with China representing about 20% of the total foreign investments for the US shale gas industry. Furthermore, China also lacks the experienced technical personnel required as well as key equipment and service suppliers that cater to the complete exploration and development stages. Nevertheless, as China gains valuable experience as well as the necessary technological expertise in shale gas exploration over the future years, development costs are expected to decline.

4 — Regulations

China’s Ministry of Land and Resources (MLR), Ministry of Finance, National Development and Reform Commission (NDRC) and National Energy Administration (NEA) jointly issued a development plan designated for China’s shale gas development in 2012. Also, the NEA, under the NDRC, published the Shale Gas Industry Policy in October 2013, which detailed rules and procedures relating to shale gas exploration and external cooperation. However, unavailability of a single set of defined rules to regulate shale gas activities is resulting in lack of good governance and increased environmental risks. In addition, there are at least seven authorities supervising the shale gas industry in the country, leading to a considerable overlap in their functions. Overlapping responsibilities result in one of the agencies issuing regulations; however, the details or implementation may be left vague to account for lack of clear authority. Moreover, the central government issues a large number of directives, some of which might matter more than others. Determining which directives are paramount often leads to studying how frequently they are mentioned by officials at various levels. Companies and potential investors are left in a fix as to when and whether the regulations will be enforced and whether some targets are optional or mandatory.

5 — Pollution

Although shale gas is meant to tackle greenhouse gas issues that have arisen due to the prolific use of coal in China, its extraction (through the fracking process) is leading to massive water pollution. China has set 13 provinces as priority areas for shale gas exploration. Four of these areas are situated in the north and the north-western regions, where ground water provides nearly 70% of drinking water. Crops in China are getting contaminated due to irrigation of polluted ground water. For instance, in Hunan, one of the 13 priority shale gas regions, 36% of rice growth was recorded to have cadmium levels above the ones stated safe by Chinese food regulations. Additionally, in another priority region, Henan, shale gas exploration has led to 81% of shallow ground water being contaminated by volatile phenol while 29% of water is contaminated by cyanide. About 90% of China’s shallow ground water is polluted and 37% cannot be treated for consumption, making the scarce resource a severe bottleneck, both in terms of supply and regulatory compliance, for the Chinese shale gas industry. Compared to the US, shale gas extraction operations in China are poorly developed, and monitoring programs are mostly absent. This is resulting in poor well construction, which in turn, is leading to high contamination of groundwater reserves in the country.

6 — Land Rights and Oligopoly ­

The majority of shale gas fields in China are held by state-owned and national oil companies (NOC). This is in contrast to the situation is the USA where most of the gas fields are operated by private players. The unconventional shale gas resource land overlaps with the conventional oil and gas resource land in China. Shale deposits are usually deep under the ground, and therefore, on the same patch as conventional resources, albeit at different depths.  This leads to several entities holding different mineral rights on the same piece of land. Of the shale gas resources in the country, 77% of favorable blocks and 80% of potential resources overlap with the conventional resource fields owned by the NOCs CNPC and Sinopec. Furthermore, land exploration rights’ priority to exploit new-found resources is given to already existing oil and gas companies. This delays the entry of new players in the industry that are bidding for the same unconventional resource. Even if the new entrants do acquire shale exploration licenses, they are not permitted by the NOCs to carry out operations on profit-sharing basis on any overlapping areas. To add to the trouble, shale fields that are not overlapping and available for auction to private players have the worst geology. This makes it difficult for new players to carry out exploration activities, which eventually results in loss of motivation to enter the industry.

7 — Lack of Existing Pipelines and Access

The USA has a system of over 210 natural gas pipelines, with 490,850 km of transmission pipelines, whereas the total length of China’s pipeline network is around 43,452 km. The lack of infrastructure to transport shale gas necessitated the development of pipeline infrastructure by the government, which requires heavy funding. Furthermore, the existing pipeline network is monopolized by the NOCs, holding nearly a third of the total pipelines. For instance, CNPC has ownership of the West-East gas pipeline while Sinopec owns the Sinchuane Shanghai gas pipeline; these are important natural gas transportation pipelines. The NOCs thus have the clout to influence the market structure and pipeline pricing, impeding the growth of entrants, especially the private players.

With the geopolitical and environmental implications being immense, China will have to reform its technology and regulatory frameworks as well as its pricing regime in order to transform the industry.

If China is aiming to replicate the shale gas revolution of the USA and achieve the goal it set for the year 2020, then there are some major reforms that the country will have to make to address development bottlenecks. Firstly, in terms of technology, China will have to gain expertise that is more home-grown and suited to extract shale gas, overcoming the challenges that its unique geology poses. This will also help in reducing exploration costs over the years. Next, China will have to establish alternative fracking technology. For instance, NEA officials and scientists have been working on using liquefied carbon dioxide instead of water for hydraulic fracking. This technology would help address the water scarcity issues that China faces for shale gas exploration.

Other important business reforms that China requires is establishing a strong regulatory framework and pricing regime that attracts foreign and private players, and promotes fair competition. A consolidated set of regulations will help China to put in place a single authority for looking over the shale gas industry, break monopoly of NOCs, and resolve land and pipeline access issues.