Tapping into China's unconventional gas stores
Beijing has big plans to exploit its huge reserves of unconventional gas but major problems stand in the way
China, sitting on the world's largest undeveloped shale gas resource and the third-largest coal bed methane reserves, has outlined a bold five-year plan to replicate the United States' success in exploiting unconventional energy.
But analysts said a number of factors might thwart China's ambitious goal.
For a start, insufficient competition due to the industry's dominance by a few state firms, underinvestment in exploration and complex geology could hamper development. A low gas price, underdeveloped pipeline and storage infrastructure also add to the challenge. And then there's the scarcity of water and inadequate technology.
It all means Beijing needs to do more to improve the economics of such projects if it is to succeed in its plan.
The existence of shale gas and coal bed gas - natural gas trapped within sedimentary rocks and between coal seams - is formed in the process of the decay of organic materials over millions of years. Miners have known about it for many decades, but technological and economic barriers mean the resources have been largely untapped.
In the United States, technological innovation and huge investment led to coal bed gas output almost quadrupling in the past two decades, while shale gas production has quadrupled in the past four years alone.
Because of the technology-driven boom to extract previously uneconomic energy resources, the US is predicted by the Western governments-backed International Energy Agency to overtake Russia as the world's largest natural gas producer by 2015, and surpass Saudi Arabia and Russia as the top crude oil producer.
This would see the US, which imports about a fifth of its energy needs, become energy self-sufficient by 2035.
China, whose energy import reliance is expected to keep climbing as output growth has failed to keep up with demand, is watching the US with envy.
China is 80 per cent self-reliant on energy, thanks to its vast coal reserves. But imported oil takes up more than half its needs, while gas imports amount to over 22 per cent of consumption. It became a net importer of oil in 1993 and net importer of gas, a cleaner-burning fuel, in 2007.
Beijing has set fuel and gas retail prices at below overseas levels to cushion consumers from the full brunt of cost increases and prevent social unrest.
In the past two years, this has resulted in mainland state oil and gas firms incurring losses of tens of billions of US dollars on gas imports to keep up with demand, while lacking the incentive to pour the investment needed to develop the vast but expensive-to-extract unconventional gases such as shale and coal bed gases.
"Paradoxically, it has been easier to import expensive liquefied natural gas [whose price is linked to crude oil] than raise domestic gas prices," US brokerage Sanford Bernstein senior analyst Neil Beveridge said in a research report.
Analysts expect this idiosyncrasy to gradually diminish as Beijing implements long-awaited reforms on the gas pricing system.
Currently, prices are set by the state based on production cost plus transmission, rather than being driven by demand and supply.
There are trials in Guangdong and Guangxi regions to link the gas price to imported partially refined oil and liquefied petroleum gas, with a plan for Shanghai to be a national gas pricing hub. No timetable is yet available.
A much-delayed gas price rise is expected next year, which would help viability of unconventional gas.
Residential gas prices were last raised by an average 25 per cent in mid-2010 and by 12 per cent in late 2005. In addition to those two rises, industrial and transport users absorbed an extra 35 per cent increase in late 2007.
Beijing released in March this year a development blueprint for the unconventional gas industry, in which it outlined a goal to raise shale gas output from almost nil to 6.5 billion cubic metres in 2015 and between 60 bcm and 100 bcm in 2020. The US produced 151 bcm of shale gas in 2010.
Mainland coal bed gas output is targeted to rise from 1.5 bcm in 2010 to 16 bcm in 2015, according to an industry development plan released last December.
While Beijing is expected to take many years to complete gas pricing reform so that domestic prices will catch up with overseas levels, it has offered subsidies in the meantime to unconventional gas developers to jump-start the nascent industry.
Analysts are not optimistic that Beijing's 2020 shale gas goal will be met.
Liu Honglin, deputy director of China National Shale Gas Research and Development Centre, projected China's shale gas output at between 12 bcm and 60 bcm in that year.
Daiwa Securities head of Asia oil and gas research Adrian Loh estimated in a research note that the subsidy would shave shale gas production cost of 1.76 yuan (HK$2.17) to 2.2 yuan per cubic metre by 18 per cent, which would help meet the 2015 output target. But he tipped output to reach just 18 bcm to 20 bcm in 2020 unless there are more incentives and reform.
Beveridge agreed, adding that the industry's concentration of market power is a development barrier.
"We don't think [Beijing] has taken the necessary steps to ensure that the target will be met," he said.
"Development of shale gas in the US was pioneered by entrepreneurial exploration and production firms rather than the large integrated majors."