Increased Chinese shale gas production: prospects and implications

As the largest resource base in the world, Chinese shale gas represents a major wild card in global energy markets. If developed at scale, these reserves would dramatically reshape energy market dynamics. While trends for increased production are positive, the timing and magnitude of growth are open issues.

Potential for production growth

According to the Energy Information Administration (EIA), China is estimated to be endowed with about 1,100 trillion cubic feet (tcf) of “technically recoverable” shale gas resources — almost as much as the U.S. and Canada combined, and nearly 15 percent of world totals.

To date, however, this resource has scarcely been tapped. This is largely because the term “technically recoverable” does not consider economics. In other words, just because a gas reserve exists in nature doesn’t mean it can be produced for the market at costs that justify the necessary investments in drilling and pipelines.

Even so, the minuscule quantity of Chinese shale gas production levels is telling. According to recent analysis released by Wood Mackenzie, China produced about 9 billion cubic feet of gas from shale resources in 2017. Meanwhile, per data from EIA, U.S. production in 2016 was nearly 1,900 times greater (17 trillion cubic feet) — from a resource base less than half the size.

When starting from such small levels, it’s not uncommon for supply volumes to experience rapid rates of growth. And so it is with Chinese shale gas production: the recent Wood Mackenzie study projects a doubling within just three years, to 17 billion cubic feet in 2020. As Chinese experience accumulates, costs are falling and productivity is rising. The trend for future production from Chinese shale resources is clearly positive.

The Chinese government has sought to promote production. As summarized by Fan Gao at Oxford University, the country’s 12th Five Year Plan issued by the National People’s Congress in 2011 included a goal of at least 50 billion cubic feet (0.05 tcf) of gas production from shale by 2020.

Seven years later, it seems evident that production will fall well short of the ambition. The 13th Five Year Plan from 2016 was essentially silent on gas production targets from Chinese shale resources.

Many factors impeding production growth

While there is little doubt that gas production from Chinese shale will grow, there is substantial doubt as to how fast it will grow and to what scale. For example, energy market analyst Irina Slav is skeptical on the maximum upside in a recent OilPrice.com report.

Slav and other like-minded observers have ample justification for their concerns about gas production growth from shale in China. The situation in China is sufficiently different that the experience from the U.S. shale boom of the past decade won’t translate easily, for several reasons:

• Geology: Most of the shale resources in China is very deep underground — usually more than 3,000 meters, sometimes as deep as 8,000 meters — and is primarily found in mountainous terrains, subject to extensive networks of fissures associated with tectonic activity. All of these factors make drilling much more expensive, often requiring unique technological solutions yet to be developed.
• Expertise: The world’s leading oil/gas practitioners are generally not employed by Chinese firms, which tend not to be able to exploit state-of-the-art technologies, methodologies and processes. And, it’s not easy to get best practices imported into China.
• Water: Producing natural gas from shale requires a lot of water, yet much of the Chinese shale resource is located in arid regions. Moreover, with much higher Chinese populations, competing demands are more significant for what little water that exists. The water supply challenges place additional pressure on shale production economics — often to the point of impossibility.
• Pipelines: The Chinese natural gas pipeline network was never extensive to begin with, and has been struggling to cope with growth in demand and domestic conventional production. Attempting to increase production from shale resources only exacerbates this issue, particularly since they are mainly located where there is virtually no pipeline infrastructure in place.
• Regulations: Chinese bureaucracy overseeing shale gas production is extensive, often overlapping and conflicting, at both the national and local level. This adds costs to or otherwise stymies resource development initiatives.
• Capital: The lack of transparent energy markets within China impedes private capital in its ongoing imperative to find and flow to attractive investment opportunities. In addition, foreign firms that are leaders in shale gas production techniques and expertise are often highly restricted in their ability to participate in Chinese resource development or production.

Even with all these caveats, it remains vital to monitor developments in the Chinese shale gas arena, given its massive potential.

Implications for energy markets

With the “peak oil” pessimism from a decade ago being only one example, it is important to remember that energy markets and expert observers have often been wildly wrong in the past. The combination of unexpected surprises and the compounding effects of exponential growth can change situations profoundly. Such changes come seemingly overnight, but are rather a result of the patient accumulation of successes.

For instance, if production were to continue to grow at 25 percent per year — what Wood Mackenzie projects for the next few years, and well within the realm of U.S. experience over the past decade — gas production from Chinese shale would top 160 bcf by 2030. While this is still modest relative to U.S. production levels, it’s nevertheless a sizable enough increment of volume to be meaningful in affecting pricing in Asia-Pacific energy markets.

On the margin, increased Chinese gas production will push down prices for natural gas in China and in markets that export gas to China, either via pipelines or by ship (a la LNG). In turn, this increases vulnerability for owners of gas production or transportation assets, especially assets that primarily serve China.

Meanwhile, Chinese energy companies are increasingly partnering with foreign firms specialized in shale development. Consider the $84 billion investment in projects related to U.S. shale announced in November 2017 by the China Energy Investment Corporation, as reported by World Oil. Not only is this a strategy to obtain access to resources for shipment to China, but is also intended to help Chinese producers bring technology and insight back to their domestic shale reserves.

Since it will take decades for Chinese production to achieve its ultimate scale, it may be that such foreign forays into shale development to accelerate eventual repatriation of capabilities back to China will exert a more significant impact on energy markets over the next several years than increases in domestic production from Chinese shale resources.