NATURAL GAS

Will U.S. shale technology make the leap across the Pacific?

The Chinese government is expected to hold its second-ever auction of shale gas drilling rights this summer in a sign of official interest in a fuel that has revolutionized the American energy landscape.

But despite extensive Chinese shale gas deposits -- China's technically recoverable resource base is estimated at 1,275 trillion cubic feet, according to the U.S. Energy Department's Energy Information Administration, compared with an estimated 862 trillion cubic feet equivalent for the United States -- it seems unlikely that China's shale gas industry will take off anytime soon.

"The current situation is that in fact, there's much more talk than action," said Wenran Jiang, a senior fellow at the Asia Pacific Foundation of Canada and a founding director of the University of Alberta's China Institute. There is "a lot of talk, a lot of enthusiasm," Jiang added, "but a lot of people realize it's not that easy" to transplant the American experience across the Pacific.

First off, while China appears to have abundant natural gas resources locked away in shale formations, the geology there is generally agreed to be much more challenging than in the United States.

Domestically, advances in hydraulic fracturing and horizontal drilling have allowed companies to access natural gas that had previously eluded capture. But Chinese shale formations are much deeper than American ones, experts say, and other geological differences suggest that getting to the gas will be more challenging. "The rock formations might be a lot harder, the resources a lot deeper, than in North America," Jiang said, meaning that more chemicals will be needed to fracture the rock and that complex technical issues can be expected.

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Industry observers say that even in the simplest of cases, hydraulic fracturing, or fracking, technologies are not straightforward to transplant.

"The reality is that even if Chinese companies have the technologies, using those technologies to tap into shale gas resources in China is going to be very, very difficult," said Bo Kong, research director for the East Asian Energy and Environment program at Johns Hopkins University's School of Advanced International Studies. "You have to have the techniques, you have to have years of experience, you have to have know-how to apply the technologies," he added.

Noting that the recent U.S. success at shale gas extraction is rooted in a series of technologies that have been around for years, Kong said China's shale gas story is likely to unfold over the medium to long term.

"Of course now it's a big story [in the United States] because of the magnitude of volumes of production, but everything was in the works for the past two decades," Kong said.

Development barriers

Natural gas industry-watchers often point to the "perfect storm" of factors that have facilitated the U.S. shale gas boom. For starters, American landowners generally also own rights to minerals below the surface. That is not the case in most other countries, including China.

The United States also has an advanced hydrocarbon infrastructure, including extensive natural gas pipelines in parts of the country and an inventory of drilling rigs and other heavy equipment, thanks to having strong related industries.

In China, the state owns mineral rights, including those for natural gas deposits, so landowners cannot expect the windfall payouts that have helped gas rigs in their gallop across the major American shale formations. Instead, landowners there can expect to experience the downsides of development without a financial sweetener.

In that setting, state-owned oil and gas companies -- with their insider ability to access state-owned hydrocarbon resources -- have the upper hand over the fledgling field of privately held firms. But those companies also have access to plenty of proven, conventional resources with a much clearer path to production, said Kong. "They don't have to put the resources into developing shale gas. ... When you have other options, unconventional is not the most appealing one because it is simply a very, very hard nut to crack."

Kong said a ranking of the options available to China's big, state-owned companies would probably put conventional natural gas first, followed by coalbed methane extraction (a technique for extracting natural gas from coal seams). Shale gas would be the lowest priority, Kong said.

Natural gas pricing poses another challenge. Gas prices are administratively controlled by the central government in China and held artificially low to promote accessibility. That puts already pricey exploration and research around shale gas extraction techniques at a further disadvantage, Kong said.

Producers are under intense government pressure to make more product to meet the high demand stemming from China's strong economic growth of the past decade, he added. "Natural gas pricing limits the ability of companies to divert money to produce more natural gas [in the future], especially higher-priced unconventional gas."

Another Chinese challenge lies in the long distances between some of the key shale gas formations and population centers. "Location remoteness is a serious bottleneck," said the Asia Pacific Foundation's Jiang. It's not just the distance that produced gas will need to travel to reach markets but getting equipment to rural locations that may lack good roads and moving water and drilling supplies around.

Natural gas infrastructure looks tough too, though some say that is not among the biggest issues. China has limited natural gas pipelines, and production from new regions would require new long-distance conduits. But Beijing has a history of swift execution on projects like that, unlike the United States, where rights of way and lawsuits add significant lead time.

"Given the track record of how fast Chinese companies build pipelines, I'm not worried," Kong said.

But he said down the road, securing third-party access to privately owned pipelines is a bigger concern. "If you don't have access to pipelines, what are you going to do? This issue has to be resolved," he said. In this case, the layers of state ownership, state-owned company involvement and private investment could prove complicated.

A much bigger issue is the industry's water use.

As in the United States, some of the most promising shale gas fields in China are in water-poor areas where municipal use and agriculture already compete for limited surface flows. When observers talk about "environmental concerns" with hydraulic fracturing in China, they are generally not referring to earthquakes, groundwater contamination or chemicals in reinjected fracking waste, but simply the several million gallons of water required at each well to break open the rocks.

That also ties to worries over emissions from caravans of diesel trucks carrying water to remote drilling sites and carrying wastewater away, because vehicle exhaust is one of the areas where Chinese environmental sensitivity is relatively high.

In the United States, shale gas developers point out that their water use is lower than that of agriculture or other forms of energy development, like coal mining. But those arguments may hold limited sway when it comes to establishing a new industry in regions where there is not enough water to go around or in building up a significant presence in regions where other users have staked prior claims (ClimateWire, Oct. 14, 2011).

Modes of tech transfer

Despite the challenges, the allure of a massive new domestic energy source has the Chinese government and private and state-owned companies moving cautiously toward development. Today, virtually all of the key intellectual property behind shale gas extraction lies with North American companies, and one of the first steps the Chinese have taken is to pour money into U.S. and Canadian ventures where those technologies are in use.

In 2010 and 2011, China National Offshore Oil Corp. (CNOOC) paid $2.3 billion for partial stakes in plays by Chesapeake Energy Corp. in Texas, Wyoming and Colorado. Earlier this year, Sinopec bought into Oklahoma City-based Devon Energy Corp.'s holdings across Louisiana, Mississippi, Colorado, Ohio and Michigan in a $2.5 billion deal. Chinese companies have also aggressively pursued investment deals in Canadian shale projects.

But Johns Hopkins' Kong said attempts by Chinese companies to negotiate North American on-the-job training have been blocked.

The deal with Chesapeake, for example, limited the interaction of CNOOC personnel with sensitive technologies by restricting the company's right to send workers into gas fields, Kong said. "The Chinese companies have agreed deliberately not to send their oil workers to American gas fields and not to participate in boardroom decisions," Kong said. "The Chinese companies have agreed to this long-term, slow, gradual approach to gaining know-how in the North American energy sector."

The caution stems mostly from a political firestorm that broke out when, in 2005, CNOOC tried to buy Unocal Corp. in an $18.5 billion deal that was eventually withdrawn in the face of opposition from Congress. Since then, there has been a general awareness among Chinese players of the need to move slowly and avoid raising red flags (E&ENews PM, Aug. 2, 2005).

So what do Chinese investors gain from these North American investments, then, if not direct access to fracking technologies? "By investing in the U.S. ... they benefit from the spill-over effect," Kong said. They have some personnel involved with the projects, even if they're not learning the nitty-gritty of how to develop a fracking plan, and may be able to pick up some very high-level management expertise that is relevant at home.

Home or away?

Jane Nakano, a fellow with the Center for Strategic and International Studies' Energy and National Security program, stressed that investing in U.S. projects is not China's most effective means of technology transfer, especially given companies' failure to crack the personnel firewall.

"If it's just a matter of getting profits from what comes out of each well or each project, then the amount of money they're pouring into North America does not make economic sense," she said.

Rather, Nakano said Chinese gas interests would be best served by opening the domestic market to foreigners. "The most straightforward way would be for them to involve Western or non-Chinese technology holders more proactively" at home, she said.

There has been limited involvement by major non-Chinese companies. In 2007, Houston-based Newfield Exploration Co. did a resource study with PetroChina. Royal Dutch Shell PLC has worked with PetroChina under a broader partnership agreement. And Exxon Mobil Corp. has had limited dealings with Sinopec.

The first round of bidding on government shale gas leases, which occurred last summer, was open only to state-owned companies, and the final bids awarded parcels to just two large firms. There is speculation that the second round, which could come as early as this month, will expand participation to privately owned companies or even foreign bidders.

There are other configurations that could also serve to carry the needed intellectual property into Chinese gas fields. In addition to joint ventures in North America or China with the supermajors, firms could hire foreign service companies to carry out work in China, observing their approach. Chinese companies or government interests could buy up some of the cash-strapped U.S. gas companies that are struggling to stay afloat until U.S. prices rise again and bring their expertise back to the Far East. They could buy U.S. shale resources -- even small ones like those held by individual property owners -- outright, then dictate the terms of development so as to ensure full access to the technologies used.

Outside of industry, government-to-government interactions tout cooperation on shale gas, among other forms of energy that could help both U.S. and Chinese carbon emissions reduction efforts. And Chinese scientists work to develop home-grown strategies for shale gas production modeled on what has worked elsewhere.

The University of Alberta's Jiang said Chinese shale interests, including both government and industry players, are undecided on how to move forward and how much to focus on domestic development versus lower-cost production overseas. "I don't think they have reached a conclusion one way or the other," he said. As a result, the country pursues "a two legs walking approach -- on the one side they want to explore domestic possibilities, on the other they want to explore possibilities with lower ... prices" elsewhere.

That likely means a timeline of a decade, at a minimum, before Chinese shale gas resources are well-understood and a clear path to their development emerges, and potentially as long as two decades, observers say.

In the meantime, the Chinese will continue to pursue contracts for natural gas imports to satisfy the strong and growing demand.

"It's not a political decision, or environmental consciousness, as much as it is a market consideration," Kong said.

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