The stage is set for China’s Big Three oil companies and private firms to start tapping shale rock for natural gas

Commercial production is zero, and no one knows how much natural gas lies trapped but accessible deep underground in China’s shale rock formations.

Nevertheless, the nation’s oil and mining companies are sharpening drills for what could be a wild scramble for shale gas now that the government has set a production target.

The National Development and Reform Commission (NDRC), Ministry of Land and Resources (MLR) and the Ministry of Finance issued jointly a first-of-its-kind plan March 16 with a goal to recover 6.5 billion cubic meters per year by 2015.

That target represents a fraction of the potential cited two weeks earlier as part of an MLR preliminary evaluation, which pegged recoverable shale gas resources in China, excluding Qinghai Province and Tibet Autonomous Region, at 25.1 trillion cubic meters.

Zhang Dawei, deputy director at MLR’s Oil and Gas Resources Strategy Research Center, told Caixin the government’s recoverable reserves estimate is based on geological studies in about 20 key development areas.

Zhang said MLR estimates tend to be cautious. And a source with MLR’s geology division said only about 60 wells were drilled for the survey, which means the nationwide estimate should be considered “very preliminary.”

In releasing the Five-Year Shale Gas Development Plan, the government agencies said the industry in coming years would be encouraged to focus on “proving reserves, mastering exploration and extraction technology, and laying a foundation for the next stage of development.”

But there’s more to the strategy. MLR is looking at shale gas development as an opportunity to break up a monopoly grip on the energy sector in China shared by the Big Three state-owned oil companies – China National Petroleum Corp. (CNPC), China Petrochemical Corp. (Sinopec) and China National Offshore Oil Corp. (CNOOC).

Active Explorers

MLR has already used a shale-gas exploration tender process to test the market’s ability to support a more diverse and competitive energy sector.

The government categorized shale gas as a mineral that can be extracted by companies without an oil or natural gas extraction license. To date, licenses for conventional oil and gas exploration and extraction are controlled by the Big Three.

The first tender for rights to explore for shale gas in southwestern China was held in July 2011. The winning bidders Sinopec and Henan Provincial Coal Seam Gas Development and Utilization Co. agreed to invest a combined 838 million yuan in shale gas exploration.

Much larger tenders are expected in second and third rounds of bidding scheduled for later this year.

But the Big Three are definitely in the game. Thirty-nine shale gas wells has been drilled in the country, with nine each having an expected preliminary production capacity of more than 10,000 cubic meters of oil and gas a year. Of the nine, CNPC has six and Sinopec has three.

Foreign energy giants are busy looking for shale gas in China, too. In fact, CNPC has been working with Royal Dutch Shell PLC since 2009 to explore formations in southern Sichuan Province.

On March 20, Shell and CNPC announced a plan to work together on a shale gas production project. Government regulators are now reviewing the proposal for what would be the first joint-venture shale deal in China. No details of the plan have been announced.

At any site where tests determined that shale gas is commercially extractable, Chinese and foreign partners will likely sign production-sharing contracts.

Meanwhile the vice president of Sinopec’s Unconventional Energy Resources Technology Support Department, Bao Shujing, told Caixin his company is also looking for shale gas in Sichuan.

The greatest potential for recoverable gas lies in and along the rim of the Sichuan Basin, a fertile region on the province’s east side which includes Chengdu, Bao said. Moderate depth makes the gas suitable for large-scale extraction, he said.

Sinopec has cooperated with foreign oil companies as well. In 2010, for example, the company started working with BP PLC in Guizhou’s Kaili block and with Chevron Corp. in Guizhou’s Longli block. Each project is now in the risk-assessment stage.

Last year, Sinopec began a joint geological research project with ExxonMobil Corp. in a southwest section of Sichuan.

CNOOC joined the scramble in December by launching seismic testing in western Anhui Province.

Despite these moves by the Big Three, MLR’s effort to diversify the energy industry through shale gas is having some success. For example, last July newcomer Henan Provincial Coal Seam Gas Development and Utilization won shale gas exploration rights in blocks straddling the border between Chongqing and Guizhou Province. Sinopec also won some tenders.

Meanwhile, the Big Three are drilling for shale gas in North America. Sinopec paid US$ 2.2 billion in January for equity in Devon Energy Corp.’s five gas blocks in the United States. In February, CNPC bought a 20 percent interest in a Shell shale gas project in Canada for an undisclosed price. And last year, CNOOC teamed up with America’s Chesapeake Energy Corp. for a shale gas project.

Learning Curve

China’s energy companies hope lessons learned in U.S. shale gas fields will prove useful as they rev up production at home.

The U.S. Energy Information Administration says shale gas production has grew 15-fold between the early 1990s and last year, when output reached 170 billion cubic meters, equal to 30 percent of total U.S. natural gas production. America has estimated reserves of 24 trillion cubic meters of shale gas.

Compared to U.S. shale gas drillers, China’s energy companies are still at an early stage in terms of extraction technology. But U.S. systems are not necessarily applicable in China due to differences in geological conditions, a CNPC vice president who formerly worked on shale gas exploration told Caixin.

Since much of the U.S. shale gas business has been fueled by small companies, MLR and NDRC’s National Energy Administration think private companies can join state-owned concerns in the race for shale gas in China.

But Jia Chengzao, a scholar at the Chinese Academy of Sciences and former CNPC vice president, told Caixin he’s already worried that domestic energy companies may be moving too quickly for the shale industry’s good.

“Going too fast… could easily lead to two results: First, drilling wells everywhere is difficult for the government to regulate,” Jia said. “Second, shale gas enthusiasm may lead to a surge for drilling activities. But maybe there will be no gas.

“In the end, there may be a large number of empty wells left all over the place.”

MLR officials hope to prevent such a scenario by means of the tender process. Pan Jiping, a researcher at the MLR Oil and Gas Resources Strategy Research Center, said bidding qualifications would be set at levels that attract private companies but do not lead to a “herd mentality” and a rush to drill.

China’s energy regulators also want to avoid the mistakes that surfaced when the country was racing to develop coal methane gas.

There were high hopes for methane found in coal beds, but the extraction business has yet to reach expectations. Mineral rights obstacles, insufficient investment and technological issues have held back the business.

In addition, MLR hopes to avoid mineral rights issues tied to shale gas. In its first round of tenders, the agency prevented trouble with overlapping mineral rights by seeking bids only for blocks not already claimed by the Big Three for access to other resources, such as oil.

But overlapping mineral rights issues are likely to surface in the future, since the Big Three have already registered for rights to more than 3 million square kilometers of land.

Gao Bingqi, a researcher at MLR’s Geological Exploration Division, told Caixin his agency hopes to get around the overlap issue by designating certain areas where one or more of the Big Three controls mineral rights exclusively for shale gas extraction. It would then require a license-holder to drill for shale gas or lose the mineral rights.

Left unanswered are questions about how MLR would award shale gas rights in areas with oil in the ground, said a CNPC source.

However, according to an industry source, MLR may find the tender process less complicated than feared. He noted that the Big Three’s enthusiasm for shale gas has been subdued by the fact that shale gas development costs exceed those for conventional natural gas wells.

By staff reporter Wang Xiaocong