Shale gas production facing double hurdle

Recent progress in China's shale gas sector has convinced some analysts that the unconventional fuel has a commercial future here, but the regulatory framework and water issues remained key barriers to rapid development.

After spending two days visiting drilling operations in Sichuan Province, the "shale capital" of China, analysts at Sanford C. Bernstein concluded that flow rates were better than expected and costs lower than forecast.

They visited the Changning block, a key shale site highlighted in China's current five-year plan for development of the industry.

Shale gas has become a game-changer in the US energy industry, and China is hoping to duplicate that success. It's all part of a broader national strategy to cut reliance on coal and oil and to protect the environment.

Though China possesses the biggest shale potential outside the US, it has yet to produce any shale commercially, mainly because of technical challenges. The government aims to start initial commercial production before 2015.

In the US, advances in horizontal drilling and hydraulic fracturing have successfully unlocked, at low cost, deposits trapped in formations previously thought unreachable.

In order to advance China's technology and technical expertise, the nation has opened some shale resources to foreign companies, and Chinese companies have acquired companies and assets overseas.

Although the government has announced ambitious targets for shale gas production by 2015, there has been little public information on progress to date. The Bernstein visit provided some rare, positive insights into China's technical capabilities as a major shale gas producer.

In the Changning block, 15 wells are being drilled to assess feasibility ahead of any decision on full-scale development, according to Bernstein. These wells typically take 60 days to drill and cost around US$8.2 million each, higher than in the US but below earlier estimates of between US$10 million and US$15 million.

Better than US

The one well in the appraisal program that has been stimulated so far reported an "impressive" flow rate of 150,000 cubic meters per day, equal to or better than the US, according to the brokerage firm's report.

"In short, shale development in China looks like it will be commercial," Bernstein analysts, led by Neil Beveridge, said in a recent note.

"Despite this, the regulatory environment and water management remain the two biggest barriers to rapid development of the sector and suggest material volumes are still some way off unless reform happens."

While water is abundant in Sichuan, clean water is less so. Local people are concerned about possible surface water contamination from shale operations. That's in addition to challenging terrain and lack of pipeline capacity, the analysts said.

Last week, China National Petroleum Corp said it had started building the country's first dedicated shale gas pipeline to link gas wells in Changning to other provinces. But it didn't give a timeframe. In small volumes, the gas could be compressed and trucked.

Beveridge said China needs to improve the current regulatory framework. He cited reform in natural gas pricing - currently strictly regulated - and better upstream oil and gas asset access for non-state companies.

China has held two auctions for shale blocks since 2011, which marked the start of commercial exploration. Winners were mainly state-backed companies.

The US last month opened a new era of energy exports, authorizing the Freeport LNG project in Texas to export gas to countries without free trade agreements with the US. This was the first such approval granted in two years, amid heated debate over how best to benefit from the shale revolution. US manufacturers, like chemical companies and steel mills, are against worldwide gas sales approval, saying it will hurt their competitive edge.

A recent Deloitte report said shale gas is expected to remain a largely regional source of energy over the next three years, with an uncertain impact on the global energy market past that timeframe.

It is "highly unlikely" that China will emerge as a shale exporter because of rising domestic demand and exploration challenges, said Charles Yeung, leader of China energy and resources at the consulting and accounting firm.