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Chinese shale gas still slow-going

December 20, 2012 China's latest shale gas bidding round had been intended to accelerate development by encouraging more players to participate but the process may not yield much results.

The Ministry of Land and Resources announced the winners of its second shale gas bid round on December 6, unveiling a raft of domestic state-owned companies and some private companies. The tender closed in late October and the ministry said it had received 152 bids from 83 companies for the 20 blocks on offer although one block was excluded after it failed to receive the minimum three bids.

State oil and gas companies such as Sinopec and PetroChina were glaringly absent from the list of winners and analysts attributed the result to other non companies -- eager to gain acreage -- submitting generous bids.

The oil and gas companies on the other hand, had a better understanding of the acreage on offer and therefore put up more conservative bids.

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State power company China Huadian Corp. and its subsidiaries were awarded four blocks -- Suiyang in Guizhou, Huayuan block in Hunan, Hefeng and Laifeng Xianfeng in Hubei. See a map of the major shale gas basins in China.

Others went to companies affiliated to provincial governments and other state-owned giants such as coal producer Shenhua.

Privately held China Coal Geology Engineering Corp. was awarded the Fenggang block in Guizhou and the Sangzhi block in Hunan while coal giant Shenhua won the Baojing block in Hunan. PetroChina came in third with its bid for Sangzhi.

A source with Sinopec said the company had bid for only one block while other industry sources said state oil trader Sinochem was also said to be interested in the bid round.

Sinopec's bid for Qianjiang in central Chongqing province was unsuccessful and the block was ultimately awarded to Chongqing Energy, a subidiary of the Chongqing provincial government.

"Our bid was probably quite low compared to the other companies," the Sinopec official said. The other two shortlisted companies for Qianjiang were coal giant Shenhua and State Development and Investment Corp, which is a state-owned investment holding company under the direct management of the central government.

Bidding criteria had been expanded to allow the inclusion of foreign joint ventures -- to show that the government was indeed serious about opening up the acreage to foreign participation -- although to date no such ventures are known to have submitted bids.

But a major drawback of the bid round was that the acreage on offer was not prospective. Both PetroChina and Sinopec had to give up some of their existing onshore acreage to the Ministry of Land and Resources for the bid round and the companies ceded frontier areas with little or no prior drilling.

The winners of the tender, completely lacking in expertise and technology, will almost certainly bring in both domestic and foreign partners to work on the blocks.

"We don't intend to partner with the winners this time," said the Sinopec official. "Unless they approach us to help them with the technology ... but so far we have not been approached," he said, adding that Sinopec already has its hands full with its own shale gas acreage in China.

Slow progress even with foreign help

The challenges facing China's shale gas sector are by now well-known. Despite the abundance of reserves -- billed by some as the second largest in the world after the US -- too many above and below ground risks remain.

The government has been slow to make public a regulatory framework for shale gas and midstream infrastructure bottlenecks will limit commercialization options for shale resources stranded in remote areas. Above all, the geological challenges are huge.

Even with the existing presence of Western oil majors, work has been slow. Sinopec has joint assessment agreements for technical evaluation with BP and ExxonMobil but no wells have yet been drilled even though the blocks were awarded at least a year ago because the geology is difficult to crack. Chevron has drilled one well at the Longli block in Guizhou province, but "results were not very good", the Sinopec official said.

"Time and technology are the two major current challenges for Chinese shale," Credit Suisse analysts David Hewitt and Horace Tse said the bank's report on global shale gas published December 13.

China has drilled fewer than 100 shale gas wells -- versus over 150,000 in the US -- and its companies are still at the start of the learning curve and technology, Credit Suisse said.

The government said it would offer producers a Yuan 0.4 (6 cents)/ cubic meter subsidy for shale gas production, at least until 2015, to help support the nascent industry.

While this is double the current production subsidy given to operators of coalbed methane blocks, there is no definitive way of quantifying its significance, simply because drilling has been so scant and sparse and it is hard to get a clear picture of general costs and what they might be like in future.

Yet the urgency to develop shale resources is particularly apparent in the aggressive acquisition strategies of the state companies abroad.

Since 2010, Chinese companies have entered into at least $7.3 billion worth of shale gas deals in North America, primarily to strengthen their access to fracking technology and grow equity reserves and production. This does not include China National Offshore Oil Corp.'s $15.1 billion takeover of Nexen Inc., which will also give it greater access to technology, among other things.

Most recently, PetroChina entered into a $2.2 billion shale partnership with Canada's Encana to develop assets in the fast-evolving, liquids-rich Duvernay play in west-central Alberta on December 13. This came just two days after it announced a $1.63 billion deal to farm into the conventional Browse LNG project offshore Western Australia.

PetroChina said it would take a 49.9% interest in Encana's 445,000 undeveloped acres in the Duvernay play. It paid Encana an initial C$1.18 billion, with a further C$1 billion payable over four years to cover half of Encana's share of the acreage's development capital.

Valued at C$9,817/acre, the deal is more expensive than similar transactions in the Duvernay, said Bernstein Research, pointing out it was about 10 times the average 2011 price.

While comparable with the Eagle Ford shale play, development costs in the Duvernay will be significantly higher given the greater drilling depth. Typical well costs are around $15 billion compared with $5-$7 million in the Eagle Ford, Bernstein said.

Despite the hefty price tag, the acquisition gets PetroChina into "one of the most promising shale liquids resources in North America, Bernstein said.

Related map: Major shale gas basins in China

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