Not a bang, but a whimper

The state monopoly will prevent a shale gas revolution in China

Not a bang, but a whimper

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China will have overtaken the US as the world’s largest economy by 2030, the US intelligence community projected in its early December report “Global Trends 2030: Alternative Worlds.” But the report contained perhaps an even more enviable prediction for North America: By that time, the continent may be entirely energy independent.

The secret to North American self-sufficiency lies in its vast reserves of shale gas. Companies have succeeded in unlocking shale gas through hydraulic fracturing or fracking, a technique in which a slurry of water and chemicals is shot into a horizontal well at awesome pressures. The blast cracks the earth for hundreds of meters, allowing tiny bubbles of gas to escape and float up through the well to the surface.

The resulting natural gas boom has slashed energy costs for US homes and businesses, and it will bring further advantages. The natural gas revolution is reducing American dependence on oil and thus the Middle East. Since shale gas burns cleaner than coal or oil, it is also helping clear the air and mitigate climate change: US emissions are already down to 1992 levels and still falling. 

Chinese leaders have undoubtedly viewed this transformation with interest. China is energy hungry, but it also desperately needs to cut carbon emissions. It already consumes roughly half the world’s coal, and if left unchecked its use of fossil fuels is projected to rise more than 40% by the end of the decade. Finally, China is sitting on top of what may be the world’s richest supply of shale gas: Experts say China’s shale reserves may be up to 50% larger than those of the US.

While shale gas seems to offer an easy answer to China’s energy problems, the industry has been slow to take off. Chinese companies face several big obstacles, including mastering an advanced technology and piping gas from rich reserves in the country’s west to the populated east. Another problem is that China’s west is relatively arid, and current extraction techniques pollute millions of gallons of water per well. But the biggest obstacle to development is China’s tight restrictions on the energy sector, which are stifling the kind of market activity needed to trigger a development boom.

Capitalist roaders

The rise of the North American shale gas industry is a story of creative destruction. It was small American oil drilling firms that first perfected fracking technology in the 1990s. These small players were so successful at cracking open the market that many put themselves out of business. The wealth of natural gas caused prices to plummet, leading oil majors such as Total, Shell and ExxonMobil to snatch up small extractors as they began to fold.

China’s big three energy companies, PetroChina, China Petrochemical Corporation (aka Sinopec Group) and China National Offshore Oil Corporation (CNOOC), are now partnering with some of these same majors to learn fracking techniques. The latest in the string of partnerships is CNOOC’s massive US$15.1 billion takeover of Canada’s Nexen, which has shale gas projects in British Columbia.

Chinese state-owned energy companies will need time to acquire this technology and adapt it to domestic projects. Fracking is a complicated technique, and China’s shale gas formations have a composition that has proved particularly hard to crack.

But Chinese state-owned companies may suffer from a deeper lack of motivation to trigger a US-style shale gas revolution. For one thing, shale gas could result in losses on their other existing contracts. Since China’s reserves of traditional natural gas are scarce, the big state-owned energy companies continue to sink substantial investments into decades-long contracts for imports of liquefied natural gas (LNG) and cross-border pipelines, paying anywhere from US$12-18 per thousand cubic feet for gas from Australia, Central Asia and the Middle East. Given these contracts, developing a cheap alternative source of gas would run counter to their commercial interests, as it has for many gas producers in the US.

The government is attempting to jumpstart development by injecting more competition into the sector. China’s first shale gas auction in June 2011 attracted only six bids from state-owned companies for the four blocks on offer, and only two blocks were ultimately sold. The Ministry of Land and Resources (MLR) then opened its second-ever tender in December to smaller companies and foreign-Chinese joint ventures in an attempt to speed up industry development “through the mechanism of market competition.”

But apparently China’s energy sector was not ready for that. At first glance, interest appeared strong, with 152 bids from 83 companies for the 19 shale gas blocks on offer. However, some of these bids were not even from energy companies: one was a consumer company that sells home appliances, candles and bathing products, while another was a hardware company, The Wall Street Journal quoted Simon Powell, head of Asian oil and gas research at CLSA, as saying. In the end, only two private Chinese companies won bids, in addition to 14 state-owned companies.

The simple explanation is that the state energy monopoly has left few small, private companies equipped to pursue the shale gas boom. China’s three state-owned companies continue to dominate domestic oil and gas production, in part because subsidies to the state-owned sector and low government-set prices often keep profit-driven companies out of the market.

As in the US, private companies will likely be the answer to unlocking China’s shale potential. But if the Chinese government wants to attract profit-driven foreign and Chinese companies, it needs to do more to reassure companies that it will provide an even playing field. It could start by reassuring foreign companies that it intends to respect property rights, by extending the three-year limit on exploration rights the MLR set for the first two auctions.

Without a sharp change in strategy, China is likely to dramatically underperform its ambitious targets of raising shale-gas output to 6.5 billion cubic meters by 2015 and as much as 100 billion cubic meters by 2020. Energy research firm Wood Mackenzie predicts that by 2020 production might reach only one-tenth of the government’s target. China may be cultivating the world’s largest future economy, but it is likely to remain far behind the US when it comes to energy independence.