China's Own Shale Revolution Looks Unlikely

|
Includes: CEO, CHIE, FRAK, HAL, SLB, SNP
by: Alpha World

Summary

China has been looking to replicate the success of the U.S. in extracting shale gas and tight oil.

Much of China’s reserves are in difficult to reach terrain.

Lack of water resources is another challenge.

Low prices have already forced PetroChina to scale back and CNOOC to shelve their respective shale projects.

The shale revolution in the U.S. has changed the dynamics of the energy market. Although in the past eight months, shale producers have struggled in the wake of a slump in prices, the U.S. shale industry is here to stay thanks to ongoing innovation. Indeed, as I had noted in an earlier report, despite a drop in rig counts, there has been no impact on U.S. oil production. One of the reasons for this is improving productivity.

China, which is one of the biggest energy consumers in the world, has been looking to replicate the U.S.'s success in shale. The country has the largest technically recoverable shale gas in the world.

China has been looking to reduce its dependence on coal and increase natural gas's share in the energy mix. As part of this strategy, the country signed a major gas agreement with Russia's Gazprom. However, the world's second-largest economy needs its own energy resources as well, and this is why there has been increasing focus on developing shale fields.

For now though, China is way behind the U.S. in terms of technology and output. A report from the Energy Information Administration (EIA) last year noted Sinopec (NYSE:SNP) and PetroChina (NYSE:PTR) have combined shale gas output of 0.163 Bcf/d. This is miniscule compared to the U.S., where in the Marcellus region alone, the output was 14.6 Bcf/d in 2014, according to EIA data. And there are a number of reasons why China may never replicate the U.S.'s success in shale.

A report from the World Resources Institute (WRI) highlighted one of the problems for China and other countries that are looking to start their own "shale revolution." The problem for many of the countries with technically recoverable shale gas is scarcity of freshwater. The WRI notes in its report, "lack of water availability could curtail shale development in many places around the world." China is one of the countries the report mentions face "extremely high water stress where the shale is located."

Apart from scarcity of water, the other problem is geology and terrain, which make extracting shale gas much more complicated than in the U.S. Importantly, China currently does not have the technology or the expertise to overcome these challenges. Still, China set itself some ambitious targets. The Ministry of Land Resources had set an ambitious target of 60 bcm/year by 2020. Wu Xinxiong, the director of China's National Energy Administration, though last year admitted that only half of this could come on-stream by 2020. And this would be just 1% of the country's energy needs. Reuters, citing a government source, noted in a report last year 30 bcm is a more realistic target.

The leader in China's efforts to boost shale gas production is state-owned Sinopec. In December, the company said that its Fuling field has so far produced 1.1 billion bcm of gas and is on track to reach a capacity of 5 bcm by 2015 and 10 bcm by 2017. However, a lot would depend on whether the government continues with its subsidy of 0.40 yuan per cubic meter for shale gas production beyond 2015, as noted by Jiao Fangzheng, Senior Vice President at Sinopec, in a news conference last year.

In addition to the water-scarcity, geological and technological issues, the other problem is the slump in oil prices, which has already forced PTR to scale back on shale project in Sichuan province and CNOOC (NYSE:CEO) to shelve its shale gas project in Anhui province. CNOOC is slashing its capex by 35% in 2015 and therefore it is not surprising that is shelving a difficult to develop project.

Sinopec has also announced capital spending cuts and this will have some impact on its shale gas production targets, although in December the company had said it was committed to shale gas spending for 2015.

With oil prices unlikely to return to the $100 a barrel mark anytime soon, producers, even state-owned ones like in China, will have to take the call on unviable projects. For now, it looks like China will not see its own shale revolution.

The failure of the Chinese shale industry to take off as anticipated is bad news for U.S. oilfield services firms such as Halliburton (NYSE:HAL) and Schlumberger (NYSE:SLB). With China lacking the technological expertise to exploit shale gas, U.S. oilfield services firms saw this as a major opportunity given their experience in the field. Halliburton has a joint venture with STP, a Chinese oil company. In 2012, U.S. oilfield services firms expected to generate significant revenue from China's shale gas push. But with Chinese companies slashing or shelving projects and the government itself lowering its ambitious targets, shale exploration in China is not quite the growth market U.S. oilfield services firms initially expected it to be.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.