China’s unconventional gas sector has barely gotten off the ground.Work to develop China’s abundant coalbed methane (CBM), for example, has been ongoing for more than 15 years, with only limited commercial CBM production to date. Driven by demand, significant volumes of unconventional gas are expected to enter the domestic market from around 2020, meeting much of China’s incremental demand growth beyond this time.As the industry develops,Wood Mackenzie models more than 12 Bcf/d of unconventional gas production by 2030.

Because China’s tight gas production is broadly considered conventional, both from a fiscal and a reporting perspective, it is excluded from this discussion.

Challenges for unconventional resources
The growth of unconventional gas in China is likely to be gradual rather than dramatic, particularly as the technical, economic, and logistical requirements for undertaking large-scale domestic unconventional gas developments have yet to be established. It is therefore misleading to look at China only from the perspective of what has been achieved in North America, as many of the key success factors that supported rapid growth in the US are absent.

Following the signing of China’s first CBM licenses in the 1990s, analogies were quickly drawn to the US, where rapid production growth was achieved after initial commercial development.

When the Chinese government published its 11th “Five-Year Plan” from 2006-2010, CBM targets were set at just under 500 MMcf/d by 2010. Output will fall well short of this target.

At present, analogies again are being made with the US in terms of China’s shale gas potential. But Wood Mackenzie believes it is critical to understand the local conditions facing China.

To put it simply, China is not the US and will not replicate US experience in a linear fashion.

Unconventional gas development has been slow to evolve in China, and there are several major challenges China will continue to face. The ways in which China overcomes these unique challenges will dictate the future pace and location of growth.

The first of these challenges is local CBM geology. China will require accelerated investment in basin-specific technology to address its unique geological conditions. Taking CBM as an example, Qinshui Basin coals have proven to be variable in quality, and the permeability of the largely anthracite coals in the southern section of the basin is low compared to basins in the US and Australia. China’s shale gas geology remains largely untested, and accordingly there is limited understanding. The results of pilot projects will be critical to the industry’s understanding of the full potential.

Accessing relevant technologies will pose another challenge. Based on geological conditions, progress will depend on companies being able to transfer technologies from proven plays (both domestic and overseas) and develop them to deal with local conditions. This requires a combination of the right companies and a commercial environment that facilitates technology transfer and innovation.

Wood Mackenzie believes the licensing regime and the lack of a competitive environment in China have stifled new technologies and slowed the pace of transfer.

There also is the matter of access to infrastructure and markets. While there is access to a liberalized pipeline transmission system in the US, that is not the case in China. Limited third-party access to

The November 2010 announcement of China’s first shale gas license round for domestic companies is further evidence that the government is keen to stimulate domestic company interest in the sector. This map shows the CBM basins and licenses. (Images courtesy of Wood Mackenzie)

transmission pipeline infrastructure has affected CBM development.

While many CBM blocks are in close proximity to major trunk lines, this has not led to access to gas markets for upstream developers.

Unconventionals will require more investment if it is going to be a commercial enterprise in China.

Large-scale investment is required to accelerate unconventional exploration, prove up reserves, and develop projects. In the early years of China’s CBM investment, foreign capital accounted for at least 70% of the exploration spend, as China United Coal Bed Methane Co. Ltd. relied heavily on foreign companies for funding and technological knowledge. However, most of the foreign license holders are relatively small companies whose capital resources are not able to extend to major exploration campaigns. The sector will require major new inflows of capital to achieve its potential.

Another challenge is limited service sector capabilities.

Unconventional gas developments traditionally have low per-well recovery rates. This means companies must drill a large number of wells in a material project.With rapid depletion rates and marginal economics, these wells must be completed quickly and at low cost. To date, only a small number of horizontal wells have been drilled onshore China each year, and the supply chain is limited, particularly for more complex equipment. Scaling up drilling fleets to cope with increased demand and the array of services required will take time and result in cost pressures.

Access to land and water also will be a critical factor in the future success of unconventional gas development in China. Mineral rights are held by the state, and land owners do not benefit directly from production but from compensation for land access and loss of income. This restricts the incentive to cooperate with upstream operators. It will be challenging to secure local government approvals in basins such as Ordos and Junggar, where the climate is arid, because water rights will have to be diverted from other uses to drilling projects.

The final concern is the regulatory environment. The National Development and Reform Commission (NDRC) places great emphasis on understanding new technologies, developing appropriate regulatory frameworks, and considering the ultimate impact of policy on the Chinese population. The process of achieving approval for CBM project plans has been notoriously slow.Wood Mackenzie expects that it will take some time for the NDRC to become familiar with new technologies and issues related to water handling and disposal so the organization can achieve a level of comfort in understanding the environmental impact of large-scale developments.

Unconventionals are expected to make up 26% of China’s total supply in 2030 (conventional gas includes tight gas).

The unconventional future
Despite significant near-term challenges, there are reasons to be optimistic about the long-term potential for unconventional gas in China. While technical and operational challenges will have to be confronted, undoubtedly the most important factor driving Wood Mackenzie’s future view is China’s need for unconventional gas to meet demand.

China’s gas demand will rise from 10 Bcf/d in 2010 to 43 Bcf/d in 2030, with a compound annual growth rate of 7.5%. Domestic conventional gas supply (including tight gas) is continuing to grow but will not be able to keep pace with such rapid demand.

With LNG and piped gas imports expected to increase to 44% of the supply mix by 2018, the NDRC now is actively promoting unconventional gas development to reduce rising import dependency.

Pricing signals have been positive as well. The June 2010 announcement of an average 25% increase in domestic onshore wellhead prices is an explicit recognition by the government that domestic gas prices need to be at levels that stimulate increased investment in domestic exploration – similar to the US, where shale gas development was encouraged by upward pressure on prices – and that allows China to import higher cost, oil-indexed imports.

Investment from China’s national oil companies in unconventional gas also is going to be critical. While Wood Mackenzie expects PetroChina to be more focused on developing conventional gas reserves and encouraging gas price reform to reduce current losses on Central Asian imports, the company also recognizes the key role that unconventional gas needs to play in the future. The November 2010 announcement of China’s first shale gas license round for domestic companies is further evidence that the government is keen to stimulate domestic company interest in the sector.

The involvement of foreign companies now is publicly recognized in China as critical to the successful pursuit of unconventional gas development. China will require partnerships and technology in the initial phase of development, creating a window of opportunity for qualified foreign players, although there will be a limit to how many of these opportunities will ultimately convert into profitable production-sharing contracts with foreign partners.

Lastly, although currently there are no regulations or fiscal terms specifically governing shale gas, the NDRC has established working groups to assess the sector.Wood Mackenzie expects more clarity over a suitable regulatory and fiscal framework for shale gas development over the coming one to two years.

With some positive indicators already positioning China’s unconventional industry, CBM and shale gas in particular will begin to define the long-term supply outlook for the Chinese gas market by the end of the current decade. While significant technical and commercial uncertainties remain, unconventional gas output is expected to rise above 12 Bcf/d by 2030, which puts unconventionals in the position of being the major supply option to meet incremental demand beyond 2020.