The biggest story in the energy market in the past few years has been the surge in production of natural gas from shale formations in the U.S. This previously untapped resource, made accessible by new drilling technologies, has the potential to turn North America’s energy industry on its head.

Through higher energy self-sufficiency, it could reinvigorate the domestic industry and revive an economy still recovering from the aftermath of the financial crisis.

The euphoria surrounding U.S. shale continues, but the focus is already shifting towards China. According to the U.S. Energy Information Administration, China has the world’s largest shale gas reserves, exceeding those of the U.S. Here at Standard Chartered Bank, we have investigated China’s commercial shale gas potential by interviewing regulators and domestic and foreign players and by observing on-the-ground progress firsthand.

Our findings suggest that China can become the next U.S. in terms of shale gas output.

We estimate that China’s shale gas production could rise to about 61 billion cubic meters by 2020.

This would be more than double consensus estimates, which so far have been pessimistic about the country’s shale gas prospects.

To drive this surge in output, we estimate the amount of investment required between now and 2020 at $60 billion. To put this into perspective, this is around 30 percent more than what China’s energy giants have spent in capital expenditures over the past seven years.

By 2030, we expect shale gas to form the biggest component of China’s gas supply.

This will help to reduce China’s gas import dependence from a projected peak of 40 percent of supply between 2016 and 2018 to 25 percent and ease its reliance on its neighbors for resources.

It will also support the government’s push to promote the use of natural gas and reduce consumption of more polluting fuels, especially coal. Our research suggests that the combined share of natural gas and energy from sources other than fossil fuels should rise to 24 percent of China’s energy usage by 2020 from the current amount of around 15 percent.

Master and apprentice

To understand what is required for successful shale gas development, we studied the U.S. model. We found that, while resources and favorable geology are vital, the recent boom in U.S. shale gas would have been impossible without government support. And contrary to general perception, the U.S. shale story has not been a revolution but a drawn-out evolution, the foundations of which were laid by the government more than three decades ago.

Legislation to deregulate gas prices in 1978 attracted small but agile private U.S. energy companies to invest in shale gas development throughout the 1980s.

These small companies with the requisite know-how were subsequently acquired by larger entities at the start of this century.

After the entry of the big players, U.S. shale gas output grew 19 percent per year between 2002 and 2005, and annual growth has accelerated to an average of 43 percent since 2005. U.S. shale gas output is currently around 265 billion cubic meters, and represents 40 percent of total U.S. gas supply.

This compares with shale gas’s share of just 2 percent in 2002.

According to the Energy Information Administration, China has 32 trillion cubic meters of shale gas resources, 68 percent more than the U.S. China’s Ministry of Land and Resources estimates reserves at a more conservative 25 trillion cubic meters, still 32 percent more than U.S. reserves. Given this resource abundance, why is there so much skepticism about China’s ability to replicate the success of the U.S. in developing shale gas?

The challenges most commonly cited are: higher production costs due to more complex geology; higher population density, which limits the scope of drilling; the regulated nature of China’s natural gas sector; the lack of technological expertise; and insufficient water resources.

Beijing was by no means oblivious to these challenges when it set a production target of 60 billion to 100 billion cubic meters by 2020.

To surmount them, China is emulating the U.S. not only from a technological perspective but also in terms of policies such as fiscal incentives for shale gas, measures to attract foreign investment and deregulation of gas prices.

So far, these policies are showing signs of success.

Entrepreneurial drive

China has also shown an entrepreneurial instinct to tackle challenges that are unique to the country. For example, we have found that high costs arising from harsh terrain can be reduced by as much as 50 percent if operators maximize the use of local content.

Topography has also stimulated innovations such as foldable water tanks, invented by an oil services company.

China also possesses some advantages relative to the U.S. These include financial backing from big national oil companies, a huge shale resource base, ample pent-up gas demand and the chance to draw upon the U.S. experience, which will help shorten the development time frame.

Tight gas: A supporting case for shale

The spectacular increase in tight gas output is a key example supporting our view that China will beat expectations on shale gas development. China classifies tight gas as conventional gas, so it does not enjoy the preferential policy treatment that coalbed methane and shale gas do. Despite the lack of policy support, tight gas production jumped from 4.8 billion cubic meters in 2006 to 32 billion cubic meters in 2012.

This was due to accelerated development in the Ordos and Sichuan basins, and has made China the world’s second-largest tight gas producer after the U.S.

Advanced technology brought in by foreign partners has almost halved the duration of well drilling to about 120 days, and has doubled per-well daily gas flow to about 1.2 million cubic meters.

This success with tight gas could well be repeated with shale gas given the similarities between the two types of resources.

The main beneficiaries of China’s shale gas boom are its upstream producers, as their gas reserves and earnings will be boosted when commercial production takes off. Local oil services and equipment companies should also gain significantly from aggressive capital investment.

Strong volume growth should be a catalyst for gas distributors with the capacity to expand and penetrate undersupplied markets.

Hopefully, the biggest prize will be reserved for the country’s population, which would benefit directly from the availability of cleaner and cheaper fuel and indirectly from the economic stability resulting from improved energy self-sufficiency. 

By Duke Suttikulpanich

Duke Suttikulpanich is a director of oil and gas equities research at Standard Chartered Bank. The opinions reflected in the article are his own. ― Ed.