China's environmental degradation has become a growing source of public consternation and a potential political liability. Premier Li Keqiang declared a "war on pollution" in March 2014, vowing to reduce emissions from power generation and transport—the main culprits of China's recurring bouts of toxic smog, referred to as "airmaggedon"—by replacing coal and oil with natural gas. The government has already laid out ambitious plans to more than double the share of gas in China's energy mix, from 3.9% in 2010 to 8.3% in 2015, as part of the 12th five–year plan (2010–2015). Beijing had anticipated that gas consumption would increase threefold by 2020, reaching 300-350 billion cubic meters (bcm), up from 100 bcm in 2010. But with an aggressive fuel-switching agenda on the cards, the State Council, in late April, revised its target to 400–420 bcm of gas consumption by 2020.
While China's domestic production is increasing rapidly, it cannot meet the surge in demand. As a result, its import dependency has risen steeply: in 2006, China relied on imports for 2% of its gas. In 2013, a third of its gas came from imported LNG and pipeline gas. If the current trends in demand and domestic production growth are sustained, import reliance could reach up to 50%. Global LNG producers from Russia, Australia, the Eastern Mediterranean and North America are all looking to position themselves in the Asian market as China, Japan and Korea become top global gas consumers. Yet if China successfully taps into its vast shale potential, it will fundamentally alter the dynamics of the global gas market.
Beijing has therefore made shale development a top political priority. Ministries have been busy reviewing and learning from the US shale revolution, while Chinese oil and gas companies have been investing in shale plays in North America in order to acquire the expertise to develop their own shale resources. China's Ministry of Land and Resources initiated regulatory changes that would allow it to tender shale blocs to private investors—a dramatic departure from the existing practice of licensing out oil and gas acreage to state-owned companies. Shale was also elevated to the ranks of a "strategic emerging industry", giving it a boost in funding for technology and experimented with various incentive schemes. Finally, shale was one bright spot in an increasingly tense US-China bilateral relationship, as US firms started investing in shale and both governments initiated a joint shale gas initiative.
In 2010, Beijing was hopeful that China was on the brink of its own shale revolution, and issued a target of developing 6.5 bcm of shale. It had also hoped to produce 60-100 bcm of shale by 2020. Earlier this year, China's state-owned Sinopec announced breakthroughs at its Fuling block in Chongqing, promising to reach the government's 2015 targets.
In early August, however, China's National Energy Administration (NEA) reportedly said that it would revise its 2020 target to around 30 bcm. Such a revision should not come as a surprise. The sector is at a nascent stage, the geology is still unclear and therefore the technological needs and the pricing environment are all open questions. Producing 60 bcm, let alone 100 bcm, within 10 years was ambitious from the outset. Even the US shale revolution, that essentially took off in 2000 and reached a dramatic increase in output within five years, was almost 20 years in the making – thousands of wells had been drilled by private firms, backed by various government incentive schemes and, when shale took off, natural gas prices were high enough to sustain development efforts. China's state-owned oil and gas companies have thus far drilled tens of wells, in a low price environment that leaves their ability to make a return on investment uncertain. Private players hoping to tap into the sector face even greater uncertainties, including access to pipelines—which are controlled by the state-owned companies—and consumers reluctant to pay the price of what could prove to be a costly investment.
The revision of the 2020 goal does not suggest, however, that the government's commitment to shale is wavering. On the contrary, a new and more realistic target will put the sector's development on more sustainable footing. Moreover, the initial (and tentative) lessons from Sinopec's Fuling breakthrough will be instrumental in guiding the regulatory framework going forward.
The good news so far from Sinopec's (short) experience at Fuling is that even in the current price environment, Sinopec seems to be breaking even. Further price hikes—recently announced by the government—could allay investors' fears about the commercial viability. The bad news is that Sinopec's technological breakthrough was home grown. Sinopec's Fuling discoveries seem to have been made using Chinese technology, which could lead Chinese oilfield service companies to try and crowd out foreign investors, and lobby the government for protection.
These are still early days, and China's other shale plays may require different technologies. Moreover, western technology leaders will still find plenty of opportunities in China's burgeoning gas sector, especially as the Chinese government gradually opens the energy sector to more private and foreign participation. The Ministry of Land and Resources is planning a third shale bid round, in which it hopes to deregulate licensing and approval powers to local governments. Joint-government initiatives will also span numerous topics, including industry best practices; environmental issues and conduct joint technological studies. The road to China's shale revolution is still long. There will be bouts of optimism, but also setbacks, followed by adjustments in targets and policy tools to achieve them.
In the meantime, the US still has a significant role to play in China's shale sector, as investor, advisor and advocate for different industrial or environmental practices. And maybe, if the 30 bcm shale target proves to be ambitious in 2020, it could also become an important gas supplier.
