Chinese Shale Gas: Potential Market Changer

The sector once again came under the spotlight last week with the announcement that Houston-based oil and gas giant ConocoPhillips (NYSE:COP) has teamed up with China’s largest oil and gas producer, PetroChina Company (NYSE:PTR,HKEX:0857). The partnership is based on agreements related to unconventional resources in Western Australia and China’s Sichuan Basin.

PetroChina will acquire an interest in two Western Australian exploration assets and establish a joint study agreement (JSA) for unconventional resource development in the Sichuan Basin, according to a company statement. The agreements still require government and partner approval.

China’s interest in unconventional plays is not entirely new. It began its push in that direction in late 2009, inspired by the shale boom in the US. Since then, its state energy firms have entered multibillion-dollar shale deals with Chesapeake Energy (NYSE:CHK) as well as Devon Energy (NYSE:DVN).

Working interest and shale gas study

PetroChina will acquire a working interest in the Poseidon offshore discovery in the Browse Basin, as well as in the Goldwyer shale in the onshore Canning Basin; however, most attention has been focused on the parties’ decision to enter into a JSA to identify unconventional gas reserves in the Neijiang-Dazu Block in the Sichuan Basin.

Under the JSA, ConocoPhillips and PetroChina “will study the potential for unconventional resource development in the approximately 500,000 acre Neijiang-Dazu Shale Block in the Sichuan Basin.” The study is touted in ConocoPhillips’ press release as an important step in evaluating the potential for unconventional resource exploration in the area; if technically and commercially viable, the companies will advance development under a production-sharing contract.

The Sichuan and Tarim basins are considered the most promising shale gas exploration areas in China due to their thick marine sediments, which were laid down on the bottom of ancient seas, a recent Reuters article notes. Developing plays in these areas also make sense from a logistical aspect: Sichuan is close to populated areas and already has gas pipelines and other infrastructure in place as a result of the development of conventional gas fields in the surrounding area.

China’s gas potential

While China boasts geology that is largely different to that of North America, many in the industry believe that gas trapped in difficult-to-access areas, such as Sichuan, is in fact recoverable. An article published in Oil & Gas Financial Journal notes that researchers believe that these regions boast deep reservoirs that carry low permeability and porosity, adding that steps taken by the US to develop similar reservoirs in North America over the past few years could also be effective in China.

The country’s shale gas reserves have become a prime focus of its energy sector over the past few years. At the end of 2011, China’s recoverable continental shale gas reserves (excluding reserves in Qinghai and Tibet) reached 25 trillion cubic meters, as per a preliminary evaluation by the Ministry of Land and Resources conducted last year. That’s equal to the volume of its conventional gas reserves.

Reuters notes that estimates regarding the country’s potential vary, but most analysts put China’s technically recoverable shale resources at around 1,000 trillion cubic feet (tcf) (28 trillion cubic meters). That estimate makes them the largest in the world, overshadowing the US (862 tcf) by approximately 20 percent. Further, in its latest annual outlook, BP (NYSE:BP,LSE:BP) forecast that by 2030, China will be the most successful shale-gas developing country outside North America.

Challenges remain

While agreements between notable players are all well and good, China’s shale program faces a number of hurdles. The country’s basins are nowhere near as well explored as those in the US, and most deposits are buried very deeply below ground. A National Geographic report also notes that some observers claim China’s gas-bearing formations may have higher clay content than that seen in North America, meaning that they will likely be more difficult to fracture and prop open.

From a geographical aspect, Sichuan is also mountainous — a far cry from the wide open plains of shale hotspots such as North Dakota and Texas — making it a lot more challenging for surface fracturing operations.

Are western projects at risk?

One important issue for investors to consider is what initiatives like the ConocoPhillips-PetroChina study will mean for North American markets. With prices in the US plummeting as a result of increasingly efficient means of extraction, many are banking on schemes aimed at exporting gas to Asia.

Less than two months ago, Chevron (NYSE:CVX) announced that it would be buying out the minority positions that Encana (TSX:ECA,NYSE:ECA) and EOG Resources (NYSE:EOG) held in a proposed liquefied natural gas project in Kitimat, a town on Canada’s British Columbia coast. That was followed by TransCanada’s (TSX:TRP,NYSE:TRP) confirmation that it had been chosen to build a $5-billion pipeline to connect expanding volumes of British Columbian shale gas to Canada’s West Coast. Both of these projects are highly reliant on Asian gas price premiums, which could be at risk if Chinese shale formations prove economical.

China’s shale exploration is still at an early stage and many believe that exporting gas eastward is the future of the North American market. Those circumstances mean that if China is able to effectively tap into its own shale formations, North American projects like the one planned at Kitimat might not be economical.

Large-scale production of shale gas from the Sichuan Basin will not be easy as each formation poses its own unique challenges. However, these problems do not appear to be worse than they are in any other part of the world. Further, China is enormous, meaning that there will be little question of where to market any shale gas that is recovered. Taking into account the country’s shale resources, large prospective market, readily available capital and proven engineering expertise, investors should keep China’s potential impact on the North American market in mind.

Securities Disclosure: I, Adam Currie, hold no direct investment interest in any company mentioned in this article.

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