Producers Shift Focus to Chinese Shale Gas

Royal Dutch Shell (NYSE:RDS.A) announced that it plans to spend at least $1 billion a year on the exploitation of shale gas resources in China.

In an interview with Reuters, Lim Haw Kuang, Shell’s top China executive, confirmed that the investment is part of an aggressive strategy to expand into the world’s largest energy market.

The move is seen as yet another step in the company’s attempts to gain a stronger foothold in a country estimated to hold massive natural gas potential. Earlier this year, Shell signed a production sharing contract aimed at developing a shale gas block in China with state-owned China National Petroleum (CNPC). The deal was the first of its kind in the country and gained global attention across the natural gas market.

The deal is focused on shale gas exploration, development and production in the Fushun-Yongchuan block in the Sichuan Basin region. It is seen as a positive move for both companies in that Shell hopes to leverage the operational and technological expertise it has gained from developing shale gas plays in North America, while CNPC hopes to progress its premium oil and gas acreage.

China of growing interest to investors

Interest in China’s gas potential and the country’s willingness to partner with foreign third parties will no doubt be on the radar of many natural gas investors. China is still in the very early stages of tapping its shale gas resources, and the government has indicated that it is eager to identify the technology to unlock them.

A preliminary Energy Information Administration (EIA) assessment of world shale gas reserves undertaken in 2011 indicates that China has the world’s largest “technically recoverable” resources — an estimated 1,275 trillion cubic feet (tcf). That currently amounts to 20 percent of global reserves, far more than the 862 tcf in US shale gas stores.

Earlier this year, China’s top energy agency, the National Energy Administration, officially unveiled a target to produce 6.5 billion cubic meters (bcm) of shale gas by 2015, while the government announced that it intends to dramatically boost output to 60 to 100 bcm in 2020.

These goals may be overly optimistic, but oil and gas majors are certainly not sharing this pessimism. When asked whether Royal Dutch Shell remains committed to the plan to invest $1 billion a year in China’s shale gas over the coming years, Lim responded, “[i]f there has been an adjustment to that pledge, it could only be an upward revision.”

Interest not limited to Shell

Gaining a market share in one of the highest energy-consuming nations in the world has not only been of interest to the Dutch firm. Oil and gas majors, including Chevron (NYSE:CVX), Total (NYSE:TOT), BP (LSE:BP) and ExxonMobil (NYSE:XOM), are all currently working towards gaining a stronger foothold in China, where the use of natural gas is forecast to triple over the coming decade. Meanwhile, state-owned oil giant Sinopec has already started drilling the first of nine planned shale gas wells in Chongqing, and expects to be producing 11 to 18 bcf of natural gas by the end of this year.

This surge in interest is bound to escalate as more analysts speculate on the direction that gas is moving in a nation desperate for an affordable and abundant energy source. Natural gas prices in China could rise by up to 80 percent from current levels as the government stimulates domestic shale production to reduce its energy imports, according to a report released last week by Bank of America Merrill Lynch. The report also states that gas may rise to as much as $11.4 per million British thermal units by as soon as 2016 as the government revises its pricing formula for the fuel.

Besides wanting to expand its reserve base, Royal Dutch Shell also confirmed that it plans to relocate its global business unit for coal bed methane (CBM) to China later this year in an attempt to establish a global research hub for unconventional oil and gas. China estimates that CBM — essentially gas trapped in coal seams — could meet up to 15 percent of the country’s needs as soon as 2020.

Not all plain sailing

Despite such large-scale investments, China still faces challenges in replicating the North American shale gas revolution. In comparison to other natural gas hubs, one of its main hurdles is its unique geology and population density. Above ground, China lacks the pipeline network that has enabled the US to quickly bring its new natural gas supply to market. There are also mounting concerns related to whether water-intensive energy development would be able to flourish in the country given the current strains on irrigation-dependent agriculture.

Despite these setbacks, China has shown its support in moving the sector forward through energy price reforms and spending billions of dollars on gas imports and infrastructure to minimize its coal use. According to a report published earlier this year, the sector currently has a combined market value of approximately $32 billion and boasts valuations of more than 20 times historical earnings.

China’s Five-Year Plan

A recent report by National Geographic puts the Asian nation’s natural gas ambitions and potential clearly into perspective. It notes that in its 12th Five-Year Plan (2011 to 2015), China set the goal of producing 229.5 bcf of shale gas by 2015, while the US produced 30 times that amount in 2011. However, the report goes on to highlight the fact that while the US shale gas revolution has amounted to roughly a seven-fold increase in production over the past five years, China’s aim will see it ramp up shale production by at least 10-fold between 2015 and 2020 alone.

Investors will be following the development of China’s shale gas resources closely. Although there is still a sense of mystery shrouding the country’s true gas potential, many will be seeking to invest in both junior and large-scale companies that have successfully established, or are seeking to establish, Chinese business relationships. China presents a unique market opportunity in that it is not only a source for vast quantities of natural gas, but also a market desperate for product.

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