China attempts to shake its dependence on coal by turning to shale gas

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Once an exciting prospect on the international energy scene, China’s long-awaited shale gas boom has failed to materialise, with interest waning as oil prices fall. Eventually, however, the country’s hunger for energy will trump all other concerns

Prior to its use with oil, the technique of fracking was actually pioneered for use in shale gas extraction; Mitchell Energy produced the first shale gas in the north of Texas in 2000. The technological process behind fracking involves extracting gas from sedimentary rocks, through a mixture of horizontal drilling and hydraulically fracturing rocks – hence the name ‘fracking’. Since 2000, natural gas production has surged, lowering the cost of the energy source around the world. Increasingly, it is now favoured over other cheap sources of energy such as coal. However, despite a crash in prices – as happened with the fracking revolution in petroleum oil – production has not fallen in a major way. Rather, shale gas is set for a continued boom.

As any observer of energy markets will know, the US has stormed ahead in the extraction and use of shale gas, becoming by the far the world’s largest producer. However, while it has a technological and commercial lead for now, it is far away from a monopoly on accessible reserves of shale gas. According to Advanced Resources International’s World Shale Gas and Shale Oil Resource Assessment report, prepared for the Energy Information Administration (EIA) in 2013: “Two-thirds of the assessed, technically recoverable shale gas resource is concentrated in six countries: the US, China, Argentina, Algeria, Canada and Mexico.” Canada and Argentina have since commenced large-scale extraction of their shale gas reserves.

China, meanwhile, has only steadily increased its ability to extract shale gas in recent years. And yet, although China only produces a small amount of shale gas now, its reserves are estimated to be 1.7 times larger than those of the US. This means China has the largest reserves in the world, as well as a growing population and economy that will require their use. Currently heavily reliant on coal for its huge and growing needs, natural gas is seen in China as a cheap and clean alternative.

The Chinese state relies on the steady performance of the economy to legitimise, in the eyes of its citizens, Communist Party rule. At the same time, tied to this is the guarantee of improving living standards. While coal has definitely boosted living standards in some regards, air quality has become an increasing concern for Chinese citizens. Transitioning from coal to liquid natural gas promises to provide a practical solution, mitigating the effects on air quality without forsaking the cheapness and abundance required for China’s economy and growing prosperity. However, since 2015, China’s shale gas development has stalled. International firms, essential for its development, have been pulling out of agreements and partnerships, raising the question of whether China’s purported shale gas boom is just a paper tiger.

China has the largest shale gas reserves in the world, as well as a growing population and economy that will require its utilisation

Energy needs
China is the world’s second-largest economy and the world’s biggest consumer of energy. Its consumption outstrips that of the US – the world’s largest economy – by 30 percent. Collectively, the nations that make up the EU also have a larger GDP than China, yet China consumes twice as much energy. Being the workshop of the world, it could be no other way – China’s economy is incredibly energy intensive. According to Arthur Kroeber, in his book China’s Economy: What Everyone Needs to Know, China “needs to burn the equivalent of 2,000 barrels of oil to generate a million dollars’ worth of economic output”. To put this into perspective, it is more than twice the figure of the US and three times the collective total of EU member states.

To service this huge energy demand, as mentioned previously, China currently relies on coal (see Fig. 1). Since embarking on its rapid industrialisation – primarily spurred by energy-intensive heavy industry – China has found coal to be both cheap and abundant. The country now consumes nearly the same amount of coal as the rest of the world combined, according to the EIA, accounting for 49 percent of total global coal consumption. Roughly three quarters of China’s gigantic energy demand is met with coal, half of which goes into power plants to generate electricity, with the rest being used to directly fuel industrial activity.

China’s coal-fuelled economic boom has done wonders for the country. Millions have, since the 1990s, been lifted out of extreme poverty. Across both city and countryside, incomes have risen, and China has gone from being crushingly poor, technologically deprived and isolated, to a modern industrial economy in just a few decades. As the country enjoys cheap and abundant reserves, coal has played a key role in this – such development would scarcely be imaginable without it. The country’s demand for coal grew at an average of 10 percent per year in the 2000s. In recent more recent times, however, as China has become richer, it has started to pay more attention to some of the concerns over the heavy use of coal.

Shale 1Down the shaft
Coal is a dirtier alternative to other fossil fuels, releasing more pollution into the atmosphere than other hydrocarbons such as gas or oil. The results of large-scale pollution are being felt across China, with cities becoming blanketed periodically by thick smog. Most significantly, in late 2015, Beijing issued a red alert over air pollution for the capital city for the first time. School classes were cancelled and traffic numbers reduced. As The New York Timesreported at the time: “Chinese cities, especially northern ones, have some of the world’s worst air pollution…most of it comes from industrial coal burning.” For an industrialising country, smog is, however, par for the course. London in the late 19th and early 20th centuries suffered similar issues, alongside other great economic powers in their early years, from Tokyo to Pittsburgh. Increasingly, however, Chinese citizens are becoming dissatisfied with both the smog itself, and the disruption to everyday life that it can bring.

As a result, China has come to focus its attention on creating what it terms an ‘ecological civilisation’. This policy is not some attempt to do away with China’s much-needed ongoing industrialisation, but rather, according to leaders, is a move to factor in some environmental concerns while maintaining economic growth. In the west, environmentalism and meaningful economic growth are often portrayed as opposing concerns, with a trade-off required to favour one over the other. China, however, seems to view it otherwise. The ecological civilisation policy, according to China Dialogue, “is set alongside the other high-level political slogans that are emerging as the signature of Xi Jinping’s leadership, notably the Chinese Dream” of doubling GDP and per capita income by 2020.

Therefore, China is opting for a transition from using coal to service its energy needs, moving to the much cleaner liquid natural gas. According to Smithsonian: “Burning natural gas…produces nearly half as much carbon dioxide per unit of energy compared with coal.” According to Kroeber, China’s leaders are now committed to changing their “energy mix to rely less on coal and more on cleaner fossil fuels”.

Related to this is another issue with coal. As mentioned above, China is uniquely energy intensive. This stems from the fact that coal is less efficient than other fossil fuels; to produce a single unit of electricity, it takes 25 percent more coal than natural gas. Using gas as a source of electricity not only allows for a better environmental outcome (without sacrificing economic advancement), it also allows for more efficient energy use.

China has, since the early 2000s, increasingly looked to natural gas as a source of energy. According to Kroeber, in China natural gas imports from around the world “rose from almost nothing in 2002 to about 30 percent of demand in 2014”, with much of this coming from nearby producers in the Asia-Pacific and central Asian regions. China’s reliance on coal was, for many years, a matter of common sense: it was abundant in easy-to-reach reserves, while gas had to be imported at higher costs. Now, however, China is looking to make use of its own vast shale gas reserves.

Collectively, the nations that make up the EU have a larger GDP than China, yet China consumes twice as much energy

Frack attack
As noted, China has seen a steady growth in its demand for natural gas imports. Between 2012 and 2013 alone, China’s demand grew 15 times faster than the rest of the world’s. Yet, if this demand is to be sustained – and the evidence suggests it will be – domestic production must step in. With the world’s largest shale gas reserves, China must look to meet its needs with its own production.

Shale gas was first discovered in China in the mid-1990s. However, with coal still king, little was done to utilise it. Small efforts were made to develop production – in 2014, 1.3 billion cubic metres of shale gas were produced – but overall, the numbers remained negligible when compared to China’s overall energy use. This was also the case when compared to the size of its conventional natural gas use, of which shale accounted for a mere 0.2 percent in 2013. Of the shale gas that was produced, nearly all of it came from a single field, operated solely by the firm Sinopec.

The Government of China has been attempting to change this, announcing bold targets and making deals with international firms. The key site of China’s shale gas revolution was supposed to be the Sichuan Basin, in the east of Sichuan. It is here that much of China’s large reserves of shale gas can be found and this province has often served as the scene of development in communist-run China. Following Deng Xiaoping’s ascent to power and the start of economic liberalisation, Sichuan has been at the forefront of reform. It was one the first regions in the country to start to experiment with market-based economic reforms.

International firms have been courted to develop wells on the site. Gary Locke, the United States Ambassador to China between 2011 and 2014, said at the 2013 US-China Oil and Gas Industry Forum: “From Sichuan to Eagle Ford, Texas, from Bohai Bay to the Marcellus Shale in Pennsylvania and Ohio, US and Chinese companies are investing and working together to increase energy production in both countries.” China and the US have since signed various agreements, most notably in 2009 when President Obama and President Jintao signed a deal for mutual cooperation in developing China’s resources, with shale gas at the forefront. Shortly after this, state-owned PetroChina signed an agreement for cooperative exploration and development of shale gas with Shell for the Fushun-Yongchuan block in Sichuan Province. Soon, many of the world’s top energy firms started to take an interest. AirChina even started offering direct flights from Texas to Beijing, facilitating the transport of any Texan energy executives with an interest in investing.

Coal is still China’s dominant and most important energy source
Coal is still China’s dominant and most important energy source

Since 2015, however, the country’s shale boom has looked in doubt. Many international firms have pulled out. After a two-year study, ConocoPhillips ended its talks with PetroChina, following the conclusion of a two-year study questioning shale gas production’s commercial viability in the country. Shell was also set to be one of the biggest investors and partners in China’s shale industry, pledging billions of dollars. As Shale Gas International reported: “As recently as March 2013, Shell pledged to spend as much as $1bn a year to explore shale and other resources in China. At the time the company bet hard on shale exploration in the Sichuan basin in cooperation with PetroChina.” However, in 2015 the company announced it would be pulling back much of that investment, before announcing it was completely quitting Chinese shale earlier this year. At the same time, China’s shale gas production targets have been slashed. As Bloomberg reported: “China missed its annual shale gas target of 6.5 billion cubic meters last year, and earlier reduced its 2020 production goal to about a third of its original estimate.”

Tough times
Many of the international energy firms quitting Chinese shale exploration have done so due to a general tightening of spending, following the onset of the 2014 oil slump (see Fig. 2). However, any decision as to where to cut spending depends upon the specifics of a certain project. And shale gas in China, while abundant and promising for the future of China, is, according to Shale Gas International, “a thankless job” for those exploring and developing it.

The geological formations of China’s shale sites are rather different to those of the US. This means that any firm with US experience will face new challenges, rather than merely being able to replicate their US approach and apply existing technologies wholesale. This inevitably increases the cost. Added to this is the fact that, beyond just being different to US, the geology is difficult to work with, while there is also a severe lack of data regarding the geology of many sites – again, increasing or making uncertain extraction costs. All of this – compounded by the pressure of soft oil prices – has led many international energy firms to disengage from what seemed to be a promising prospect.

Shale 2However, this should not be seen as the end of China’s shale gas boom: rather, it is a delay. China has clear and valid reasons for developing its shale gas industry. Right now, energy firms – owing to the global oil glut – are being cautious, and are therefore scaling back. But the current climate is not necessarily set to continue. Oil prices may never reach the $100 highs again, but concerns from energy firms about investing in shale gas exploration are predicated not on the price of oil itself, but the uncertainty it is currently bringing. Large, speculative projects are being cut across the board in response to such uncertain times, in an effort to recalibrate in an era of low prices. Once the market has stabilised, we can expect renewed interest from energy producers in Chinese shale gas. Until then, the gas will remain underground, and China’s need for it will only grow. The vast shale fields in the Sichuan basin will not go anywhere and nor will China’s desire to develop them. Indeed, the size of shale gas reserves seems to be growing and Chinese state-owned firms are still exploring too: in August last year, PetroChina reported it had discovered an additional 63 billion cubic meters of proven shale gas in Sichuan.

China has always been a tough environment in which to invest: Hank Paulson, the former US Treasury Secretary, recounted in his recent book Dealing with China the complex processes he and other officials from Goldman Sachs (where he was working in the 1990s) had to navigate to make many of China’s large IPOs. Yet, despite the complex Communist Party hoops that had to be jumped through, and the bureaucratic intricacies that had to be navigated, firms such as Goldman Sachs persisted, and eventually they successfully took Chinese state-owned firms to their IPO and the returns justified the entire process.

Likewise, for international energy firms, the potential returns for investing in Chinese shale gas will be worthwhile in the long run. China has the largest shale gas fields in the world and is the largest energy consumer. Once distantly related issues such as low oil prices ease, investing in Chinese shale gas development will once again seem not only commercially viable, but vital. China may not have quite managed to set its shale gas boom in motion yet, but it is only a matter of time until it does.

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