Pipe Dreams: Can China Extract it’s Shale Gas Reserves?

Shale Gas

China’s shale gas reserves, if exploitable, could lessen the country’s reliance on coal and oil imported from neighboring states

The Chinese government has set an ambitious target for domestic shale gas production, an energy source which could support the country’s growth. However, China is yet to develop a commercially viable method of extracting shale gas and without substantial technological development, it’s unclear how this target will be reached. Can China tap this precious resource to buoy its slowing economy?

Professor Liu Antung

Professor Liu Antung

After the US began successfully extracting vast quantities of shale gas, a valuable energy source, a decade ago, the rest of the world launched massive exploration projects to locate shale gas deposits. China is reportedly sitting on huge shale gas reserves which represent an enormous and cheap, home-grown energy supply—if  only it could be extracted. Recently, the Chinese government re-doubled exploration efforts by inviting foreign as well as Chinese firms to bid for exploration rights, a suprisingly open move in the normally restricted domestic Chinese energy sector. With environmental pollution and energy costs looming as potential inhibitors of China’s economic growth miracle, developing the domestic shale gas industry could allow the world’s second-largest economy to overcome these challenges.

Liu Antung, Visiting Assistant Professor of Economics at CKGSB, investigates China’s environmental policies and their economic impact. He sat down with CKGSB Knowledge Center’s Liz Mahoney to discuss what a shale gas industry would mean for China and the obstacles hampering the industry’s growth.

Q. What is the potential scale of the shale gas industry in China and what would a fully developed industry mean for the country’s development?

A. The shale gas industry has enormous potential in China. A couple of years ago, the Energy Information Administration (EIA) released estimates of the size of shale gas reserves across the world.  It found that China had the biggest reserves, far bigger than even the United States. Considering the enormous impact which shale gas development has had on energy policy in the US, the impact on China could certainly be even more profound.

Shale gas will have two major macroeconomic impacts on China if it is developed to scale.  First, it will lower the cost of energy, which is great for industry and for consumers. Second, it will create new jobs.  These jobs typically include high-paying positions in engineering, mining and construction, as well as affiliated services, like restaurants and hotels.

Q. Would the price of energy be affected just in China or would there be global implications as well to energy prices?

A. Certainly the price of energy should be affected within China. The price of natural gas in the US fell by about half over the last five years, largely due to the influx of cheap new sources of natural gas. I would expect significant drops in the price of natural gas in China as well. This could have significant global implications to energy prices. Right now, China imports a substantial amount of its energy, particularly coal and oil. If China turns to its own natural gas sources, I would expect shifts in the types of energy China uses, diminishing the demand for these imports. The result could be lower energy prices for everyone.

Q. The Chinese government has set a goal of 6.5 million cubic meters production capacity of shale gas by 2015. Do you see this as a realistic goal in terms of the current rate of exploration and infrastructure development?

A. There are fundamentally many uncertainties about the process of exploiting shale gas. I think it’s quite difficult to project with accuracy what will happen. You can certainly have goals but (meeting) those goals is not assured.

Q. What are the limitations to developing this industry?

A. The biggest limitation in developing shale gas resources is the lack of water. Shale gas extraction basically works by squirting huge volumes of water into the ground to force natural gas out of little pockets and fissures in the rock. They have tried using other fluids, but my understanding is that water, mixed with a few other chemicals, has worked the best. So water is a crucial ingredient in the work. And water in China is very limited. China has some of the lowest per capita resources of fresh water in the world. The volumes of water you need to make this technology work are simply not available here. Until new technology that doesn’t make use of a lot of water is developed, it’s going to be very tough for China to extract meaningful amounts of its shale gas.

Another big concern in China is geography. A lot of shale gas happens to be located near Chengdu, which is really mountainous. This makes it more expensive to find and to exploit, since you have to move a lot of drilling infrastructure to the site.

Q. How damaging is the process to the actual water which is used and is any of that recoverable?

A. I heard an estimate that only about 15% of water pumped into the ground is recoverable. The rest remains underground. The effects on water quality are still being debated. I have not seen any studies so far which have conclusively shown that shale gas drilling causes ground water pollution. The closest I have seen are studies conducted by Resources For the Future (RFF), which says that Shale gas drilling has an impact on the salinity of water but not the pollution levels. If this pattern holds, shale gas is relatively innocuous in terms of its impacts on the environment.

Q. In January this year, Beijing and cities across north China experienced a prolonged period of high levels of air pollution which, according to World Health Organization (WHO) and United States Environmental Protection Agency (EPA) indexes, created an environment which was hazardous to humans (the indexes measure the concentrations of particulate matter and toxins in the atmosphere and are used to inform sensitive groups, or in worst case scenarios the general public, when they ought to limit prolonged exposure to outdoor air conditions or suffer adverse affects). How would an increase in the percentage of China’s energy consumption derived from natural gas affect air pollution levels which are largely a result of burning coal?

A. Everyone’s very excited about this possibility. Right now China is by far the top consumer of coal in the world. Coal is, as we know, the dirtiest source of energy, both in terms of air quality and in terms of carbon intensity. A shift from coal to natural gas in the US sharply reduced the carbon intensity of that country. For China in particular, a reduced reliance on coal and a greater reliance on natural gas would definitely improve air quality and would certainly reduce the carbon intensity of the economy.

Concretely, I think we would certainly see less “crazy bad” air quality days if China used more natural gas and less coal.

Q. Would a shale gas industry realistically provide an economically viable and less environmentally damaging option to coal fuel in China? Is there a potential for China to shift very completely from coal to shale gas?

A. Certainly, both coal and natural gas can co-exist. They have different physical properties in terms of their fixed and marginal costs, which makes them viable to different types of energy demand.

There is potential for a huge transformation in the way China uses its energy. Certainly, if the volumes of shale gas that can be exploited in a cost-effective manner are anywhere near what the EIA has projected, we should see substantial shifts in the composition of China’s energy mix toward cleaner-burning natural gas.

However, I hesitate to say whether China can shift completely over. The coal industry in China is established, it’s proven, and China has very large reserves of coal. I think it is more likely that when shale gas begins to develop, we will see a slowing of new construction on coal power plants, coupled with the construction of new natural gas plants.

Q. How would developing a shale gas industry affect other energy industries such as hydropower, wind power and solar industries?

A. Probably hydropower wouldn’t be affected very much. Hydro depends on large fixed-cost installations which run very efficiently once they have been set up. China already has extensive hydropower resources in place, and is looking to develop more, limited only by the areas where geography is appropriate.  I think it likely that nuclear also wouldn’t be affected. Again, nuclear power has high fixed costs, and is basically run at absolutely full capacity once it is installed.

Solar and wind would definitely be affected. Right now, I think the main factor driving demand for solar and wind power is their environmental benefits. The technology is still not at a place where these sources of power are cost effective, so these environmental benefits actually have to overcome how expensive solar and wind are. If shale gas comes into play, people may think that solar and wind are displacing natural gas rather than coal, and the environmental gains will be comparatively less. So I would guess that unless the technology for these forms of power improves significantly, these renewable energy industries would see the biggest adverse effects from shale gas development.

Q. In the latest round of tender bidding for shale gas exploration rights conducted in October 2012, heavy weights China National Offshore Oil Corporation (CNOOC) and China’s major gas producers were unsuccessful in acquiring blocks for exploration while relatively inexperienced companies were successful. It has been reported that these firms deliberately underbid as fiscal incentives were insufficient at the time, for exploration and research and development into the industry to be profitable. From an economic point of view, what fiscal or regulatory incentives could be introduced to encourage firms with the best knowledge and resources to enter the shale gas industry in China?

A. The biggest incentive to encourage shale gas development would be to allow developers to reap rewards commensurate to the huge risks they are taking. In the US, the shale gas industry was led by wildcatters, independent extraction companies which bet the farm on drilling for shale gas. I heard an interview where one of the founders of Mitchell Energy, one of the pioneers of shale gas extraction, talked about how nobody, even those in his own firm, really believed in the technology. Then they hit it big, and pioneered the first economically viable extraction techniques. A lot of people failed before these big successes could happen. Once the technology was developed, the major players moved in, purchased the small fish for big sums of money, and developed the industry into the size it is today. But nobody would have taken the risk of developing shale gas if they were not assured that they would keep the rewards of success.

In China, I would say that the risk-reward equation is more ambiguous.  The state controls so much of the energy industries. Entrepreneurs should expect that the state will control the shale gas industry too, if it gets developed. That may not be the right set of incentives to encourage development of this risky, difficult-to-develop industry.

Q. What can China learn from other countries, not only with regard to the technical side of shale gas production, but also management of the industry and its contribution to the energy sector and economy overall?

A. To compliment risk-taking with reward-setting. I think the Chinese government should credibly assure early entrants into the shale gas production industry that they will reap big rewards if they succeed. Setting up the correct incentives is important to encouraging the entrant of risk-taking participants in the development of shale gas.

Q. Is there anything which other countries have done wrong which China is doing better or could be doing better?

A. So far, some countries appear to have oversold the risks of it. France, apparently, has enormous shale gas reserves but it isn’t exploiting them because of environmental concerns. I think shale gas is an enormously promising industry and I’m excited to see how the potentially enormous positive benefits will be realized by the Chinese government. I’m very optimistic that good things will eventually materialize from these opportunities.

 

(Image courtesy: Flickr user Yukon White Light’s photostream)