Author: Jonathan Strahl and Joe Chang
In July of 2008, natural gas prices at Henry Hub, Louisiana – the most liquid trading point in the U.S. – reached over $13 per MMBtu, the highest in recent memory. Many industry commentators believed that high gas prices, due to fast-declining production from conventional reservoirs, were a fait accompli, and that the U.S. would need to massively increase its gas imports in order to keep up with demand. However, as of today, natural gas contracts traded at the same hub are in the anemic sub-$3 range, and instead of imports, companies are actively examining and investing in export facilities to send North American gas abroad. What happened?
While the global financial crisis and recession in the second half of 2008 contributed to the fall in prices, the real story is the growth in gas production from shale. In response to high natural gas prices of the last decade, gas production from shale – primarily from enterprising small producers – began to grow. As production grew, the supply of unconventional natural gas from North American shale began replacing and outpacing the declines in conventional gas production, leaving the continent flush with cheap gas.
Cheaper electricity prices, lower heating costs, and a revitalized petrochemical industry are among the economic effects of what has amounted to a dramatic shift in the U.S. energy landscape. It is natural to consider whether China, a country with vast yet unproven shale gas resources, can repeat the “miracle” that has taken place in the United States.
At first glance, a boom appears plausible. China has the world’s largest shale gas resources. Recent figures from China’s Ministry of Land and Resources indicate that, at more than 25 trillion cubic meters, unconventional reserves dwarf China’s paltry conventional gas reserves. In a country of 1.35 billion people, with high GDP growth, there is certainly no lack of potential demand for gas. However, as the world’s largest emitter of carbon dioxide (largely from coal), China and its central planners see developing cleaner sources of energy as a priority. According to the 12th Five Year Plan, the goal is to increase the share of natural gas from last year’s 4.4% of the total energy mix to 10% by 2020, when the country may be consuming as much as 400 billion cubic meters of gas. Compare this to the U.S., where gas accounted for 28% of the total primary energy consumption in 2011, and it is clear that China has substantial room to grow both supply and demand.
Nevertheless, the story will be far more complex than that.
Despite the abundance of unconventional gas resources, ample Chinese energy demand, and ambitious political targets, actually developing shale gas in China remains a difficult proposition. Aside from the purely physical challenges—such as complex geology and lack of water supplies near most of the major deposits—there are some economic and regulatory barriers that may thwart the hoped-for boom.
The richest shale plays are located in the western part of China, far from the largest demand centers on the eastern seaboard. An extensive pipeline network is needed to transport the gas from the wellhead to the factories, businesses, and households for consumption. The U.S., with 480,000 km of pipelines built over decades, has the equivalent of the interstate highway system for natural gas, as well as a legal mandate for open and competitive pipeline access. In China, pipeline capacity is severely constrained. The country has only 36,000 km of pipelines today, with a goal of 100,000 km in place by 2015—which is still only one-fifth the size of the U.S. network. Furthermore, China National Petroleum Corporation (CNPC), a state-owned oil and gas giant, owns and controls 90% of the existing pipeline capacity and as much of the gas supply. CNPC is naturally inclined to keep the limited capacity for its own gas, which hinders the ability for small and medium-sized companies to lead the growth of the shale gas industry as they did in the United States.
High prices drove the widespread development of shale gas in the United States. In China, gas prices are state-controlled, and producers’ returns are limited. Nevertheless, gas is already quite expensive in China. For example, at current prices, natural gas in the city of Guangzhou is generally 4 to 5 times more expensive than in the United States. Even at these prices, gas shortages occur in China with alarming frequency. Herein lies the problem: in order for shale gas to flourish, prices would have to be even higher. The Chinese regulators understand this, and have started taking steps towards liberalizing the country’s complex system for setting gas prices. As of 2011 price controls have been relaxed in the provinces of Guangdong (where Guangzhou is located) and Guangxi as part of a pilot program so that buyers and sellers are free to set a market-clearing price. However, these are two of the richest provinces in China, and rolling out price reforms to the rest of the country would be fraught with additional political and economic complications.
Besides pipelines and pricing, Chinese policymakers must confront and overcome other obstacles such as defining the roles of the private vs. state-owned enterprises and determining mineral and water rights management. Nevertheless, these are not insurmountable challenges. Like the development of any large-scale infrastructure project in China, given the proper amount of government support, the pace of construction could exceed all international expectations. Market reforms, likewise, can take place with surprising alacrity – as long as there is enough political will. China is still extremely early in shale development: there is no commercial production, and there won’t be any substantial volumes for a few more years. Regardless of the pace of reform, we can be certain that any shale gas ‘miracle’ in China will evolve quite differently from North America’s boom.
Jonathan Strahl earned his Master’s in 2012 from the Ford Dorsey Program in International Policy Studies (IPS) at Stanford University, pursuing a concentration in Energy, Environment, and Natural Resources. As an IPS student at Stanford and a research assistant at the Program on Energy and Sustainable Development, he explored how to create economically and environmentally efficient incentives to transform the energy sector.