Blog Post

Stimulating Shale Gas Development in China: What Lessons to Learn from the US Experience?

Jul 22, 2014 | Zhongmin Wang, Alan J. Krupnick

China’s pressing need to reduce coal consumption has created a strong demand for the natural gas trapped in its large shale reserves. The Chinese government has already experimented with a number of policies aimed at promoting shale gas development, but building an industry that can successfully utilize these reserves will be difficult. Although the Ministry of Land and Resources has estimated that China contains about 25.1 trillion cubic meters of recoverable gas, less than favorable geology and infrastructure will make drilling, extraction, and transportation much more challenging than in the United States.

Despite these differences, analyzing the US shale gas experience offers useful insights into how China could overcome the problems inherent in exploiting its hard-to-reach shale reserves. In a new RFF discussion paper, with coauthors Lei Tian and Xiaoli Liu of the Energy Research Institute in Beijing, we do just that. Much like the US experience, China will need to first lower costs through investments in drilling and other innovations in order to become profitable enough to encourage further capital investment. Once an initial innovation stage has produced cost-effective technologies, a second scaling-up stage can increase production to increase profitability and explore new plays.

In the US, shale innovation was promoted by the federal government through the adoption of a number of policies aimed at developing new natural gas sources in response to severe shortages. These policies took the form of R&D support as well as fiscal and incentive pricing programs; combined with major private entrepreneurship from Mitchell Energy, they jump-started the shale gas boom. Unlike US private operators and service firms, China’s oil and gas industry is mainly dominated by three vertically integrated national oil companies (NOCs), which form an oligopoly. Many in the country see this as a hindrance to unconventional gas development; in their view, opening the market to new and smaller companies would encourage competition and investment from a wider number of firms, providing a more optimal environment for innovation.

But although the presence of an independent natural gas firm (i.e., Mitchell Energy) played a critical part in spurring early US shale innovation, it would be wrong to assume that opening Chinese shale development to non-NOCs would solve the country’s innovation problems. New entrants may be helpful in scaling up production later, but they do not have any prior experience in oil and gas drilling and they do not have any of the advantages that Mitchell Energy enjoyed when it started to drill shale gas wells, including technical expertise and financial resources.

Rather, the size and experience of China’s NOCs give them huge advantages over the new entrants; this is especially true for two of the companies, CNPC and Sinopec, which have already acquired some advanced technologies through their years of experience in drilling and fracking tight gas. NOC access to production sharing agreements and geologically favorable tracts also offers them advantages over shale development. Ultimately, the technical and financial capabilities of China’s national oil companies will be critical in the development of technologies that can overcome the geological complexity of China’s shale basins. Though the implementation of market-oriented reform through the inclusion of new participants can be justified in a number of ways, it is China’s NOCs that remain best equipped to undertake the challenges of developing the country’s shale gas industry.