Shale Gas Exploration Greatest Winner From Private Investment Drive

BMI View : CNPC's decision to open their doors to private sector investment offers significant opportunities to international oil companies. We see the biggest potential upside falling to the country's nascent shale gas sector, which will benefit from the wider involvement of experienced international majors.

China National Petroleum Corporation (CNPC) has announced plans to open six key sectors to private investment. According to CNPC chairman Zhou Jiping, the company will seek joint investments in unconventional oil and gas exploration, pipeline construction, refining and petrochemical complexes, overseas exploration and production and financial operations. What form these joint investments will take remains unclear, with CNPC indicating that shareholding structures will vary by project. The move is the latest indication of the government's desire to build a more open and competitive energy sector. Last month downstream behemoth Sinopec announced its decision to sell up to 30% of its oil retail unit, which comprises over 30,000 fuel stations, to private sector investors. The implications for China's oil and gas sector and potentially wide-ranging; however, in our view, CNPC's decision holds especial significance for the country's nascent shale gas sector.

China has become heavily dependent on imports to satisfy ballooning domestic energy demands. We estimate that in 2013 natural gas imports reached 47.83bn cubic metres (bcm), and forecast this to increase rapidly over the next 10 years, hitting 121.12bcm by 2023. In a bid to rein in their spiralling import dependency, the government is looking to develop the country's vast shale potential, which China's Ministry of Land and Resources estimates at around 25.1tn cubic metres (tcm).

Consumption Outstrips Production
China Natural Gas Production and Consumption (bcm), 2013-2023

Shale Gas Exploration Greatest Winner From Private Investment Drive

BMI View : CNPC's decision to open their doors to private sector investment offers significant opportunities to international oil companies. We see the biggest potential upside falling to the country's nascent shale gas sector, which will benefit from the wider involvement of experienced international majors.

China National Petroleum Corporation (CNPC) has announced plans to open six key sectors to private investment. According to CNPC chairman Zhou Jiping, the company will seek joint investments in unconventional oil and gas exploration, pipeline construction, refining and petrochemical complexes, overseas exploration and production and financial operations. What form these joint investments will take remains unclear, with CNPC indicating that shareholding structures will vary by project. The move is the latest indication of the government's desire to build a more open and competitive energy sector. Last month downstream behemoth Sinopec announced its decision to sell up to 30% of its oil retail unit, which comprises over 30,000 fuel stations, to private sector investors. The implications for China's oil and gas sector and potentially wide-ranging; however, in our view, CNPC's decision holds especial significance for the country's nascent shale gas sector.

China has become heavily dependent on imports to satisfy ballooning domestic energy demands. We estimate that in 2013 natural gas imports reached 47.83bn cubic metres (bcm), and forecast this to increase rapidly over the next 10 years, hitting 121.12bcm by 2023. In a bid to rein in their spiralling import dependency, the government is looking to develop the country's vast shale potential, which China's Ministry of Land and Resources estimates at around 25.1tn cubic metres (tcm).

Consumption Outstrips Production
China Natural Gas Production and Consumption (bcm), 2013-2023

The government has set an ambitious target for shale gas development, aiming to increase production from its current level of 0.2bcm to 60-100bcm by 2020. However, as we have highlighted previously, several geologic and commercial factors may serve to undermine China's shale gas development ( see 'Short-Term Shale Gas Targets Still Look Daunting', February 4 2014). In particular, China's reservoirs tend to be comparatively deep and thick, requiring a large amount of water in the hydraulic fracturing (fracking) process by which shale gas is typically extracted. Aside of straining the country's water resources, this also entails heavy transportation costs in delivering the water to China's often inaccessible shale gas play locations. Resources are also located far from the major demand centres, and expensive pipeline infrastructure would be required to bring the gas to consumers.

According to official estimates, the costs of drilling a shale gas well in China is around US$10mn; as a point of comparison, in the U.S. it costs just US$4mn. In recognition of these economic restraints, the Chinese government is looking to overhaul its domestic gas pricing mechanism. They are currently in the process of developing a more market-based pricing regime, and a trial reform is currently being conducted in the Guangdon and Guangxi provinces, indexing gas prices to oil. The government has recently announced that it intends to accelerate pricing reform in 2014, and when this takes effect, we believe higher domestic gas prices will help the commercial viability of China's shale gas potential.

Another major obstacle to China's shale gas development lies in the lack of expertise of domestic companies, which have dominated the first two licensing rounds. In the U.S., rapid development of its resources was driven by the plethora of highly specialised companies, contributing to a diverse competitive landscape and high efficiency. In light of this, we believe greater involvement of international oil companies will remain key to developing China's shale gas industry ( see 'Drilling Efficiency Key To Shale Growth', March 4 2014). The international oil majors have already demonstrated their desire to build a strong presence in China, with ExxonMobil, Shell, Chevron and ConoccoPhillips all having signed deals with Sinopec and PetroChina over their shale gas developments in recent years. As such, we believe the offer of a stake in CNPC's highly prospective shale gas licences will generate strong international interest, and significant upside to exploration and production following from these prospective joint ventures.

Major IOC Involvement In China's Shale Gas Exploration
Date IOC NOC Block Basin Area (sq km) Type*
Jul-11 ExxonMobil Sinopec Wuzhishan Sichuan 3,643 JSA
Mar-12 Shell PetroChina Fushun-Yongchuan Sichuan 3,500 PSC
Apr-11 Chevron Sinopec - Qiannan - JSA
Dec-12 ConocoPhillips Sinopec Qijiang Sichuan 3,917 JSA
Feb-13 ConocoPhillips PetroChina Neijiang-Dazu Sichuan 2,023 JSA
Mar-13 - CNPC Rongchang Sichuan 2,000 JSA
Nov-13 Shell Sinopec Xiang E Xi - PSC
*JSA = Joint Study Agreement; PSC = Production Sharing Contract; na = not available/applicable. Source: Shell, ConocoPhillips, Eni, ExxonMobil, Chevron, BMI
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