UACA Friends Society

China’s Energy Investment and Strategy in Gas Shale

Good morning! My name is Ralph E. Winnie, Jr. I am the

Vice-President of US Asian Cultural Academy (UACA),

Director of China Programs for the Eurasia Center and the Vice-President

of Global Business Development for its Eurasian Business Coalition,

responsible for the promotion of business development, tax and trade

between the United States, China and the fifty nine nations comprising

Eurasia. I have worked on developing international business strategies

and reviewed business models for clients to ensure conformity with

Chinese laws and business practices. I first visited China in 2005 with a

firm client who had an interest in doing business in China and I was

eventually appointed by the Provincial Government of the province of

Guangxi, through the recommendation of the Guangxi Investment

Promotion Agency, as a Business Development Representative for North

America for several years. I was a guest of the Guangxi Investment
Promotion Agency in 2005, 2006 and 2008 at the annual China-ASEAN

Exposition which was established to introduce foreigners to the benefits of

doing business in China. I have hosted Chinese delegations on a regular

basis when they come to Washington, D.C. to meet with businessmen and

policy leaders on Capitol Hill regarding mutual business collaboration

between China and the United States. While working in China, I have

conducted market research, analysis and inspection of business

development opportunities in Central and Southern China and arranged for

a Hawaiian based land development company to go to a city in the Beibu

Gulf region called Fangchenggang to review and evaluate leisure property

development. I have also been presented a number of business

opportunities in China in areas such as bio mass, green energy, coal and

natural gas.

Over the past twenty years, China has experienced dramatic

economic growth, transforming itself from a basically agrarian society into

the world’s second largest economy behind only the United States. Since

the initiation of economic and political reforms in 1978, China has produced

an average annual growth rate of 10%. From 1978 to 2008, China

increased its GDP 83 times (NBS,2009) and lifted over two hundred million

of its people out of poverty. This has continued to generate increased

energy supply. Within China’s energy sector, production was stimulated by

the clarification of mineral exploration rights, the development of

transportation and roadway infrastructure projects, diversification of

management structures and the liberalization of environmental and safety

regulations. Rising living standards necessarily create more domestic

consumption, including high energy items such as air conditioners,

refrigerators and televisions. Consequently, the growing use of

automobiles by the Chinese consumer is creating energy security concerns

as China must routinely import more than half of its oil from countries such

as Iran, Russia and Venezuela. Therefore, it is not surprising that China is

scrambling to secure its future sources of energy today. The Chinese are

continuing to seek new sources of energy fuels throughout the world and

have even considered going into outer space, considering the possibility of

mining the moon for Helium 3 which is used in nuclear fusion research and

potentially a second generation fusion fuel.

Furthermore, as the sale of automobiles in China is expected

to surpass those in the United States within the next five years, there is

growing concern in China about energy security, power capacity shortages

as well as air pollution which are generating an increased desire on the part

of the Chinese Central Government to focus on alternative technologies,

including clean coal technology, nuclear power and renewable sources of
energy. In fact, China is expected to invest over 10 billion in support of

renewable energy development targets for 2020. However, achieving

these targets will depend on several factors , including well-trained and

highly skilled personnel, cost reductions in technology and effective

distribution of power generation (electric grids) through electric utilities. In

addition, international co-operation since the 1990’s has recognized the

importance of improving energy efficiency in China’s industrial sector,

ranging from pilot projects involving industry-government power contracts

to the development of energy service companies nationwide, including

energy performance standards for the Chinese industry. When China’s

energy consumption surged in 2000, a landmark renewable energy law

enacted in 2005, supported continued expansion of renewable energy as a

national policy objective. China obtains roughly 8% of its energy and about

17% of its electricity from renewable energy like wind power and solar
power (biomass and biofuels). These percentages are projected to rise to

roughly15% and 21% respectively by 2020.

In terms of energy consumption, China is now second only to

the United States. It is the world’s NO.1 consumer of coal, steel and

copper and as a consumer of oil and electricity, it is second only to the

United States. Given China’s vast coal reserves, coal is currently China’s

main fuel source and supplies roughly two-thirds of its energy needs. A

decision had to be made by the Chinese Central Government to exploit

such an abundant and reasonably inexpensive resource, but coal is

clumsy, inefficient, low grade and hard to adopt to modern energy. As

China’s coal demand has been rising, coal production has been falling

behind. 70% of electricity in China is based on coal which is an increase of

19% since 2000. Furthermore, through the use of coal over the past twenty

five years, China has now become the largest emitter of greenhouse gases

in the world. The IEA estimates that China, which generates more than

70% of its electricity with coal, will build 600 gig watts of coal fired power

capacity within fifty years. The amounts of gig watts is almost as much as

is currently being generated with coal in the European Union, Japan and

the United States combined. Also, domestic supply of coal in China has

failed to keep up with demand because China’s coal is generally located in

the remote northern and western areas of the country and is quite far from

coastal cities where energy demand is strong. China’s coal mines are old

and the coal is very deep underground and expensive to extract.

Increased amounts of stimulus funding by the Chinese Central

Government have been directed at massive economic and infrastructure

development projects in the rural areas, including establishing an elaborate

freeway system and a new east-west passenger railway line as well as

paving existing roadways. Therefore, existing tracks for coal transport can

then be freed for coal transport which is currently hampered by congested

railways and roads, making domestic deliveries of coal dangerous,

unreliable and more expensive than imported coal.

Since coal based power is directly responsible for such a major

share of global CO2 emissions, it will be imperative for China to develop

new technologies which allow energy to be extracted from coal without

noxious emissions. Given the rapid economic development in China,

China has become not only a major energy consumer, but also a significant

energy producer. Domestic coal accounts for roughly 76% of the total

production , followed by crude oil at 13%, hydro power at 8% and natural

gas at 3%. Furthermore, as coal fired generation and heavy

manufacturing make up a significant share of China’s emissions, the coal

boom has created many profitable deals. Last year, the coal industry made

a record number of mergers and acquisitions totaling roughly 52 billion and

Chinese state backed firms have continued to invest heavily abroad.

Even though China is one of the biggest energy producers and

consumers, the mentality and perspective of the Chinese Central

Government reflects a conundrum regarding coal. On the one hand, the

Chinese Central Government is concerned with making an efficient

contribution to energy security in the world markets. China has exported

over 13 million tons of charcoal and over 80 million tons of coal. According

to Prime Minister Hu Jintao, at whose lunch I had the privilege of attending

back in Washington, D.C. in late January, “ China is closing down a dirty,

coal-fired power generation facility at the rate of one every one to two

weeks, putting up a wind turbine at the rate of one every hour and has set a

target by 2020 of reducing carbon pollution by 40-45% per unit of gross

domestic product.” Indeed, China has embarked on the adoption of a vast

program to build hydro nuclear , wind and solar power stations to reduce

the proportion and amount of electricity China would generate using coal.

However, while China has developed the technology to build high

technology power plants, it comes at the end of a long cycle of construction

building lower tech coal-fired plants as well and construction has now

slowed dramatically because of the economic slump. Furthermore, it

cannot be refuted that China has adopted a process (“Ultra-Supercritical

Technology”) which uses hot steam to achieve the highest efficiency.

China has also drastically cut costs by building energy efficient power

plants throughout the country, making it more efficient to build a power

plant in China than to build a less efficient coal-fired plant in the United

States.
However, the overall perspective on coal echoed by the

Chinese Central Government is that coal fuels the Chinese economy.

They believe that if China is to continue to generate jobs, economic

stability and continue to lift people out of poverty, it cannot turn its back on

coal as a source of wealth, no matter how dangerous the mines or how

dirty the electric generators may be. The Chinese Central Government will

correctly point out that coal powers half of the nation’s railways and

supplies over half of the country’s feedstock. The power companies in

China are rumored to wield great political leverage, much like the tobacco

and railroad industries did in the United States for many years, and as long

as the power companies do not challenge the Chinese Central Government

regarding price powers on technology, they are allowed to expand China’s

coal fixed electricity system at a relatively modest pace. In short, the

Chinese power companies have traditionally wanted to stay with what they

know and that would be coal. Furthermore, while the power stations

currently being built in China to feed the new electricity grid is purported to

be very efficient and less polluting that many of China’s older coal plants,

coal is very cheap and hurts efforts to reduce greenhouse gas emissions.

China is doing a great deal to replace old, highly polluting

stations by building clean state of art coal-fired power stations at an

average of one a week to feed its booming economy, but there is no such

thing as a clean coal-fired plant. Indeed, Changhua Wu, China Director of

the Climate Group in Beijing, echoes the sentiment of many Chinese

officials when he repeatedly states that “in China you have to try everything

because of the scale of the economy and the speed of growth.” It has

been argued that China should seriously scale back its extensive nuclear

energy program as a result of the earthquake in Fukushima even though

nuclear has been a part of the picture in China to move away from coal.

While it is true that earthquakes pose a real threat in many parts of China,

according to Changhua Wu, “all energy options have risks” and if China

gave up its nuclear program in response to Fukushima ,or at least delayed

construction of new nuclear power plants, China would necessarily have to

rely on increased coal usage which poses greater pollution and

environmental challenges for the Chinese people which the Kyoto Protocol

Agreement strives to avoid. Consequently, the costs of nuclear power

have fallen drastically in coastal China, whereas coal involves the

importation of sources from abroad and the expensive transportation of

coal from inland China over an overextended rail/roadway system. These

factors necessarily make nuclear close to becoming economically

competitive with coal as it has become cost effective for the Chinese

moving in the direction of nuclear power. This is especially true when

recognizing that China’s earthquake challenge lies in moving towards

Japanese standards of construction as relatively few deaths in Japan

resulted from the earthquake itself or any radiation from the nuclear reactor

Rather, the ensuing tsunami resulted in most of the deaths. Furthermore, it

was not surprising when China’s Vice-Minister of Environmental Protection,

Zhang Lijun, was quoted as saying, “ We can learn lessons from Japan in

the development of nuclear power in China.”

In an effort to alleviate some of China’s reliance/addiction

towards coal as a major source of China’s energy policy, the Chinese

Central Government has been actively looking at other cost efficient

alternative energy sources. This has led the Chinese to seriously embark

on an international campaign aimed at development and exploration of

shale gas as part of China’s energy strategy focusing on natural gas.

China is drafting a National Shale Gas development plan, studying

relevant policies and establishing pilot shale gas development areas. It is

interesting to note that, in my discussions with younger Chinese energy

ministry officials, I found a large degree of enthusiasm for shale gas as a

cheap, relatively cleaner alternative to coal. It appears that this attitude

is slowly beginning to permeate the upper decision making levels of the

Chinese Central Government.

The Chinese have targeted North America because it has the largest

amount of shale gas and China recognizes the enormous opportunity for

shale gas exploitation as the gas produced from shale has over 40 billion

cubic meters which accounts for 8% of all the gas production. Until

recently, China has not carried out a comprehensive study on shale gas,

but it has recently been determined that Sichuan and Zhungaer are two

areas containing very large shale gas deposits.

China is believed to have significant shale gas potential. The

preliminary findings by the United States shows that the shale gas

resources in China might be 100 trillion cubic meters, the same level as

that of the United States. According to the Ministry of Land and Resources

in China (MLR), reserves of shale gas that can be mined amount to 26

trillion cubic meters. In April 2010, the MLR announced that the shale gas

field in Chongqing would be available for commercial production starting

this year. The Ministry of Land and Resources in China has a goal of

building its total production capacity to 3-5 billion cubic meters from 10-15

leading shale gas fields by 2015 and a further expansion to 15-30 billion

cubic meters from 20-30 fields by 2020. The goal is for shale gas

production in China to be equivalent to 8-12% of the total annual domestic

natural gas output. Besides the MLR in China, the energy regulatory

agency in China, the National Energy Administration (NEA), have also

begun developing policies to support exploration, development and

utilization of shale gas since 2020. Shale gas has been incorporated by

the Chinese Central Government into the “National Energy Strategies

Toward 2030.”

When oil prices crashed, most countries turned inward,

focusing on their respective domestic agendas in an effort to minimize

political fallout. China, on the other hand, saw an opportunity to penetrate

the oil market because the Chinese recognized that it would be highly

unlikely that the price of crude oil would ever be as cheap again. Therefore,

China embarked on a worldwide campaign to seek out new sources of

crude oil no matter where it happened to come from. The Chinese Central

Government became notorious for making deals just to get a cut of future

production. China National Offshore Oil Corporation, CNOOC, paid over

1.3 billion dollars for a stake in Angola’s profitable offshore oil fields as

China recognized Angola’s role as Africa’s largest oil producer. Now

China’s quest for energy security has led them to focus on shale gas

which will create a huge opportunity for U.S. companies to engage in joint

venture partnerships with Chinese oil and gas companies seeking to learn

the procedures and mechanisms of shale production. China’s first step

towards producing its shale gas resources will be a learning experience

and right now the United States does shale gas exploration and production

better than any other country in the world.

China has watched the shale gas boom explode within the

United States for the past few years and is looking to emulate the efforts

of the United States in shale gas production. China holds roughly 30

trillion cubic meters of shale gas resources and the goal of the Chinese

Central Government is to have about 12% of their natural gas production

come from shale gas wells by 2020. However, extracting natural gas from

the shale is quite difficult and requires a little bit of western know-how and

entrepreneurial skills to understand the mechanics of shale gas exploration

and production which, as I stated earlier, is something that companies in

the United States have been perfecting for many years.

China is already beginning to penetrate the shale gas arena.

In 2009, China enlisted the help of Royal Dutch Shell to begin its first

venture in developing China’s shale gas. In September 2010, China

Petroleum Corporation (SINOPEC) signed a joint venture partnership with

Chevron to develop shale gas near Guiyong City. Sinopec’s goal is to

increase production from various unconventional sources, such as shale

gas, to approximately 2.5 billion cubic meters within the next five years.

Furthermore, in October 2010, CNOOC, China’s biggest offshore oil

producer announced a deal with Chesapeake Energy where CNOOC

(China National Offshore Oil Company) paid 1 billion for one third of the

state assets of Chesapeake Energy in the Eagle Ford shale gas site which

is located in South Texas. In addition, Petro China, the largest oil producer

in China, said in early February that it will pay 5.4 billion for a stake in

Calgary based Encana Corporation’s shale and deep well gas assets.

Furthermore, it is worth noting that Petro China recently announced that

the company had finished the drilling of China’s first horizontal shale gas

well, the Wei 201-H1 well, in Sichuan province in southwest China.

Petro China drilled 1,079 meters horizontally at the Wei 201-H1 well after

sinking vertically 2,823 meters. The conventional wisdom in China is that

horizontal shale gas wells are more productive and have proven to be the

most commercially viable method of extracting shale gas based on the

success of shale gas development in the United States. Since China is

attempting to unlock massive amounts of shale gas reserves to meet the

increasing demands of its rapidly growing middle class, but because

China has not been able to access these deposits due to a lack of technical

expertise, China’s National Energy Administration (NEA) is studying a

policy of setting up pilot exploration areas and is attempting to industrialize

shale gas as early as possible. The Chinese Central Government is making

a concerted effort to make major technological breakthroughs in developing

shale gas because, according to Xinhua News Agency, the Chinese

Central Government wants to “optimize the nation’s energy structure”.

It is the belief that China could conceivably produce enough clean energy

to take the pressure off of the coal and the automobile industries in China

and, thereby ensure that shale gas, China’s natural gas gamble, becomes

a resounding success. Sources from the Ministry of Land and Resources

of China have acknowledged that there has been and will continue to be

public bidding for shale gas blocks in the first quarter of 2011. China is

keen to kick start the sector by introducing more competition in the bidding

process.
While China’s natural gas production in 201 stood at 94.48

billion cubic meters, the Chinese Central Government believes that

consumption could reach 300 billion cubic meters by 2020. As China

pursues policies aimed at raising and tripling its share of natural gas, as

part of raising China’s total energy use to 10% by 2020, which is up from

4% at present, foreign participation, expertise and creativity is essential.

Once China meets its natural gas goals through the development of shale

oil, foreign participation becomes less lucrative and more and more

problematic. Bilateral co-operation becomes difficult to maintain in the long

run. Issues concerning proprietary knowledge relating to shale gas

exploration and intellectual property considerations will have to be

examined in the near future. In fact, as previously stated, China still faces

significant hurdles to getting gas out of the ground on its domestic soil,

transporting gas and delineating the size of the reserves. However, the

most pressing issue, moving forward, is clarifying the legal framework for

contracts. This is to ensure protection of intellectual property

rights/technologies of foreign companies involved in the shale gas sector.

These issues will certainly be raised in the near future now that the United

States and China recently signed a co-operation agreement last November

to jointly appraise shale gas reserves in Northern China and Jiangsu

province. This issue is further highlighted by the fact the Statoil,

headquartered in Norway, has been giving serious consideration to

teaming up with Sinopec on investigation and study of offshore oil and gas

reserves in China.

China recently raised interest rates in response to Europe’s

worsening debt crisis. For example, in Ireland, the housing market forced

the country to take over three large financial institutions and a financial

bailout of Greece put pressure on commodities and raised concerns

about diminished demand. The recent earthquake and tsunami in Japan

have also contributed to global uncertainty in the oil and commodity market.

Furthermore, the shale gas sector in China currently lacks policy support

for certain tax breaks and other financial incentives currently offered to

other sectors in China. The Chinese Ministry is currently pushing the

Chinese Central Government to extend the same incentives already offered

to coal methane developers by pushing for the establishment of a

renewable industry services system along with tax incentives, such as

depreciation deductions on equipment, waiving the corporate tax rate for a

fixed period of time and a tax holiday. However, insufficient pipeline

infrastructure in China currently hampers shale gas development and

severely impacts market prices.

Therefore, when assessing the long term projections for shale

gas exploration, it must be recognized that China will increase its natural

gas demands by 77% in 2015 from this year as China aggressively pushes

for the use of cleaner burning fuels to curb carbon emissions. In the long

run, shale gas has a large potential for supplying the Chinese market and

its development will continue to attract much interest from many countries,

including the United States. China holds the world’s third largest coal

reserves after Russia and the United States and China’s environmental

restrictions for shale gas are less strict than in other countries. In

China, most gas shale gas fields are located in thinly populated areas,

compared to Europe, which makes shale gas development and exploration

very lucrative for foreign companies who are increasingly entering the

Chinese shale gas market under joint ventures with Chinese companies.

However, serious water shortages in China may pose a problem for shale

gas exploration as large amounts of water are essential to the development

of shale gas. Furthermore, in the United States, exploitation of shale gas is

based on the price which is roughly in the $100 range. The industry ebbs

and flows based on the market price. In China, it is well established that the

Chinese Central Government is able to control many economic factors

which make long term projections for shale gas exploration in China very

strong. These factors adopted by the Chinese Central Government to

support the development of shale gas include establishing sustainable and

stable market demand through favorable price policies, mandated market

share policies,, government investment and government concession

programs. In an effort to ensure the projected success of shale gas

exploration, the Chinese Central Government also has the ability to set

renewable power tariffs and cost sharing policies as well as increasing

fiscal input and tax incentives. Accelerating technological improvement

and industry development through the integration of various renewable

energy technology resources, such as research institutes, are additional

options that the Chinese Central Government can implement at its own

discretion.

In conclusion, the future of China’s shale gas industry is

enormous, given China’s 2015 natural gas demand may rise to 77% and

the Chinese Central Government is making concerted efforts to encourage

foreign participation in the development and exploitation of China’s shale

gas industry. China has further taken the initiative of investing in various

shale gas projects in the United States and Canada in an effort to gain the

proprietary understanding of the technology involved in shale gas

development. As China’s national oil companies increase their shale gas

activity, they will look for partnerships in the initial phase of development,

creating a window of opportunity for qualified foreign players to gain access

to China’s market. China recognizes shale gas as the clear alternative to

coal in an effort to reduce its carbon emission footprint and move away

from coal fired power plants towards a cleaner, safer technology in an effort

to meet the increasing demands for energy among the rapidly growing

middle class in China.