Unconventional, but promising

Chinese unconventional gas – roughly split 50/50 between shale gas and coal bed methane (CBM) – has huge investor potential. The estimated resource base is one of the largest in the world, there is increasing demand locally for cleaner energy, and the government is actively supporting the development of the sector.

To realise this vast potential, Chinese companies are looking to partner with experienced foreign exploration and production companies – both large and small. It is these partnerships where some of the best investment opportunities will be seen.

JUMPING ON THE BANDWAGON

The US shale gas and Australian CBM revolutions were years in the making, though they have only recently caught the attention of the global media. Unconventional oil and gas is typically held in shale or coal deposits. Technological advancements such as hydraulic fracturing and horizontal drilling have given these resources the ‘unconventional’ tag (as opposed to conventional vertical drilling), and have opened up huge new energy reserves.

The implications of the US becoming energy self-sufficient or even developing into an energy exporter are strategic, far reaching, and have not been lost on numerous other countries with shale and CBM deposits. All over the globe efforts are being made to replicate the US plays. China, India, Australia, Indonesia, the UK, Argentina and Poland, to name a small selection, all have ambitious plans. With oil priced at over $100 a barrel, and with developing countries hungry for clean energy, gas is becoming an increasingly popular and accessible option.

International price discrepancies have also encouraged significant investment in both local gas E&P and LNG export/import projects. High prices in China and Japan have not only encouraged the development of numerous international LNG projects, they have also been a major driver in the growth of shale gas and coal bed methane development. Countries like China see increased local production reducing the strategic reliance on LNG imports.

However, reproducing the US results is by no means a straightforward exercise. Key geological and operational lessons have to be learnt in all of the major gas-producing areas – no two are the same. Crucially, for those companies involved in the unconventional E&P business, like Dart Energy International, there is now a high demand for partnerships with experienced operators which can transfer skills around the world.

BIG PLANS FOR CHINA

The Chinese authorities have big plans for the unconventional oil and gas sector. Around 70 Chinese public and private sector companies bid in the recent second round of shale gas exploration block tenders. This process was only open to local companies. However, a large number of these bidders had no previous experience in unconventional E&P. This is not necessarily an impediment, as minority partnerships with foreign experts are actively encouraged.

The Chinese authorities understand the need for investment in the unconventional gas sector – that skills will need to be brought in, and that pricing mechanisms need to be developed to ensure E&P is a sound investment. A strong signal was recently sent to the sector in the adoption of pricing subsidies – further encouraging the development of exploration and production (E&P) of shale gas deposits.

The scale of the proposed sector development – in terms of the estimated reserves, the investment dollars, and the number of operators looking to be involved – means there are significant opportunities for companies of all types in the coming years. If the Energy Information Administration’s (EIA) figures come even close to being correct, and there are 1,275 trillion cubic feet (tcf) of shale gas reserves, the global energy industry will be in for another shake up. Already we have seen a number of the majors signal that they will invest heavily in unconventional gas – and China will be central to these investment strategies.

Of course, there are many uncertainties relating to the unconventional gas sector’s development in China – pipeline infrastructure, new geological challenges, pricing, and developing the right domestic-foreign partnerships.

But what cannot be denied is that, in true Chinese fashion, there will be pragmatic solutions to these problems. Few other countries have the ability to undertake and support ventures of such scale. For those of us who have worked in the Chinese CBM/shale business, our local expertise and experience is where we have our biggest advantage, and the most to share with local partners.

DART STRATEGY

Early movers in the US and Australian unconventional E&P sector were small, independent operators. Dart Energy International has taken a similar position in China. From both an operational and investment perspective, companies of this size stand to make significant gains in new markets. Operationally, it takes time to learn the geology, to unlock the extraction ‘puzzle’ of different gas deposits, and to develop the infrastructure to get the gas to market. Companies which manage to get an initial foothold in China will be able to build up local technical knowledge and develop realistic expectations with regulators and commercial partners on the delivery of results.

We were one of the first foreign unconventional E&P companies to enter the Chinese market – working in partnership with Fortune Oil and CUCBM on the Liulin project, the contract for which was awarded in 1999.

The Liulin project has been declared a ‘State Pilot Project’ by the Chinese government. In October 2010, an initial 15-year gas sales agreement for the Liulin block was concluded for an annual volume of 1.4 billion cubic feet (bcf). First gas sales are expected to take place in 2013.

BUILDING A NICHE

The Liulin project is a good example of where foreign companies of any size can develop significant projects. It is also a good example of where a company like DEI can add most value to a local-foreign partnership. DEI brings international CBM experience into a partnership of this nature, with our various projects spanning multiple countries and geologies. This range of unconventional E&P experience and our ability to apply it efficiently in China brings value to our partners.

Through this experience, DEI has built something of a niche position in the market. The big local players will, logically, turn to the international majors as partners. But for network operators, heavy industry, another other relatively new players in unconventional E&P, DEI, and others like us, are ideal partners.

CONCLUSION

The opportunities for international investors lie in the partnership structures that are being set up across the Chinese unconventional sector. It is the experienced, tried and trusted foreign E&P companies that have already built a reputation in China which have the best prospects. Many of these companies are listed, or actively looking for funding to develop projects and drill more wells. Given the infancy of the sector in China, the early-mover investment opportunities are considerable.

As in so many other sectors, the energy business in China has huge potential. But it also takes time, patience, and a local presence to fully take advantage of the opportunities on offer. But with China’s goal being to produce 6.5 billion cubic meters of shale gas by 2015 and as much as 100 billion cubic metres (bcm) by 2020, there are significant opportunities, in every aspect of the shale gas supply chain.

John McGoldrick is chief executive officer of Dart Energy, an Australian listed company focused on the development of unconventional gas in Australia, China, India, Indonesia, the UK and Europe.