May 15, 2014 03:29 PM

Sinopec Digging Deep in Effort to Take Lead in China's Shale Gas Industry

(Beijing) – A drilling rig stands in lush forest on a mountain in Jiaoshi Town, in the southwestern region of Chongqing. It is conspicuous, towering over the homes of area residents.

It is one of 63 shale gas wells China Petroleum and Chemical Corp. (Sinopec) has drilled in Jiaoshi as of April. The company plans to drill 200 more over an area of 260 square kilometers over the next two years.

Some 23 wells are producing 2.7 million cubic meters of shale gas every day. They have yielded a total of 390 million cubic meters as of April. Sinopec's shale gas wells in the region will have annual output of 3.2 billion cubic meters in 2015, the company's chairman, Fu Chengyu, said in March.

That figure could account for as much as half of the country's planned 6.5 billion cubic meters of shale gas by 2015.

China National Petroleum Corp. (CNPC) also plans to speed up production of shale gas. The country's largest oil and gas producer says it will invest 10 billion yuan to drill more than 100 wells that it hopes will have the capacity to produce 2.6 billion cubic meters of shale gas per year, a CNPC researcher said.

Sinopec, which has few oil and gas reserves, sees the nonconventional shale gas as an opportunity, Fu said. He wants his company "to walk in front of others on the exploitation of shale gas."

The opportunity may be there for Sinopec, but so are the challenges. The company is finding that drilling conditions are much more complicated than they are elsewhere, and it has reached technological barriers regarding how deep it can drill. Last but not least, government subsidies are helping the nascent industry get by, but that help will end soon and Sinopec has no clear model for turning a profit after that.

The Broken Plate

The United States had new technologies in place to start extracting shale gas by 2006. This got the attention of China, a large developing country with a thirst for energy.

China's shale gas reserves are different from those in the United States because its are deeper underground and the conditions are more complicated, all of which make exploitation difficult.

"Shale gas reserves in the United States are like a flat plate, but in China that plate fell to the ground and broke and then someone stomped on it again," said Guo Xusheng, the general manager of a Sinopec exploration subsidiary in the southwestern province of Sichuan.

Sinopec started looking for shale gas in Chongqing, which lies on Sichuan's eastern border, in 2009, Guo said, and only when it found reserves in Jiaoshi in 2012 did it become confident it had a future in the industry.

The Jiaoye 1HF well, Sinopec's first in Jiaoshi, started production in November 2012, and by April 2014 it had been running smoothly for 500 days with a daily output of 60,000 cubic meters. This prompted Sinopec to dig more wells nearby, wells that had to reach 2,500 meters to 3,000 meters into the Earth.

Sinopec's exploration team wants to drill wells over an area of 3,000 square kilometers in Sichuan and Guizhou, a province that also borders Sichuan to the east, Guo said. That area could have reserves of 2.1 trillion cubic meters.

About 150 kilometers south of Jiaoshi, near the border with Guizhou, Sinopec has drilled two wells. One 4,400 meter deep project is producing up to 100,000 cubic meters of shale gas a day from 4,400 meters deep. The yield is not steady, revealing the limitations of Sinopec's capabilities.

"The company has conquered the technological barrier for extracting shale gas from 3,500 meters down," Guo said. "It needs to do more work to develop technologies to drill shale gas from 4,400 meters."

Analysts from investment banks said the success Sinopec has had at Jiaoshi was limited and it is unclear whether it can duplicate it in other regions.

Just Getting By

China had drilled 285 shale gas wells by the end of last year, but only 23 had daily output of 100,000 cubic meters, data released at an industry conference this year showed. Thirty-eight more wells had daily output of 10,000 cubic meters. This is a far cry from a good natural gas well, which produces 1 million cubic meters a day.

A shale gas well has steady production for the first seven years, but then yields falls by 30 percent to 90 percent over the next three decades, experts say.

Sinopec's wells in Jiaoshi cost about 80 million yuan each, a price tag many times higher than in the United States. Market gas prices dictate that a well must produce at least 40,000 cubic meters a day to offset daily costs.

Low profit margins have made Chinese companies slow to explore for shale gas, even after the government issued calls to develop the industry and announced preferential policies.

Sinopec is trying to cut the cost of each well to less than 60 million yuan, said Hu Degao, the deputy general manager of a Sinopec oilfield in the central province of Hubei. The CNPC researcher said production was only going to be profitable when costs fell below 60 million yuan.

The current rate of profit for Sinopec's shale gas production is 12 percent, which is on par with the national standard for exploiting natural gas on land. But the shale gas figure is aided by a government subsidy of 0.4 yuan aid for each cubic meter, help that will come to an end in 2015.

"When the government stops it, the company will not drill new wells because without the aid there is no profit," said He Zhiliang, a Sinopec researcher. The government should continue with the aid or establish new supporting policy, He said.

Follow the Money

Sinopec faces problems related to where to sell shale gas and at what price. Initially it wanted to sell its product in eastern areas of the country, such as Zhejiang Province, where it would get a better price. A source at Sinopec said the company could get about 3.3 yuan per cubic meter. The problem is that Sinopec cannot get it to Zhejiang for less than 3.59 yuan.

Also, pipelines connecting wells and trunk lines to the east are not finished, meaning Sinopec is stuck selling the shale gas to local consumers. But the price it could get locally was low, 1.92 yuan per cubic meter, the same as the price for natural gas.

Another reason for Sinopec to sell shale gas to local users is it needs local government support for land acquisitions, pipeline construction and other matters, an analyst at an investment bank said.

And local governments want Sinopec to sell to nearby companies before looking elsewhere.

Sinopec is under little pressure to secure a supply for the country so it is not yet producing shale gas at full capacity, the analyst said. Instead, it is waiting for the government to raise prices.

(Rewritten by Guo Kai)

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