Europe China Research and Advice Network (ECRAN)

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1 Europe China Research and Advice Network (ECRAN) 2010/ Short Term Policy Brief 68 Prospects for a shale gas revolution in the EU and China: Implications for energy geopolitics and March 2013 Author: Diarmuid Torney This publication has been produced with the assistance of the European Union. The contents of this publication are the sole responsibility of ECRAN and can in no way be taken to reflect the views of the European Union. This project is funded by the European Union This project is implemented by a Consortium led by Steinbeis GmbH & Co. KG für Technologietransfer

2 Background Briefing: Prospects for a shale gas revolution in the EU and China: Implications for energy geopolitics and Executive summary The exploitation of unconventional fossil fuels, particularly shale gas, has been one of the most significant developments in the global energy landscape in the past five years. While extraction techniques have attracted controversy due to concerns over environmental impacts from environmental groups and the public, shale gas has transformed the US energy market. The US experience has led to strong interest in Europe and China, and several assessments indicate large shale gas reserves in both regions. Neither region has so far seen any commercial shale gas extraction, however, and future exploitation of estimated reserves is subject to considerable uncertainty. In the EU, shale gas extraction is likely to remain limited, at least in the short term. This is due to strong public opposition in many countries, land rights issues, the structure of the European shale gas industry and the geological characteristics of European reserves. The Chinese government intends to capitalise on the potential of shale gas, but here too a number of factors may constrain extraction in the short term. These include a lack of relevant technology and experience on the part of domestic firms, regulatory and infrastructural issues around gas prices and pipeline capacity, water scarcity in many shale gas regions, the geological characteristics of reserves and the potential for public protests over issues of pollution and land rights. However, technological innovation in the shale gas industry has been very rapid, and some of these constraints may be overcome in the years ahead. A high shale gas scenario for China would benefit both China and the EU: China would gain greater energy security and lower dependence on coal, while the EU would benefit from reduced pressure on global gas markets and relatively lower Chinese greenhouse gas emissions. A low Chinese shale gas scenario would result in an increase in China s imports of natural gas, or in its coal consumption, or a combination of both. Increasing imports of Russian gas could strengthen Russia s hand as a swing supplier between the EU and China. Increased coal consumption, on the other hand, would lead to increased Chinese greenhouse gas emissions. It is in the EU s interests, both economically and environmentally, that China s shale gas development is successful, and EU-China collaboration in this area should be promoted actively. By creating a common platform for research and development, encouraging joint ventures and establishing a policy dialogue on natural gas, innovation can be accelerated, costs minimised and shale gas extraction expanded in an environmentally sustainable manner. Diarmuid Torney 2 of 11

3 1. Introduction One of the global energy landscape s most significant changes in the past five years has been the rapid development of unconventional fossil fuels. Most significant among these has been shale gas, a form of natural gas trapped in shale rock formations. Until recently shale gas extraction was not commercially viable, but technological innovations such as horizontal drilling and hydraulic fracturing (commonly known as fracking ), involving the injection of water, sand and chemicals into the horizontal borehole under very high pressure, have tipped the balance. These techniques have attracted controversy, particularly in Europe. Concerns include the risk of water contamination by chemicals used in the fracking process, the possibility of methane leakage, the disposal of recovered waste water which may contain radioactive materials and heavy metals from the surrounding rocks, and unintended seismic activity. Large-scale commercial extraction of shale gas has so far been concentrated in the United States (US), where its share of domestic gas production has risen from less than 1% in 2000 to almost 30% in This success has led to strong interest in Europe and China, and assessments indicate large reserves in both regions. If these estimated reserves could be exploited, the shale gas revolution could significantly change the pattern of gas production and consumption in the European Union (EU), China and other key countries. Considerable uncertainties surround the prospects for significant shale gas extraction outside the US, however. This policy brief analyses the prospects for exploiting European and Chinese shale gas reserves, considers implications for energy geopolitics and for the EU, and identifies areas where collaboration between the EU and China would be mutually beneficial. 2. A shale gas revolution in the EU? Europe is estimated to have large shale gas reserves, albeit significantly lower than those of the US or China. However, there has been no commercial extraction of shale gas in Europe to date, and a variety of geological, land-use, population and infrastructure issues are likely to influence the potential development of these reserves. Principal among these is a strong and growing opposition to fracking methods among NGOs and the public. Responding to public concerns, the governments of France, the Netherlands, Luxembourg and Bulgaria have introduced fracking moratoriums. Other European governments, however, have taken Diarmuid Torney 3 of 11

4 a more positive view. The Polish government is expected to adopt a shale gas law in 2013, while the Romanian government granted licences for exploration to Chevron in January 2013, reversing earlier opposition. In December 2012, the UK government lifted a moratorium on exploration which had previously been imposed following small earthquakes allegedly caused by shale gas exploration activities. In February 2013, the German government introduced a draft law that would allow fracking in areas not classified as water protection areas or near drinking wells, subject to an environmental impact assessment. In Ukraine, which is believed to have some of Europe s largest reserves, Shell recently entered into a joint venture with a local company to drill for shale gas. Ukraine could serve as a test case for European shale gas extraction and, if successful, reduce European dependence on Russian gas imports. Alongside public concern, other factors are also likely to limit shale gas extraction in Europe. First, the geology of European shale gas is significantly different from that of the US. European shale gas plays are typically smaller and deeper underground, and the shale has a higher clay content which makes the fracking process more difficult. Second, whereas in the US royalties accruing from underground resources belong to individual landowners, in much of Europe these royalties accrue to the state, making landowners less likely to accept the disruption associated with the extraction process. Third, the nascent European shale gas industry, dominated by a small number of large operators, is arguably less innovative than its US counterpart which has been driven by a large number of relatively small, entrepreneurial firms. Finally, adapting US technologies to make them applicable to European circumstances will require significant basic research. Whereas in the US this was publicly funded, there is currently little appetite within Europe for large-scale investment of public funds in shale gas research. For all of these reasons, shale gas extraction in the EU is likely to remain limited at least in the short to medium term. Even if successful, it remains to be seen whether European shale gas will be able to compete on cost with gas imported from Norway and Russia. 3. Shale gas prospects in China There is currently no commercial extraction of shale gas in China, but the government has set its sights on rapid expansion. In March 2012, the Ministry of Land and Resources announced the results of its nationwide shale gas survey. This identified onshore shale gas resources of trillion cubic meters (tcm), with tcm of exploitable reserves, higher than figures for the US. The Shale Gas Diarmuid Torney 4 of 11

5 Development Plan , issued on 13 March 2012, sets a goal of 6.5 billion cubic meters per year (bcm/y) of shale gas production by 2015 (equivalent to 2-3% of projected 2015 Chinese gas production) and bcm/y by The key question is how realistic these targets are. Several analysts have questioned China s 2020 targets, and a number of factors may constrain extensive extraction of shale gas over this time-period. The Chinese shale gas industry is in its infancy and lacks necessary technology and experience. China will need to either develop indigenous expertise or draw on the experience of foreign firms. Partly for this reason, China National Offshore Oil Corporation (CNOOC) and Sinopec have both invested in shale gas ventures in the US. International oil companies (IOCs), including Exxon Mobil, Chevron, BP and Statoil, have also become active in shale gas exploration in China through joint ventures. The emerging Chinese shale gas industry, however, mainly consists of Chinese companies. The two auctions of shale gas exploration rights that have so far been held, in June 2011 and October 2012, were dominated by state-owned firms. While the second round of bidding was notable for the fact that the big three Chinese oil and gas companies (China National Petroleum Corporation (CNPC), Sinopec and CNOOC) were not among the winners, it is estimated that NOCs already control nearly 80% of China s shale gas deposits. This is because much of China s shale gas reserves lie in conventional oil and gas blocks already owned by the NOCs. Under directions issued by the Ministry of Land and Resources in October 2012, 1 NOCs are required to submit a development plan for each shale gas play they own, and there are indications that they will lose extraction rights of shale plays for which they fail to submit such plans. This could lead to an opening of China s shale gas reserves, though whether and under what conditions foreign firms could participate remains unknown. Other regulatory and infrastructural issues may also constrain the development of the industry. The pricing system for natural gas requires importers and distributors to sell at government-decreed prices which are frequently lower than the production or import price, making shale gas exploration commercially unattractive. Recent pricing reforms in Guangdong and Guangxi, 2 if extended to other regions, could enhance the viability of shale gas projects. Pipeline infrastructure is another constraint. China lacks a comprehensive national gas pipeline infrastructure, and CNPC controls 1 Circular of the Ministry of Land and Resources on Strengthening the Prospecting, Exploitation, Supervision and Administration of the Shale Gas Resources [2012], No. 159, published on 26 October Circular of the National Development and Reform Commission on Initiating Pilot Reforms for Natural Gas Price Formation Mechanisms in Guangdong Province and Guangxi Autonomous Region [2012], No. 3033, published on 26 December Diarmuid Torney 5 of 11

6 many of the existing pipelines. Whether it would be willing to allow shale gas to be transported through its infrastructure is unknown. Figure 1: Precipitation Distribution in China, 2010 Source: Ministry of Environmental Protection (2010), Report on the State of the Environment in China Figure 2: Shale Gas Resource Distribution in China Source: Wayne Ma (2010), China's Shale-Gas Boom Slow to Start, Wall Street Journal, 2 December Diarmuid Torney 6 of 11

7 Access to water is also a major challenge. China possesses 21% of the world s population but only 6% of its fresh water resources, and per-capita renewable fresh water resources in China are just onethird of the world average. This poses difficulties for current fracking methods, which are highly water-intensive. China s water resources are also very unequally distributed between regions and seasons. Summer monsoons bring relatively high precipitation levels to eastern and southern China, but northern and western regions receive relatively little precipitation, with the densely-populated northern plains particularly affected by water scarcity (see Figure 1 above). Some of China s most promising shale wells are located in water-scarce regions. This is illustrated by the comparison of Figures 1 and 2 above, which show the geographical distribution of precipitation and China s shale gas reserves, respectively. The Tarim, Tuha, Junggar and Ordos basins in particular are located in arid northern and north-western regions. The Sichuan basin, however, looks more promising from a water access perspective. A further challenge is that the geology of shale gas resources in China is considerably different to that in the US. As in Europe, a higher clay content in Chinese shale wells makes the fracking process more difficult. Many of China s shale gas resources are also located much deeper underground than in the US. These differences between the geologies of Chinese and US reserves mean that existing US technologies and techniques cannot simply be copied and pasted to China, but will need to be adapted to local Chinese conditions, a process that will require significant investment in basic research. Finally, public opposition is also a possibility. Some of China s most promising shale gas reserves with plentiful water supplies, such as the Sichuan basin, are densely populated. Reserves in sparsely populated remote areas tend to suffer from water shortages and are often populated by ethnic minorities. In both cases, exploiting China s shale reserves could exacerbate land rights issues that are already causing tensions. Fracking also brings risks of environmental pollution, which could incur public opposition. Protests related to environmental issues have become increasingly common in China in recent years. Against these challenges it should be noted that with the pace of technological development in the US shale gas industry, further breakthroughs in the coming years may enable China to meet its shale gas targets (for example by radically reducing the quantity of water used in the extraction process). Achieving such breakthroughs, however, would require significant government investment in basic research. Diarmuid Torney 7 of 11

8 4. Implications for energy geopolitics Because of the uncertainties discussed above, European stakeholders should consider the implications for the EU of both low and high shale gas scenarios for China over the period to 2020 and beyond. Driven by energy security concerns and a desire to displace coal, the Chinese government is pushing a significant increase in natural gas consumption, which increased by 340% over the period from 30.4 bcm/y to bcm/y. Under the current 12th Five Year Plan, natural gas is targeted to account for 8.3% of primary energy demand by This could mean a doubling of current gas consumption which would reach 260 bcm/y in By 2020, consumption could reach 350 bcm/y, and a number of Chinese sources project natural gas demand of bcm/y by China is planning to meet a large part of this demand through domestic production. Production of approximately 150 bcm/y by 2015 is projected, with a rapid scaling-up thereafter to 250 bcm/y by 2020 and according to the Ministry of Land and Resources to 450 bcm/y by This rapid increase in Chinese natural gas production will depend on significant scaling-up of shale gas extraction over the period to 2020 and beyond. In this high shale gas scenario, China is still likely to become increasingly dependent on imports of natural gas over the medium term. In 2011, China imported 34 bcm, 25% of total consumption. This import dependence will rise to 110 bcm/y in 2015 if the 12 th Five Year Plan targets are met, and is projected to remain around 100 bcm/y over the period to 2020 and beyond. China should, over time, be able to meet this import demand through existing pipeline agreements with Turkmenistan, Uzbekistan, Kazakhstan and Burma. These agreements, signed in recent years, will provide China with a total of 110 bcm/y of pipeline gas, with the full volumes expected by China is also rapidly developing its LNG import infrastructure, with four terminals already completed and four more under construction. A low Chinese shale gas scenario, however, could result in higher Chinese natural gas imports, though China might also choose to reduce its gas consumption. A decision by China to cover the shortfall through gas imports could make the country increasingly reliant on Russia for natural gas. This would, of course, have implications for the EU, which is currently the largest importer of Russian gas. In 2006, China and Russia agreed in principle to construct two major gas pipelines, one into western China and one into eastern China. These negotiations stalled over the gas price, but recent reports suggest that the two sides may be close to reaching a deal. The proposed western pipeline, Diarmuid Torney 8 of 11

9 through Altai, would make Russia a swing supplier between China and Europe, strengthening Russia s hand in negotiations with both China and European countries. These effects could be exacerbated if European governments make future energy supply decisions based on optimistic projections for domestic shale gas production that fail to materialize. In 2011, the EU imported almost two-thirds of the natural gas it consumed, and projections by the IEA and US Energy Information Administration see European gas consumption increasing over the period to For these reasons, it is in the geopolitical interest of the EU that China s push for shale gas production is successful. 5. Implications for Whether shale gas reserves in Europe and China can be exploited successfully and at scale may have significant implications for greenhouse gas emissions trajectories. However, there are two significant uncertainties. First, there is controversy surrounding the well to burner tip emissions of shale gas. An early study by researchers at Cornell University estimated that greenhouse gas emissions from shale gas were greater than those from coal. However, this finding was criticised for being based on a life-cycle of 20 years rather than the more usual 100-year period; for assuming very high levels of methane leakage; and for ignoring methane leakage associated with coal mining. More recent studies have concluded that emissions from shale gas are somewhat higher than conventional natural gas, but significantly lower than coal. Further research is needed to clarify these uncertainties. The second uncertainty concerns the effect that increased shale gas production will have on the overall energy mix. One consequence of the dramatic fall in US gas prices has been that surplus US coal production is being exported rather than consumed domestically, altering the energy mix in other countries including within the EU. Another concern is that, rather than replacing dirty coal, shale gas will displace relatively expensive renewables, leading to an increase rather than a decrease in emissions. In the Chinese case, a high shale gas scenario would likely lead to displacement of coal in the energy mix, given the desire of policy-makers to reduce their coal dependence. What would happen in a low shale gas scenario is less certain. Chinese policy-makers could choose to stick to their relatively high targets for gas consumption and rely more heavily on imported gas, but there would be a strong Diarmuid Torney 9 of 11

10 temptation to fill the resulting supply gap with cheap coal. If the life-cycle emissions from shale gas turn out to be significantly lower than coal, a high shale gas scenario is likely to have clear benefits for climate mitigation goals. 6. Conclusion: Identifying the potential for EU-China collaboration The transformation of the US energy market as a result of a revolution in shale gas production has led European and Chinese stakeholders to look at how to exploit their domestic shale gas reserves. However, considerable uncertainties surround the prospects for doing so. It would be in the interests of both China and the EU that China succeeds in scaling up domestic shale gas production in an environmentally sound manner. In a high Chinese shale gas scenario, China would meet a larger proportion of its energy needs from domestically produced, non-coal energy sources. For the EU, this would also result in a less constrained global gas market due to lowered Chinese demand for imported gas. Furthermore, it would help reduce global emissions due to a moderate shift from coal to gas in China. Existing techniques developed in the US are not up to the task of shale gas extraction in Europe and China, where shale wells typically have higher clay content and are located deeper underground. The process of adapting US techniques to European and Chinese circumstances is at an early stage, and further innovation including publicly-funded basic research will be needed. Given mutual interests, there is a strong case for developing EU-China collaboration in this area. Such collaboration may identify geological differences between Chinese and European shale plays, but it is in the interests of both sides to work together to identify and overcome common technological constraints. Collaboration could be fostered by creating a common platform for research and development, encouraging joint ventures and establishing a policy dialogue on natural gas, as outlined below. The shale gas sector in China is at an early stage of development, and both domestic and international industry players have concerns over sharing commercially sensitive information with competitors about their operations in the country. Cooperation between European and Chinese partners will require a robust framework to address such concerns. EU-China collaboration offers the prospect of accelerating the innovation process, driving down costs and expanding shale gas extraction in an environmentally sustainable manner. Diarmuid Torney 10 of 11

11 7. Policy recommendations The two sides could benefit from joint technological development of environmentally-sound and water-sensitive technologies for shale gas extraction. This could, for example, involve adapting US shale gas extraction technologies to suit Chinese and European geological conditions better. There is also scope for cooperation to enhance the environmental performance of fracking techniques generally by reducing the potential for water pollution, methane leakage, and unintended seismic activity. China and the EU could co-finance or co-develop these technologies, which could take place within the framework of the 2009 EU-China Science and Technology Partnership Scheme. A robust framework would be needed to ensure that intellectual property is protected and shared with relevant stakeholders in both regions. The 1998 EU-China Science and Technology Agreement provides a template for dealing with these issues. Joint ventures between European and Chinese firms should be encouraged to allow technology and know-how to be shared between stakeholders in the two regions, subject to a clear framework for dealing with financing and intellectual property issues arising from such collaboration. The EU and China should establish a policy dialogue on natural gas to exchange information on best practice with respect to environmental and other regulatory issues. This could take place within the framework of the EU-China High Level Meeting on Energy. Acknowledgements The author would like to thank Bernice Lee, Antony Froggatt, Keun-Wook Paik, Paul Stevens and Jens Hein for their input and comments on earlier drafts of this paper. Diarmuid Torney 11 of 11