The outlook and opportunities for petrochemicals based on China s development of shale gas

China s shale gas The outlook and opportunities for petrochemicals based on China s development of shale gas LEE FAGG Nexant Nexant has recently completed a detailed analysis of the current and developing status of China s shale gas sector. The report has been tailored to explore potential opportunities and implications for downstream petrochemicals particularly associated with ethane. To date, the shale gas sector in China is in its infancy and, as a result, there is relatively limited data available in the public domain. This is especially true when compared to published information sources associated with the shale gas sector in North America. The North American shale industry is well established and in most cases shale resources have been mapped in great detail. In comparison, China s shale industry is still very much in the early exploration phase, with information tightly held amongst a few organisations directly involved in oil and gas exploration. China is the world s most populous country and one of the leading consumers of global energy. The domestic economy has grown rapidly Renewables 2% Oil 18% Nuclear 1% Natural gas 5% Hydro 7% Coal 67% Figure 1 China energy consumption 213 over the past 2 years, creating both a surge in demand for energy and a desire for securing future energy resources. Currently, the major part of China s energy consumption is derived from domestic coal reserves. In 214, coal accounted for approximately 67% of China s total energy consumption. In comparison, oil consumption is relatively modest at around 18% (see Figure 1). Despite this, China is the world s second largest consumer of oil behind the US and the world s largest net oil importer. Total gas consumption in China today is relatively small compared to other energy sources and accounts for approximately 5% of total domestic energy consumption. Future sources of energy supply in China are forecast to change over time as the government continues to drive increased self-sufficiency through the promotion of wider energy diversification. Additionally, due to growing environmental concerns such as air quality and global warming, there is a greater push to enact policies that diversify the energy mix in favour of cleaner burning fuels. Within this aspect of the energy sector, natural gas is forecast to become an increasingly important component of the overall energy mix. However, China only has modest reserves of conventional gas and therefore unconventional gas reserves are being actively targeted to meet the country s energy objectives. Within this context, the country s shale gas potential is therefore highly significant on two fronts: First and foremost, the potential presence of large quantities of indigenous gas could significantly boost the fuel s share of www.eptq.com Processing Shale Feedstocks 216 1

Reserves, trillion m 3 35 3 25 2 15 1 5 Figure 2 Technically recoverable shale gas reserves the primary energy mix, assuming the gas can be extracted and transported economically. Secondly, shale gas production could displace (in the long term) or partially displace (short term) Chinese gas imports from LNG and neighbouring countries via pipelines. The Chinese government was aiming to increase the natural gas share of total domestic energy consumption to around 8% by the end of 215 and to 1% by end 22. These increases are expected to substitute for domestic coal due to growing environmental concerns. To achieve these targets, the government has placed strong emphasis on developing its domestic shale gas reserves (see Figure 2). Recent data suggest that total Chinese shale gas reserves are the highest in the world at approximately 31 tcm. This estimate has been derived from an assessment of seven major prospective shale basins distributed across the country. Despite its immense shale gas China Argentina Algeria Canada U.S. Europe Australia Russia Brazil Venezuela resources, China has only recently commenced shale gas production and actual production levels to date (initiated in 212) are very small. However, based on current shale gas resource estimates and domestic natural gas demand there is significant potential for development over the long term. Shale gas development in China has not attracted the same level of environmental concern that has developed in other regions of the world such as North America and Europe. This is partly because of the industry s infancy, but also because China is still developing its economy. Consequently, the Chinese government has not placed the same emphasis on environmental sustainability as have some of the world s more economically mature countries. This attitude may change as the Chinese economy matures, but for now the achievement of economic objectives is the government s number one priority. However, the nascent Chinese shale gas industry faces multiple chal- lenges, which include: Land access Access to land surface for operations is particularly difficult in China as it is one of the most densely populated nations in the world. This will severely restrict shale gas operations, which require around.3 km² per well (average US well spacing used as proxy). The need for additional land required to construct water pits, gas processing and transport infrastructure, and roads further complicates matters. Complex topography If China aims to reach 5 billion cu m (1.8 tcf) of shale gas production by 22, and maintain it for 1 years, at least 51 sq km of land is required for drilling operations. This may not seem much compared to China s vast area, but the problem becomes apparent when topography is taken into account. Only 1% of China s land is in plains, while the rest is mostly plateaus, hills, and basins. However, plains are the only areas suitable for shale gas exploration and production operations. This presents another significant bottleneck for shale gas development. Low crude oil pricing Recent price lows in global crude oil markets have resulted in a dramatic U-turn in E&P spending globally. As a result, higher cost unconventional energy resources have become less attractive to energy companies and in many cases not economically viable. The current low oil price environment has led to a number of high profile foreign companies exiting China shale gas projects over the past 18 months. Despite this, China s national oil 2 PProcessing Shale Feedstocks 216 www.eptq.com

companies remain highly committed to the sector and under pressure to meet government set production targets. Water constraints Typical water usage per shale gas well for fracking and other operations is 11 to 15 cu m. To support 5 billion cu m (1.8 tcf) of shale gas production, an estimated average of 18 million cu m of fresh water annually would be required. Given that China s estimated per capita annual renewable water availability is around 28 cu m, this poses a significant challenge. The situation is exacerbated by the fact that several shale basins are in water-constrained provinces. China s shale resources Total shale gas resources are largely concentrated in three principal basins: Sichuan, Tarim and Yangtze. Combined, these three basins hold an estimated 87% of total recoverable gas. The Sichuan basin alone accounts for 56% of the country s total recoverable shale gas resources, and it is within this region that the majority of exploration and initial production is taking place. Initial shale gas exploration and production efforts under way are largely concentrated in the Sichuan Basin. However, there is also reasonable interest in exploration in Yangtze, Subei and Tarim regions. The remaining shale basins appear to offer lower prospects in the near term. This is largely due to technical challenges and infrastructure issues (see Figures 3 and 4). Official government shale gas production targets are set by China s National Energy Production, trillion m 3 8 7 6 5 4 3 2 1 Recoverable GIP Resource GIP Sichuan Tarim Yangtse Junggar Songliao Subei Jianghan Figure 3 Overview of shale gas reserves by basin Bureau as part of the 12th fiveyear plan and the shale gas development plan (211-215). However, in 214 all shale gas production targets were revised down as initial progress in the sector was slower than expected. Previously, the government had set a target of around 6 billion cu m by 22, but this number has now been revised down to 3 billion cu m. Based on reported progress, this production appears to be realistic. However, there are concerns that reported shale gas production numbers may Yangtse 13% Subei 4% Songliao 2% Junggar 3% Jianghan 3% Tarim 19% Sichuan 56% Total reserves 31.6 trillion m 3 Figure 4 Overview of recoverable reserves Percentage recoverable 3% 25% 2% 15% 1% 5% % also incorporate some conventional gas production. Longer term shale gas production targets have also been reduced marginally and are now forecast at around 15 billion cu m for 23. However, Nexant notes that production levels are forecast to accelerate greatly post-22 due to the completion of key infrastructure projects, greater economies of scale, reduced drilling costs, and improvements in fracking technologies. Figure 5 provides an overview of previous and revised shale gas production targets. Outlook for NGLs The shale gas produced to date in China is relatively dry, especially compared to major shale plays in the US where the ethane content can be as high as 15-2%. Available gas specification data for Sichuan Basin suggests a methane content estimated in the range 95-99%. The estimated ethane content of the gas is within the range -4%, with an average content of 2% based on current E&P www.eptq.com Processing Shale Feedstocks 216 3

Production, billion m 3 25 2 15 1 5 Initial target Revised target Figure 5 Shale gas production targets data and Nexant s analysis. Our base case scenario for theoretical ethane availability is forecast at approximately 37 b/d in 22, but is forecast to ramp up to approximately 186 b/d by 23. The increase in ethane post-22 is attributed to a forecasted increase in shale gas production (see Figure 6). Determining estimates for theoretical ethane availability is challenging and will be highly sensitive to China s total shale gas production. To combat this, we further analysed various production scenarios within its Shale gas production, billion m 3 16 14 12 12 1 8 6 4 2 214 215 22 23 Based on 2% ethane content Total production Total ethane production from shale gas 216 218 22 study to measure the sensitivity of ethane availability. These scenarios cover both variances in total shale gas production and variances in gas specification and the average ethane content. Across the different scenarios, the theoretical ethane content of China s shale gas production ranges from 123-91 b/d, 23 basis. The analysis presented is on the conservative side. However, potentially theoretical ethane availability could be higher due to the following: Higher than expected shale 2 18 16 14 12 1 8 6 4 2 Ethane production, thousand b/d Figure 6 Forecast shale gas and theoretical ethane availability base case 222 224 226 228 23 gas production over the longer term. Current production estimates are conservative and focused in the Sichuan Basin only. Discovery and production of higher ethane gas within the Sichuan Basin. Initial exploration has resulted in relatively dry gas being produced. However, Nexant notes that only a relatively small area of the basin has been analysed so far. Based on US shale gas production, gas specifications can vary greatly between wet and dry gas within close proximity. Production of shale gas is realised within the wet shale gas fields in Subei and Jianghan. Based on the analysis, Nexant has concluded at this stage that these fields will not produce shale gas before 23. Potential for ethylene China consumes over 2 million t/y of ethylene and is the largest market for ethylene in the Asia Pacific region, accounting for more than one-third of regional demand. Polyethylene accounted for about 65% of total ethylene consumption in China, with new HDPE and LLDPE capacity driving consumption growth. Furthermore, China imports around 1 million t/y of ethylene, but this represents a relatively small portion of total domestic demand at less than 5%. Additionally, China is the world s largest importer of ethylene derivatives. These include polyethylene, styrene monomer and ethylene glycol. Total polyethylene imports into China in 215 are forecast at around 1 million tons (see Figure 7). 4 Processing Shale Feedstocks 216 www.eptq.com

Many of China s steam crackers consume a mixture of naphtha and heavy gasoil, also known as hydrowax. The hydrowax is residue from refinery hydrocrackers, which are prevalent in the recent generation of Asian oil refineries mainly fed with heavy Middle Eastern crudes. As refinery development has slowed, the focus has shifted to largely coal based methanol-to-olefin (MTO) developments. Currently, conventional ethylene production via steam cracking accounts for approximately 83% of domestic ethylene capacity. However, by 23 close to half of domestic ethylene capacity will result from methanol conversion. Currently, there is no ethylene production from ethane in China. This is due to limited availability of domestic ethane. However, this situation may change longer term if theoretical ethane availability from shale gas is realised and recovered. Figure 8 provides an overview of ethane potential and ethylene production based on the base case shale gas scenario with 2% ethane content. The following should be noted: Additional ethane availability increases year on year in line with shale gas production In 22, theoretical ethane availability will be sufficient to produce around 6 t/y of ethylene In 23, theoretical ethane availability will be sufficient to produce around 3 million tonnes of ethylene. This will require around 182 b/d of ethane (see Figure 9). Ethylene production from Volume, million tons 6 5 4 3 2 1 Operating rate Consumption Net import Capacity Production Net export 215 217 219 221 223 225 227 229 Figure 7 China polyethylene supply/demand and net trade A Production, thousand b/d B Production, thousand t/yr 2 18 16 14 12 1 8 6 4 2 35 3 25 2 15 1 5 Approximately 182 b/d of ethane is theoretically feasible based on the base case shale gas forecast for 215-23 Theoretical ethane production Theoretical ethane availability Approximately 3 million t/yr of ethane based ethylene production is feasible based on theoretical ethane production during 215-23 Theoretical ethylene production Theoretical ethylene availability 1 214 216 218 22 22 224 226 228 23 214 216 218 22 22 224 226 228 23 Figure 8 Overview of theoretical ethane and ethylene production via ethane (base case shale gas production, 2% ethane content) ethane assumes that all theoretical ethane is recovered. Significant ethylene production, at approximately 8 million tons per annum, from ethane 8 6 4 2 Operating rate, % may be feasible if total shale production is in line with the high case scenario with an average ethane content of 4% assumed. This will require www.eptq.com Processing Shale Feedstocks 216 5

Methanol conversion 6% Steam cracker naphtha 9% Steam cracker naphtha/gasoil 85% Total capacity 214 = 19.6 million tons Figure 9 China s ethylene capacity approximately 49 b/d of ethane production to be realised. Figure 1 provides an overview of ethane potential and ethylene production based on the high case shale gas scenario with 4% ethane content. Speculative ethylene capacity additions are not forecast to materialise until post-22. Furthermore, the amount of theoretical ethane available initially will be relatively small Spec cap, million tons 55 5 45 4 35 3 25 Low gas production High gas production Base gas production Other feedstocks Others 2% Ethane 6% Methanol conversion 46% Steam cracker naphtha 9% Steam cracker naphtha/gasoil 37% Total capacity 23 = 5.6 million tons until shale production volumes are ramped up post-22. Therefore, initial opportunities for ethane consumption would be limited to mixed feed cracking until enough ethane supply is available. By 23, potentially 2 million tonnes of additional ethylene production capacity could be based on theoretical ethane. Nexant has incorporated some speculative ethylene capacity based on theoretical ethane to 2 215 217 219 221 223 225 227 229 Figure 1 China ethylene capacity development Total ethylene firm Total ethylene spec Total spec cap from gas production 25 2 15 1 5 Spec cap, % illustrate the potential impact of shale gas on the domestic ethylene market. However, it should be noted that the forecast assumes the following: Base case shale gas production targets are met Assumed theoretical ethane content averages 2% or higher Theoretical ethane is extracted and consolidated. China has been a big net importer of ethylene for the past eight years due to the fast development of ethylene derivatives capacity. However, imports were down by around 2 tonnes in 214. Due to the high cost of ethylene shipping, most imports are from nearby exporters in East Asia such as South Korea, Japan and Taiwan. The recent excess of ethylene in Western Europe led to imports from new ethylene exporters such as Belgium, the Netherlands and Sweden, and other regions such as Turkey and Mexico. Japan s exports to China showed a fall of around 1 tonnes in 214, while South Korea s exports to China were reduced by almost 35 tonnes. South Korea is generally the world s largest ethylene exporter, but its exports declined significantly in 214 due to a combination of economic and production issues (see Figure 11). Although new MTO plants are expected to relieve the tightness of domestic ethylene supply in China, demand will still be partly met by imports, which are encouraged by the Chinese government. From 215, import duty for ethylene has been reduced to 1% from 2% in China. China is a major importer of 6 Processing Shale Feedstocks 216 www.eptq.com

polyethylene and other ethylene derivative such as styrene and ethylene glycol. Despite a recent wave of new ethylene capacity coming on-stream, China will still remain highly dependent on polyethylene imports. In 225 we forecast total polyethylene imports at around 2 million t/y. This is equivalent to around 44% of total domestic demand. China has a clear incentive to add additional ethylene capacity. However, the rate at which naphtha cracking can develop is hindered by domestic refinery capacity development. Therefore a considerable amount of olefins capacity will come from coal based projects or MTO. Ethane based ethylene projects may be feasible longer term. However, as highlighted in Nexant s report, a critical mass of ethane will need to be available to warrant economic Trade, thousand tons 2 1 1 2 Middle East North America South America extraction. Based on current shale gas production forecasts, this situation will not be viable until post-225 at the earliest. However, the planning process for these investments will commence over the next few years. Western Europe Central Europe Africa Asia Pacific 21 215 22 225 23 Figure 11 Ethylene global trade development Lee Fagg is Principal and Practice Leader for Nexant s Chemicals Consulting business in Asia, based in Singapore. He has more than 2 years of combined consulting and industry experience covering technology, markets, business planning, strategy and M&A, spanning all major regions. He studied chemistry and business at Leeds University, UK. Email: lfagg@nexant.com www.eptq.com Processing Shale Feedstocks 216 7