What is more disappointing? Finding out that you missed out on something from the get go, or getting good news and only later finding out that it wasn't what you expected? Personally, I think the latter is harder to stomach, and that is why PetroChina (NYSE:PTR) and Sinopec (NYSE:SNP) probably aren't taking the recent news about China's shale gas reserves too well. Let's take a look at how what were once considered the largest shale gas resources on the planet may end up being a red herring after all and why this could benefit large international gas players like ExxonMobil (NYSE:XOM) and Chevron (NYSE:CVX).
From hysteria to humility
Last year, the United States Energy Information Administration published its most recent assessment of shale resources around the world. In that report, it was estimated that China's technically recoverable shale gas resources were a whopping 1.1 quadrillion cubic feet. That's almost double the United States' estimated resources and enough to meet China's current demand for gas for over 200 years. Gas resources that size are enough to completely change the dynamic of a country, even one as large as China.
However, what we are starting to discover is that technically recoverable resources don't necessarily translate to economically recoverable reserves. According to data collected by Petrochina, a more realistic amount of natural gas that can be extracted from China's shale resources is less than one-third of the EIA's original estimate, and the gas that is in place is considerably more difficult to access than the deposits found in the U.S. On average, production from wells drilled in the Sichuan Province, China's most lucrative shale formation, are about 2.5 times that of a well found in America's best shale gas play, the Marcellus. The problem is, though, that the cost for a well there is four times that of a Marcellus well.
To add insult to injury, many of the other regions where shale gas is found simply don't have the infrastructure in place to make them feasible -- be it remote locations in the Western deserts where water is extremely scarce, or in bustling urban areas that make drilling locations prohibitive.
Ultimately, this will probably mean two things. In the short term China will fail to meet its shale gas production targets. The country is currently on track to produce about 63 billion cubic feet of shale gas this year, but to keep pace with government-projected targets it would need to quadruple today's production, which will be extremely challenging. Longer term, though, several of these shale resources may be left in the ground. With China driving a hard bargain on its Russian gas supply megadeal and a dearth of LNG coming online in the next couple of years, its natural gas resources may not be tapped for several years down the road.
Making lemonade out of the sour situation
What this basically boils down to is that China will likely be increasingly reliant on natural gas imports. The country is looking to move away from coal -- or at the least less pollution-intensive coals -- and natural gas will likely need to be the fuel to replace it for the foreseeable future. China is currently in the process of building over 42 million tons per year of LNG regasification terminal capacity.
Chevon, Royal Dutch Shell, and others are working with Sinopec and Petrochina on many of their shale gas projects, but probably if they had their choice they would rather serve Chinese gas demand through LNG shipments. One of the reasons is that much of the work in China is through production sharing, but the more important reason is that the margins for LNG are much better. According to ConocoPhillips, its LNG investments -- which will likely serve the Asia-Pacific market because of location -- will average a per barrel oil equivalent margin greater than $40.
Based on the projects that are slated to come online from these players, both Chevron and ExxonMobil would be likely to benefit the most. Chevron's Gorgon, Wheatstone, and Kitimat LNG facilities would add about 19.2 million tons per year of LNG export capacity almost exclusively geared to serve the Asia Pacific market. ExxonMobil, with its Papua New Guinea LNG facility slated to start up in the next couple months, its own equity investment in Gorgon, and its potential 30 million tons per year facility in Canada, would make Exxon one of the largest LNG suppliers in the region. Also, an added benefit for Exxon is that it doesn't have any significant shale deals in place in China.
What a Fool believes
Without abundant shale gas resources, China will be more reliant on imports. The recent deal between Russia and China will help cover a large part of it, but it will still need vast quantities of LNG down the road. This should bode well for big oil and their LNG plans, provided of course that these projects can actually be built on time and reasonably on budget.
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