At the 7th Unconventional Hydrocarbon summit held in Beijing in late May, several speakers expressed the sentiment that China, and its state-backed giants, Sinopec and PetroChina, have the capital structure to weather short-term losses in their quest to unlock the country’s vast shale resources.

Senior Chinese government officials and energy industry executives voiced in several forums that they are committed to the long-term development of shale resources. Put aptly by an executive at the conference: “The free market mindset is so engrained in how we think in the West; if it doesn’t make money...it doesn’t make sense.” But Chinese companies have a completely different perspective. For them, it is an issue of national interest and not economic viability, at least in the short run.

With worsening air quality in China, the need for the country to develop its vast domestic shale resources has taken on a renewed urgency, especially as it struggles to switch power generation from smog-producing coal to environmentally friendlier alternatives like natural gas. China, which is widely believed to have the world’s largest technically recoverable shale gas resources—estimated by the U.S. Energy Information Administration to be 1,275 trillion cubic feet (Tcf)—hopes to replicate the shale revolution that has transformed the U.S. energy landscape.

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It was therefore interesting to witness the national euphoria that greeted China’s much-touted “first” commercial development success in Fuling Field, in the Sichuan Basin. Fuling is China’s largest shale gas discovery by far, with technical reserves estimated at 74 Tcf. Since the successful test run of the first shale gas well in late 2012, development and production of Fuling Field has progressed at full speed. Sinopec, which operates the field, targets 177 billion cubic feet (Bcf) of production capacity by 2015 and 353 Bcf by 2017.

In the past two years, Sinopec has cut its well costs at Fuling Field from US$17 million two years ago to $12- to $13 million today. The company now targets $10 million for 2014.

falseRecently, Sinopec disclosed well activity results from Fuling Field. Hart Energy used the initial production rate contained in the report to generate a type curve based on composite results in a U.S. shale play it considers an analogue. The Haynesville Shale play and Fuling Field share geological similarities in terms of technical reserves (73 Tcf vs. 74 Tcf, respectively) and well depth (12,000 ft vs. 15,000 ft, respectively). So far, several Fuling wells have recorded high IP rates similar to Haynesville wells. But the decline rates are unknown since Sinopec is controlling production.


When the composite curve is paired with Sinopec’s target well cost of $13 million and a wholesale gas price deck of $5.2/MMBtu—which China has held for the past three years—the Sinopec type curve generates a pre-tax NPV of $3.2 million.

Although the well seems economic on a simple pre-tax NPV basis, it is instructive to note that it does not take into consideration royalty, subsidy, corporate income tax and severance taxes. Shale gas development in China is still in its infancy, and there is still a lot of work to be done there in order to extract it profitably. The question isn’t whether these wells are economic now; the broader question is, can Sinopec be economic in time and does it have the capital background? If you ask the Chinese, the answer is yes.

For more on China's unconventional resource potential, see hartenergy.com/consulting/.

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