The Chinese government, very supportive of unconventional oil and gas development in the country, established ambitious production targets that most industry watchers thought could not be achieved in the 2015 timeframe. But now new successes in gas shale create new confidence, although long-term challenges remain.

In China, government and industry alike are striving to replicate North America's success in shale gas. Sinopec's announcement of a breakthrough in their Fuling block, Sichuan Basin, has boosted confidence. As a result, Sinopec raised its shale gas productive capability target to 5 billion cubic meters (Bcm), and CNPC increased its actual production target to 2.6 Bcm, both for 2015. If these can be realized, the government target of 6.5 Bcm production in 2015-which looked unlikely only a few months ago-could well be achieved. However, to grow well beyond these levels and get close to the 2020 target of 60-100 Bcm, China will face even bigger challenges than North America.

Shale gas exploration in China is still in its infancy. The IHS Energy study 'The Unconventional Frontier' estimated technically recoverable unconventional shale gas in China of 3,295 trillion cubic feet (Tcf) (93,316 Bcm), which is higher than North America. Economically recoverable volumes will only be a small fraction of this, maybe 5% to 10% of the technically recoverable resources, but the potential is clear.

However, locating the sweet spots of prospective basins requires significant effort in seismic surveying and analysis and exploratory drilling. As of April 2014, China had completed only 322 shale gas wells, including 108 shallow geological investigation wells, 118 exploration wells and 96 appraisal wells (horizontal). Total unconventional drilling activity is less than one month's activity in North America.

Sinopec's successful wells in Fuling have high average production of 4 million cubic feet per day (MMcfd). However, these volumes have not been matched elsewhere in China so far. Other wells in the Sichuan Basin have experienced lower production (ranging from 15 to 733 thousand cubic feet per day), with volumes varying considerably even within the same block, illustrating that shale gas exploration remains at an early stage and will still require a steep learning curve.

The low permeability of shale requires fracturing to enable profitable gas flow, yet the initial flow usually decreases dramatically after the first year. As such, shale gas fields demand large-scale drilling and hydraulic fracturing to ramp-up and maintain production. In North America, thousands of shale gas wells are drilled, completed, and fractured annually. It is very challenging for China to achieve this scale of activity as gas shale plays here are usually deeper, requiring more complex drilling. CNPC and Sinopec, the two dominant onshore operators in China, own 823 (1) and 585 (2) domestic onshore drilling rigs, respectively, and together have the capability to drill 3000 to 4000 conventional gas development wells per year.

The number looks large, but the majority of these wells are vertically drilled targeting conventional gas. In the Sichuan Basin, the average time for drilling, completion, and fracturing for a typical shale gas well is much longer than for a typical conventional well. For example, in the Fuling block shale gas well drilling, completion, and fracturing took around 90 days on average in 2013. To meet the 2020 target for China overall, a few thousand wells need to be drilled in the Sichuan Basin alone. This would mean that in each year more than one hundred rigs to be assigned there until 2020. This is a challenge because most of the existing rigs are either assigned to oil or are not capable of drilling deep horizontal wells.

Cost is another major challenge. The long drilling time and large-volume fracturing jobs have cost between 13-15 million USD for a gas shale well in the Sichuan Basin, far higher than typical costs in North America. In general, costs will decrease as greater experience is accumulated but, some costs such as water needed for fracturing, could rise as the industry develops and demand grows. As a result, the cost of Chinese shale production is likely to come down over time, but will still be higher than the North American average of about $6 million per well.

Insufficient infrastructure is the third challenge. China's major natural gas basins are located in the west, far from the coastal areas with greatest demand for natural gas. To support the shale gas boom in China, pipelines and supporting facilities need to be upgraded and new capacity built.

The Chinese government, national oil companies (NOCs), and independent operators recognize these challenges and are taking action. On the policy side, subsidies are available to producers of 0.4 RMB for each cubic meter of shale gas produced and used (approximately 1.71 USD per MMBtu). The NOCs are actively building their capabilities and seeking collaboration with companies that have North American shale experience. Examples include Sinopec's recent joint venture with Weatherford International (for drilling) and FTS International (for fracturing). The independent operators are moving slower than NOCs, but they are ambitious and anxious to benefit from shale gas boom. Chinese law restricts access to conventional oil and gas to only four licensed companies, so the only upstream resources that independents can access are unconventional.

In summary, while China has great potential for shale gas as shown by new shale gas production in the Fuling block, it still has to face major challenges. While grand expectations of swiftly replicating the North American shale gas boom are unlikely to be met, in the long run many challenges are likely to be overcome and a material shale gas revolution in China will develop.

Learn more about China Oil & Gas Service and North America Supply Analytics.

1 As of end-2013. 2 As of end-2012.

This article was published by S&P Global Commodity Insights and not by S&P Global Ratings, which is a separately managed division of S&P Global.