Chinas Shale Gas Developtment : AProspect Among the Obstacles

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MAOBA, ChinaWhen Royal Dutch
Shell RDSB.LN +0.51% PLC began a multibillion-dollar
effort to tap China shale gas a few years ago, it seemed
like a can't-miss wager. China has the world's most
extensive shale gas reserves, biggest energy market,
and a government pushing for expanded gas production.
But for Shell and its state-controlled partner, China
National Petroleum Corp. the reality on the ground
makes its bet look riskier.
The region's rough terrain, poor infrastructure and deeply
buried gas formations present tough technical
challenges. The area is so densely populated and
intensely farmed that drilling sites are being built within
360 feet of homes in villages like Maobaupsetting
residents who complain of noise, dust and environmental
concerns. To ease the way, Shell and its partners are
compensating local residents and local government
officials for using their land and roads and other
inconveniences.
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Shell's experience in China, where it is charging ahead
faster than competitors, shows how replicating the U.S.
shale boom won't be easy. While other countries have
shale gasChina, Argentina and Algeria have bigger
reserves than the U.S., according to the U.S. Energy
Information Administrationa range of obstacles make
tapping those resources far tougher than in places like
Texas and Pennsylvania.
Some shale-rich countries, including China, are short on
developed roads, water and drilling contractors trained in
modern safety standards. Others like France and
Bulgaria have put up legal barriers to the hydraulic
fracturing needed to extract shale gas.
And unlike in the U.S., where landowners generally own
rights to gas beneath their property, minerals in many
countries are owned by the state, giving residents little
financial incentive to support drilling near their homes.
From May 2010when Shell was conducting early
exploration in the regionto March 2013, the company
lost 535 days of work across 19 wells due to
"spontaneous village based blockades" or government
requests to halt operations, company officials said in a
March paper delivered at an industry conference. Many
of the villagers' complaints stemmed from money
disputes, the paper says.
Shell officials say the company is in the preliminary
stages of its China shale projectit has only drilled
about 30 wellsand it is too early to determine success
or failure. They say drilling is on schedule, and that
dealing with dense populations and difficult geology are
the sorts of challenges energy companies often
encounter when they move into new regions. Shell hasn't
released a cost estimate for the project, though the
company said it is spending $1 billion a year on
developing unconventional energy in China such as
shale gas.
The rock itself in China is more difficult to extract gas
from. There are high underground stresses, and Shell
experienced some deformed well casings early in China
drilling, according to a March paper published by Shell
employees. "In general, you have to drill deeper" in
China to reach shale gas, said Shell Chief Technology
Officer Gerald Schotman.
Regulatory concerns also heighten China risks. The
country hasn't finalized fracking regulations. And to fight
inflation, the government controls prices at which gas
may be sold, which could weigh on profits.
Even so, China's growing energy consumption, big
reserves and a state push to replace coal power with
cleaner gas make it an alluring target for big oil
companies like Shell.
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"Natural gas has the potential to spark an energy
revolution similar to the one already under way in North
America," Shell Chief Executive Officer Peter Voser said
during a speech last year in China at the Central Party
School.
The Chinese government is backing shale development
because it could lessen dependence on imported gas
and polluting coal. China says it aims to raise natural gas
to 8% of total energy consumption by 2015, up from
about 4% in 2010. The government set an ambitious
target to produce 6.5 billion cubic meters of shale gas
annually by 2015, up from almost nothing last year.
China is particularly appealing for Shell, since it has
missed out on much of the profit from the U.S. shale-gas
boom. Smaller firms pioneered fracking in the U.S.,
snapping up many of the richest drilling sites. By the time
big companies like Shell and Exxon
Mobil Corp. XOM +1.16% bought in, they paid premium
prices just when gas prices were declining.
As early as 2006, Shell leaders discussed tapping
Chinese shale with government officials, say people
familiar with the talks. But some Shell executives
remained skeptical due to China's limited water,
unknown geology and population density.
Some Shell executives were also wary of deals with
Chinese state-run companies, say people involved in
Shell's China deliberations. A decade of talks with
Chinese officials ending in the early 2000s over other
natural-gas infrastructure resulted in less business for
Shell than executives anticipated, these people say.
But by 2011, when members of Shell's board of directors
visited China, wariness was dissipating as Shell felt
urgency to capitalize on the shale boom. To Shell's
board members who visited remote shale fields in China,
the country seemed like a promising alternative to North
America, says a person who attended the trip.
Shell and China National Petroleum Corp. struck gas in
an early shale exploration well in 2011. Then in 2012,
Shell jumped ahead of its competitors to become the
firstand so far onlyforeign company to finalize a
production sharing contract with CNPC in the Sichuan
Basin. Shell's competitors,
including ConocoPhillips Co. COP +0.73%and Chevron C
orp., CVX +0.74% also are exploring China shale, but
haven't made such a big commitment.
While Shell tried to move quickly to start producing in
China, the company and its Chinese partner
encountered bureaucratic, political and physical
obstacles. Government regulators took about a year to
approve the formal Shell-CNPC arrangement.
Protests by residents and local officials resulted in lost
work days at drilling sites as Shell began work in "some
of the most densely populated and intensively farmed
agricultural land in the world," Shell officials wrote in the
March industry-conference report.
To cope with a crowded landscape, engineers said they
reduced the size of drilling pads to just over 1.5 acres
from about 2.5 acres. That limited the number of wells
they can drill from a single site.
Safety is also a concern. While the company says it
conforms to international safety norms, some
"stakeholders" in the drilling projects have an apparent
"misalignment of expectations" about how to interpret
safety guidelines, Shell workers wrote in the March
paper. The company declined to comment further.
Meanwhile, power and water shortages added
complications. In order to avoid competing with farmers
for groundwater, the drilling companies built "extensive
networks of temporary PVC piping" and storage tanks to
supply drilling sites, the officials wrote. The region's
unreliable power supply meant Shell had to install
backup diesel generators, company officials wrote in
another report earlier this year.
In Maoba, where drilling began in April, workers arrived
first to upgrade local roads, a move initially welcomed by
villagers. Then the trucks began hauling equipment,
kicking up dust and dirt residents say forced them to shut
their windows.
Adjacent to the Shell-CNPC worksite in Maoba, a
husband and wife who raise and sell fish from a small
pond initially welcomed the project. The wife says the
new gravel roads were safer when it rained.
But after drilling picked up, the couple says, they noticed
their fish dying. They say they suspected sewage from
the drilling site and confronted workers, who denied
responsibility. A Shell site official said sewage is trucked
out of Maoba, so it was impossible that sewage from the
site contaminated the pond. The official said a drought
and heat wave may have killed the fish.
Maoba resident Deng Fagui says he is concerned the
operations damaged water quality. On his farmhouse
porch one recent morning, Mr. Deng said the
groundwater he pumps for drinking and bathing has
been off color since around the time drilling began. Shell
says it takes measures to ensure local groundwater isn't
polluted.
Shell compensates villagers for land use and other
inconveniences. A person who loses a field measuring
one mua traditional Chinese measurement equal to
about 700 square meters, or about 7,500 square feet
would likely receive at least 8,400 yuan ($1,400) over
two years in compensation, according to local
government official Chen Jiayou. Shell says payments
are transferred to higher-level township governments,
which distribute them to village-level leaders, in some
cases as cash.
Other payments that Shell reimburses its partners in
China for also end up as cash given to local officials,
according to a Shell spokeswoman. Shell said in a
statement that it "follows the government laws and
regulations in terms of standards and procedures" for
doling out compensation, and that it doesn't make
payments in cash, which would violate corporate policy
aimed at preventing bribery. But it said that Shell
contractors or subcontractors might make cash
payments out of "operational convenience" and bill Shell
for the costs.
Maoba's village chief Deng Yuguo says he received a
cash payment late last year from the companies drilling
in Maoba of around 14,000 yuan to use in local road
repairs. Shell said the payment was made as a bank
transfer to township-level officials on behalf of Shell's
joint venture with CNPC, and those officials converted it
to cash for Mr. Deng. Mr. Deng said the funds haven't yet
been spent