China's Shale Round Focuses on Cash Not Expertise

March 19, 2013

Reuters reports that China's Huadian Corporation, one of the country's top power producers, which won four licences in the second shale gas licensing round last year, will tender for engineering and drilling services to meet its commitment to prospect for gas in blocks across Hubei, Hunan and Guizhou provinces.

"We will be looking for professional services from seismic survey to drilling via a tender towards late this year," a company official told an industry seminar on Monday.

The second licensing round, which closed in October 2012, has met with much skepticism from outside observers because few of the winners had any experience with drilling for oil and gas. Licence holders will all need to contract with service companies like Halliburton, Schlumberger and local equivalents like Anton Oilfield Service Group .

But the critics have missed the point. The purpose of the second licensing round was not to identify companies with existing expertise.

Big established players like China National Petroleum Corporation (CNPC) and Sinopec are already prospecting in Sichuan following an earlier licensing round, in partnership with international majors like Shell.

In addition, Chevron is prospecting in southwestern Guizhou. And ENI has recently signed a joint study agreement with CNPC to develop Sichuan's Rongchang shale gas block.

However, existing license holders have been criticised for making slow progress and not spending enough drilling exploration and appraisal wells. Only a couple of dozen pilot and exploratory wells have been drilled in total over the last three years.

"Since most licences for gas exploration have been allocated to the three domestic companies CNPC, CNOOC and Sinopec, these three companies form an oligopoly in the upstream sector in terms of licences and the bulk of domestic production," according to the authors of a recent study on "Gas Pricing and Regulation" prepared by the International Energy Agency (IEA) with input from China's regulators.

"There is little room for small and medium-sized companies as they own few licences, often with less competitive economics. As the threshold for exploration to be performed in order to keep the licence low, these companies usually keep the licences preventing new entry, and other companies have few chances to get these licences through relinquishment," the IEA explained.

The agency contrasted the situation with the UK North Sea, where bidders are required to submit detailed field development programme, and must adhere to them or have their exploration rights taken away and given to another company.

"Drill or drop clauses may apply in the licence, stimulating the licensed party to keep up with the agreed upon work programme," according to the IEA.

WALLETS, NOT DRILLS

The central objective of the second licensing round was to award licences to a broader range of companies and, crucially, to extract enforceable promises from them to invest heavily in drilling wells.

It doesn't matter that these companies have little or no experience with oil and gas exploration. It has always been assumed they would contract the work to domestic and international companies with the relevant expertise. The