The following interview with Jane Nakano [1] was carried out in Washington D.C., USA, January 14, 2014 by Patrick Renz and Frauke Heidemann. The main focus of the interview was on the Chinese shale gas potential, price implications of U.S. shale gas and tight oil as well as on strategic implications of U.S. shale. All footnotes are remarks by Patrick Renz and Frauke Heidemann, aimed at giving some additional background knowledge and especially giving the links to the cited documents so that the reader can follow up on these issues easily.

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. Chinese Shale Gas Potential

How do you assess the potential for the development of shale gas and tight oil resources in China?

In essence the Chinese have a great opportunity to commercialize their vast shale gas resources. The resources are there by everyones’ account, they are large, probably even one or even the largest gas resources. [2] The Chinese also have almost all of the right ingredients to proceed with them. To me the question is whether there is enough political commitment and institutional or bureaucratic will to move forward with these ingredients. Broadly these could be put into two categories. The one side deals with more the technical part and the geology. The geology part is something no one can control completely. From a lot of analogue geological studies the Chinese shale seems to be more challenging than what we have in the United States as they are harder to crack and farther away from the surface. The geological characteristics make it much more expensive to drill and recover unconventional gas from these deposits. The technical part is something where there is always progress, the Chinese are used to onshore and offshore production, they are one of the largest natural gas producers even though their demand has been outweighing production levels. So they have expertise but this is sort of a new area, this is the unconventional side.

I am however not as concerned, there are many ways they can approach it. They can purchase or acquire Western technologies and adjust it to their needs, go into joint ventures as some of the companies are considering or they let more Western companies with technologies come in. Subsequently, there are different ways to pursue this, it is not unsolvable if they figure out what combination to use to get access to technologies. Expertise is a little different. Within the U.S. we have long known that there are shale gas resources. The question was whether it was commercially viable for the producers to go after those resources and it also took decades for engineers and geologists to really figure out how best to recover them. There are a lot of experts in the U.S. that the Chinese geologists and engineers can benefit from and there are different ways of engaging. You could come up with an arrangement where Chinese investors could arrange or negotiate for Chinese experts being stationed at different shale gas or tight oil fields or acquire some non-Chinese companies with expertise. Even within the U.S. each shale is unique, meaning you have to have the accumulation of expertise, you cannot just bring one person and replicate it. The other category of the ingredients is institutional regulations and investment structures to make it appealing. Of course I want to be careful and not ascribe the way we do this in the U.S., the way we think of incentives and how companies can take risks. That may not be that important for some Chinese companies with greater ties to local and central government resources. But at the same time it is not just unconventional gas but overall natural gas in China that needs to expand for there to be demand and therefore to be profit-making opportunities for some of the not purely commercial companies to go into this business.

Most of the prosperous blocs are already owned by the National Oil Companies (NOCs) and they include both conventional and unconventional gas resources. [3] Therefore, they have to decide whether it is in their interest at this point to use human resources and funds to develop unconventional resources as opposed to conventional resources. I think generally China has a lot going for them, if they are interested, but there is a range of challenges. They have to figure out how to make the ingredients come to life and make it happen. One of the biggest questions is to what extent they can push the natural gas use for there to be a market attracting to go in to the shale gas side.

As in the U.S. it was mostly small companies starting the development of shale gas, what role do you see private landownership and mineral rights playing?

I think there are two ways to look at it. In the U.S. it was and has been almost essential that the private landownership comes with mineral rights ownership [4] and that the shale gas and tight oil development have been happening on private land is no coincidence. If companies had to go into public lands, we would have seen a very different pace of the unconventional so-called revolution unfolding in the U.S. Probably it would have been slower and there would have been different types of dynamics between the government whether it is county, state or federal level including regulators and communities that are both interested in job opportunities and making sure that their environment is not at stake.

In China’s case some argue that having the shale development happen in a lot more government controlled manner may actually facilitate the development and having a lot of players involved doesn’t guarantee success. It worked in the U.S. because we have a history of local residents working with companies, discussing with these producers and then local regulators to see how this might work out for the local economy and for the local environment. Given the completely different situation for China in terms of the land ownership concept, I do not see this as a part that could stop a political system as China’s.

The other thing is that having NOCs in the case of China may be better from an environmental protection perspective than otherwise. I don’t know to what extent we may be in a danger of ascribing how things have been unfolding in this country. There were some environmental issues that have come up in the U.S. such as subcontractors illegally dumping water into the environment as opposed to taking it to very select facilities for recycling. Those have been linked to the fact that some of the subcontractors and smaller contractors are a lot more concerned about a smaller day to day return on their investments as opposed to having a longer presence in the community. To some extent small independents don’t have the type of multi-year financial planning or discipline. There is some difference to majors that are starting to get into the unconventional scene in North America. Big companies in the U.S. and North America tend to be more concerned about their corporate image because they have other lines of business such as gas stations across the country and they don’t want a bad image because they have been dumping water. To the extent they can control their subcontractors’ behavior, they are interested in ensuring the qualitative aspect for their own sake. We talk to a lot of companies and regulators and there is quite a big difference from region to region, project to project, company to company and different models they use. If we are to ascribe that given how much of the energy development as acknowledged by the Chinese government has gone unregulated, not under regulated but unregulated, it would not be the end of the shale development potential or story if the mineral and land ownership issue are not in private hands.

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. Price Impacts of U.S. Shale Gas and Tight Oil

If we take an Asian perspective and look at the shale gas production, do you believe the U.S. shale gas production could influence gas prices in Asia or is this impossible due to the different markets?

Some tend to put too much influence on the scope of the influence and some are too dismissive. The truth is somewhere in the middle. Now that the U.S. is starting to export to the countries that we have a free trade agreement (FTA) with [5] and also to countries we don’t have a FTA with will allow for some of the delivered price in Asia to be lower. It could be higher as well, lower would be assuming that those contracts are written based on the Henry Hub natural gas price. [6] Given the export that could arrive and the growing volume of U.S. liquefied natural gas (LNG) exports to Asia, Asian consumers could diversify suppliers and the U.S. model would be more based on Henry Hub gas pricing. Even after you add shipping as well as liquefaction fees and costs at the current Henry Hub price level, the delivered price in Asia would still be lower than what many of them are paying today. The Henry Hub price could go up as more volume goes to export. However, as every year we are discovering greater levels of natural gas and shale gas resources in this country, I do not expect the domestic U.S. natural gas price to skyrocket, as there will still be a healthy level of supply. Related to that is if the natural gas price is way too low in the U.S., there will be less natural gas produced as there are less incentives for producers. It will be for everyone’s benefit, not just for people interested in benefitting from a national security, energy security or more economic angle. U.S. domestic users will profit as for petrochemical production it is good for natural gas prices not to be too low as otherwise there will be much less supply. China is now in this whole discussion of wanting to import U.S. LNG largely because China already has several import arrangements and their natural gas import picture is quite more diversified than that of many others in Asia, namely Japan and Korea. Korea is basically an island country so they have to import everything by LNG. China has several pipelines, importing from Central Asia and LNG import terminals. They are a lot more diversified. Even if they are not looking to seal any import deals with U.S. companies, the fact that there will be a lot more supply available for any of its fellow Asian buyers of natural gas is a good thing for China. So for example right after Fukushima the Japanese demand for natural gas of course went up because of the nuclear reactors being forced to shut down. But the price level for the region in Asia did not go up as much, in fact it was a surprisingly little increase. This had a lot do to with the fact that the U.S. has been importing so much less from abroad. In the case of Japan, a lot of the Qatari gas that used to go to the U.S. became available to be rerouted to Asia for Asian consumers.

Do you have a take on how the U.S. tight oil production will have an effect on the global oil market?

Of course you are aware that the natural gas market is still not as dynamic as the oil market, not just in terms of volume. It is however much more regionally driven when you look at pricing in the U.S. and Asia. When it comes to crude oil, it is a much more global, dynamic commodity. For example the fact that the global crude price has been a lot higher in recent years than 5-6 years ago, but it has not seen as much volatility despite the Syria crisis and the Iraq not coming back to the global producer scene as expected. The range of the Arab spring related instabilities has a lot to do with the increasing level of self-sufficiency in energy in the U.S., which has provided price relief even on the oil side. I think this is a remarkable contribution and I do want to make sure that we put it in an energy security perspective, and use the energy self-sufficiency term because energy independence is very misleading given that we are still importing quite a bit of crude products. The crude price is very much international and the U.S. will always be part of the global energy market but in the U.S., tight oil development has had a positive impact. The fact that we have been importing much less has significantly helped maintain international consensus on Iranian sanctions, that much we can say.

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. Strategic Implications of U.S. Shale

Do you believe the decreasing dependence of the U.S. on the Middle East due to more energy self-sufficiency will decrease the willingness to be active in the Middle East to keep the oil price stable? How would you see this affecting China?

The question of geostrategic consequences on countries such as China is an issue where I believe we are not there yet. Perhaps in a very select circle this is discussed. It depends on how any particular Chinese persons views the nature of U.S. foreign policy and involvement in any parts of the world. This concern is not unique to China, many other countries are also concerned what that may mean as consumers and for their relationship with China. They do see potential linkage between the growing expansion of the military capacity and what that may mean for regional security and its linkage to how China may want to proceed with its relationship in the Persian Gulf. It is even an issue for Europe, where energy security is far more linked to natural gas and Russia. Their sense is not as sharp on shockers. The Asian consumers are a lot more tuned to this line of debates and discussions. Some think the U.S. has always been in the Middle East because of energy. If you start from that notion, it is already off-track. Even within the U.S. given the fiscal situation, we have seen and heard statements in that regard. I perfectly understand why a lot of consumers, especially in Asia, are starting to worry about whether the U.S. will reduce its commitment to the stability in the Middle East and to free trade, outflow of energy as well as natural resources from the Middle East. Again, the global crude price does affect the U.S. It is all related so closely. If you are a U.S. based company, the planning is multi-decades and the shale gas and tight oil story therefore a great story but they are still interested in other resources around the world. Currently, they are increasing the level of commercial cooperation with other oil companies, whether Western, Chinese or other Asian ones. I don’t think the U.S. interest in the Middle East has ever only been oil or energy. There is furthermore a big difference between the commercial and the foreign policy perspective.

An additional question is whether the Chinese leadership believes – and of course it is not monolithic – whether it is in their interest to be more engaged in the Persian Gulf or in Middle Eastern regional affairs. They have economic interests in the region, but they have been a lot less involved politically, their investments in the Middle East require stability thus far. If they think the U.S. may be reducing its presence, someone will have to go in and it will become increasingly challenging for the Chinese leadership to be just economically present in the region. You can’t just be neutral to some extent to be able to play a sort of balancing force. They are very aware of the century old tension or rivalry between the Persian and Arab states and have thus far been very careful not to step on those sensitive issues. This has been welcomed by the Middle Eastern governments thus far, because the stability has been maintained by the U.S. Basically, China was someone just interested in business arrangements. Going forward, if the landscape starts shifting and if the U.S. would be interested in some sort of burden sharing, then would the Chinese leadership think it is in their interest to be more engaged beyond the economic arena? Are they capable of doing so? Subsequently, just because you are interested doesn’t mean you would have the means to do that. There is a host of questions the Chinese leadership has been thinking about but it may still be a little early for them to come up with a consensus. How they want to engage may be completely different from how they have to engage.

You also wrote about Japanese energy security. [7] Given the diversity of issues between Japan and China, what role does energy security play?

Energy is something that could be used as a source of conflict as well as a foundation for a much better relationship, regional stability or harmony. I do find the tensions in the East China Sea over these potential large resources to be very unfortunate. This is a lot more foreign relations than energy, both governments have whole sets of challenges they should be addressing, ranging from domestic to economic issues. Having said that, they need an outlet for their public to look elsewhere especially when the domestic politics is challenging. So this could be one reason. There is no reason why energy should be a source of conflict in East Asia. The emergence of the U.S. as a major producer is a good thing because both China and Japan are major consumers. However, the trajectory is a bit different. The Japanese population is not growing that much and China’s energy import dependence stays strong and increases. They are different enough but could both benefit from the U.S. freeing up more resources, both natural gas and oil. Once the U.S. LNG export projects go underway a little later this decade, there will probably be a greater benefit for those. There are always those feeling anxious the U.S. might use the new found energy resource wealth as a tool to delay or challenge China’s continued economic growth or rise. Some Chinese scholars mention that some Chinese elites feel that the U.S. might do so, and even within the U.S. there are people interested in using this to advance national interest or national security objectives of our allies, not just in Asia but also with NATO in Europe. Finally, there are in both countries heterogeneous views on geostrategic values of this newly found energy resource wealth. My hope is that this will not help create some sort of zero-sum picture or help those that would like this issue become a zero-sum space, because there is just no need for this to become a zero-sum rivalry among the three: China, Japan and the U.S.

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Thank you very much for the interview.

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[1] More about Jane Nakano at: http://csis.org/expert/jane-nakano.
[2] Estimates for the Chinese shale potential can be found at the Website of the U.S. Energy Information Administration: http://www.eia.gov/countries/cab.cfm?fips=CH.
[3] Jane Nakano and Ksenia Kushkina published an analysis of the second action of shale gas blocks on January 29, 2013: https://csis.org/publication/china-awards-more-shale-gas-blocks-although-much-remains-be-seen.
[4] Many analysts see the mineral rights in the U.S. as one of the primary reasons why the shale gas “revolution” cannot be replicated in other countries: Leonardo Maugeri, “The U.S. Shale Oil Boom: Potential Impacts and Vulnerabilities of an Unconventional Energy Source, Poliy Brief (June 2013): http://belfercenter.ksg.harvard.edu/publication/23193/us_shale_oil_boom.html.
[5] More on the regulation for U.S. LNG export authorizations: http://energy.gov/fe/services/natural-gas-regulation/how-obtain-authorization-import-andor-export-natural-gas-and-lng.
[6] http://www.eia.gov/dnav/ng/hist/rngwhhdm.htm.
[7] More on Japanese energy security and the prospects for U.S. LNG exports to Japan: http://csis.org/publication/japan-gears-its-quest-best-energy-mix.

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