Asia's Tough Terrain Delays Shale Gas Progress, But Latent Demand May Ignite Growth

Asia's Tough Terrain Delays Shale Gas Progress, But Latent Demand May Ignite Growth
Primary Credit Analyst: Lawrence Lu, CFA, Hong Kong (852) 2533-3517; law.lu@standardandpoors.com Secondary Contacts: Andrew Choi, Sydney (61) 2-9255-9879; andrew.choi@standardandpoors.com Chizuko Satsukawa, Tokyo (81) 3-4550-8694; chizuko.satsukawa@standardandpoors.com Mehul P Sukkawala, CFA, Singapore (65) 6239-6337; mehul.sukkawala@standardandpoors.com Andrew M Wong, Singapore (65) 6239-6306; andrew.wong@standardandpoors.com David P Wood, New York (1) 212-438-7409; david.wood@standardandpoors.com May Zhong, Melbourne (61) 3-9631-2164; may.zhong@standardandpoors.com
Table Of Contents
Asia-Pacific's Huge Shale Resources Can Feed Rising Energy Demand Obstacles Impede Shale Extraction Across Asia-Pacific In The Longer Term, Strong Economic Fundamentals Will Spark Commercial Shale Gas Production Related Research
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SEPTEMBER 12, 2013 1

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(Editor's Note: The boom in U.S. shale oil and gas production could move the country to energy self-sufficiency by 2017 and is already affecting supply dynamics globally. Standard & Poor's Ratings Services believes that the anticipated development of vast shale reserves outside the U.S--in countries such as Argentina, Australia, Brazil, Canada, China, Mexico, and Venezuela, as well as in Europe--will transform the global oil and gas supply landscape, bringing massive new production online. This article is part of a series on the development of shale gas and oil.) Harnessing Asia-Pacific's vast shale plays could tilt the region's energy balance closer toward self-sufficiency. That's because beneath the basins across the Asia-Pacific lie the world's second-largest shale gas resources, which could slash the region's widening energy deficits. According to the U.S. Energy Information Administration, China alone sits on the most extensive shale gas in the world, although it imports 30% of its gas. Indeed, China, India, and Indonesia have taken tentative steps in shale gas and oil exploration, as part of efforts to secure their energy supply and curb imports. Australia too is pursuing its promising shale prospects. Some countries have drafted shale policies, which have spurred drilling of exploration wells. Commercial production of shale gas or oil, however, won't happen anytime soonnor will it be easy or cheap. Technological limitations, inadequate skills, and tough terrains require huge and costly investments. And poor infrastructure in remote reservoirs would make it difficult to get shale resources to markets. Apart from shale, countries also have conventional resources that may be less expensive and more accessible to tap. Nonetheless, the need for energy security, the push for lower emission fuel, and robust energy demand are likely to spur Asia-Pacific countries to pursue commercial production of shale gas and oil, in addition to other hydrocarbons. Overview Asia-Pacific has the second-largest resources (after Latin America) for technically recoverable shale oil and gas in the world. China alone possesses the world's largest shale gas resources, and is expected to consume more energy to power its growth, despite its slowing growth and economic restructuring. However, due to high costs, environmental concerns, and conventional projects having greater priority, development is likely to continue to be slow. But we believe the region's robust energy demand, the need for energy security, and the push for lower emission fuel will spur commercial development of shale resources in the longer term, although it will take at least five years to get to this point.
Regulatory and environmental policies, however, including drilling bans in Europe and elsewhere, have plagued and stalled resource development in some countries. At the same time, fixed regulatory controls on gas prices in Asia-Pacific countries make it uneconomical to extract shale resources, although such controls are loosening. Regulatory certainty is critical given the reliance on private sector investment to develop unconventional reserves. Moreover, environmental issues pose risks and could delay development of these resources. Chief among these are

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concerns that hydraulic fracturing (fracking) could pollute underground aquifers and water scarcity in shale plays. Standard & Poor's Ratings Services sees Asia-Pacific supply-demand fundamentals supporting shale gas development in the longer term. However, unlocking Asia-Pacific's shale resources is likely to take more than five years. The world's soaring energy appetite, which BP's World Energy Outlook 2013 projects to rise by 36% to 2030, will fuel demand for hydrocarbons. And Asia-Pacific's strong population growth, urbanization, and industrialization will trigger a large part of this increased energy consumption. However, as developed economies rapidly mature and the global population ages, demand growth for energy may somewhat dampen. Still, resource-deficient countries will continue to import more gas--in particular, Japan will depend more on the fuel if it winds down its nuclear power plants. And if liquefied natural gas (LNG) remains indexed to crude oil, gas prices may continue to be a lucrative commodity for exporters such as those in Australia. Over time, we believe developing these resources could benefit Asia-Pacific oil and gas companies' credit quality. It would diversify their hydrocarbon resources and generate more cash flow and profits. A risk to commercial shale development, though, is an unexpected substantial deterioration in Asia-Pacific's economic growth. In this scenario, a glut in supply could occur if demand falls, eroding LNG's price link to crude oil and dragging gas prices down. This in turn would reduce gas exporters' profitability and cash flows, such as what happened in the U.S. recently. For now, however, we see this scenario as unlikely.
Asia-Pacific's Huge Shale Resources Can Feed Rising Energy Demand

The Energy Information Administration's (EIA) recent analysis of resources in 41 countries estimates a total of 345 billion barrels of technically recoverable shale oil and 7,299 trillion cubic feet (tcf) of shale gas. Of these, the Asia-Pacific region holds 1,808 tcf of shale gas resources, and 73,900 million barrels of shale oil. China ranks as the country with the largest amount of technically recoverable shale gas resources in the world (see charts 1 and 2). To put it in perspective, Asia-Pacific's shale gas resources are three-and-a-half times larger than its conventional hydrocarbon reserves.
Table 1
Shale Gas Reserves In Asia-Pacific

Estimated proved natural gas reserves (Trillion cubic feet) Australia China India Indonesia Mongolia Pakistan Thailand Seven countries Other Total 43 124 44 108 24 10 353 151 504 437 1,115 96 46 4 105 5 1,808 1,808 Unproved wet shale gas TRR*

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Table 1
Shale Gas Reserves In Asia-Pacific (cont.)

*TRR--Technically recoverable resources. Source: U.S. Energy Information Administration, as of June 2013.
The enormous untapped potential could alleviate some of the countries' energy deficits. China's gas demand continues to outstrip its domestic supply despite a jump in production. We believe the country's energy deficit will widen because China's industrialization and urbanization have some way to go. In fact, BP World Energy Outlook 2013 predicts China will match Europe as the world's leading energy importer by 2030. This is despite projections of China's energy demand growth slowing by 2020 as the country transforms its economy to being more consumption-intensive from investment-led growth.
Chart 1

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Chart 2
Japan too, is grappling with soaring energy imports. Following the Fukushima nuclear plant shutdown, the country bought A$11 billion of LNG in 2010-2011, including 70% of Australia's total exports for the fuel. In fact, Japan has incurred a trade deficit for the first time because of the huge energy costs. What's more, this energy appetite is unlikely to abate soon. Japan expects LNG imports to leap to A$30 billion in 2016-2017, spiking its energy costs because Australian LNG prices are indexed to oil. Energy security therefore would be a crucial consideration as Japanese companies venture into oil and gas exploration elsewhere. Similarly, we expect Korean demand for gas to increase significantly. Korea is the second-largest LNG import country globally after Japan. Because of critical power supply shortages, the country would need to add about 65,000 megawatts (MW) of generation capacity over the next 6-7 years. Given the growing public opposition against nuclear and coal plants, as well as private sector appetite for gas generation, we expect gas-fired energy will form a large proportion of the estimated additional capacityspiking gas demand. Meanwhile, Indonesia and India have had to resort to importing gas as conventional production fails to meet domestic demandwhich we expect to continue. We believe countries dependent on imports would look to curbing their fuel costs and ensuring energy security, potentially resorting to their large shale gas resources, in addition to conventional sources.

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However, a boom in shale resources production is not always positive from a profitability and credit perspective for oil and gas companies, if supply and demand fundamentals are not supportive. In recent years in the U.S., the shale gas boom has not led to better margins, credit metrics, or ratings for a significant number of issuers in the sectorparticularly for smaller companies that have relied more on natural gas revenues than oil production. Surging natural gas output, in combination with mild winter weather conditions, created a glut that drove down natural gas prices 85% from June 2008 to April 2012. The relative lack of U.S. LNG production and export infrastructure has exacerbated this problem.
Gas is naturally the preferred transition fuel

Natural gas is the ideal transition fuel because it emits less carbon than coal or other fossil fuels. Since coal-fired energy is heavily polluting, countries are becoming increasingly conscious of the environmental impact and choosing gas to generate power, as renewables technology becomes more efficient. However, we don't anticipate renewables to achieve significant scale in the medium term (three-to-five years).
Obstacles Impede Shale Extraction Across Asia-Pacific

Yet despite this vast potential, the pace of shale exploration and development in Asia-Pacific has been slow. Huge drilling costs and infrastructure investment are major hurdles to large-scale production and distribution. In addition, the commercial viability of their shale basins is largely unknown. Australia, China, India, and Indonesia have yet to fully prove the available amount and viability of extracting their shale reserves. Nevertheless, these countries have expressed interest in exploring their shale potential and some have at least started to draft policy frameworks for shale development. Furthermore, oil and gas companies in China and India are substantially investing in U.S. shale production to gain expertise in hydraulic fracturing, underscoring their strong interest in commercial shale oil and gas development. China's national oil company has also formed various joint ventures with various major U.S. and European oil companies to gain access to their fracking technologyand test drilling is underway.
Australia's large gas projects deter development of promising shale reserves

According to the EIA report, Australia has the Asia-Pacific's second-largest shale gas resources that are technically recoverable (see table 1) and the world's seventh-largest (see chart 1) with about 545 Tcf. The country has the sixth-largest shale oil resource in the world with 17.5 billion barrels of oil (see chart 2). These assessed resources are located in the northwestern, north, and central regions of Australia: the Maryborough, Canning, Georgina, and Cooper basins (see chart 3). Geological conditions of Australia's shale resources are more favorable for extraction compared with those of other Asia-Pacific countries. Australia has generally similar geological characteristics to those of the U.S. The Maryborough and Canning basins have marine shales that may be holding abundant gas and oil, enabling the application of the same fracking technology used in the largely marine-deposited North America shales. The Cooper basin, however, stores nonmarine-deposited shales that have higher clay content than marine shales. It remains uncertain how such shales would respond to current fracking technology.

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Infrastructure costs, too, are a key consideration for commercial shale development. As Australia's largest onshore oil and gas production region, the Cooper Basin has existing processing infrastructure to deliver gas to markets. This advantage has prompted Santos Ltd. to initiate exploration of a shale gas play that is relatively near its Moomba processing plant. Elsewhere, several independent companies are continuing to drill wells to study shale plays. In some of these exploration activities, the independents are partnering with major companies that bring more capital resources for shale development. Nevertheless, some of the shale areas are located far from infrastructure needed to put gas to markets. But in the longer term (more than five years), an expected robust demand for LNG, most notably from China and Japan, could trigger commercial shale development in Australia. The country has established long-term contracts to export LNG, prompting several projects that could add more than 100 million tons of capacity annually over the next few years, if they were completed. Surplus production in conventional gas and coal seam gas (CSG) aims to cater to this LNG demand boom. If local or global producers can't meet the demand, Australian producers might tap shale gas. This is a possibility considering the environmental hurdles that CSG is encountering. In New South Wales, the government is considering exclusion zones for CSG exploration and production within two kilometers of residential communities and some rural industry cluster areas. These environmental policies could curb CSG development and supply. Although shale gas and oil extraction does present its own environmental concerns, the current assessed shale resources are far from populated areas. As an established commodity producer, Australia has strong regulatory and institutional frameworks to support shale development. For the medium term (3-5 years) however, we don't expect shale production to take off commercially, given the existing gas projects in the pipeline.

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Tough to tap shale resources slow China's development

According to EIA's estimates, China has the largest shale gas resources in the world (see chart 1), with 1,115 Tcf of gas (see table 1). The country has the third-largest shale oil resource in the world with 32.2 billion barrels of oil (see chart 2). These assessed resources are located in the central-to-southern, northwestern, and northeastern regions of China: the South China Yangtze Platform (including Sichuan), Tarim and Junggan, and Songliao basins (see chart 4).

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The Sichuan Basin has proven to be most attractive for shale development. PetroChina, Sinopec, and Shell have started drilling wells, and several other Chinese and foreign companies are interested in engaging in exploration activities. The smaller companies, however, lack experience in drilling and upstream operations even in conventional resources. Because gas exploration expertise in China is mainly limited to the national companies, the pace of development would be limited. This is unlike in the U.S., where the entrepreneurial drive of hundreds of independent companies sped up development. Shale exploration drilling results in the Sichuan Basin have been mixed. Across the country, about 80 horizontal wells have been drilled, with only six wells reported to be producing more than 10,000 cubic meters. The complex geological structure of these shale basins and the lack of skilled drilling and hydraulic fracturing services would mean commercial production is still a long way off. A further challenge is that some reserves are in regions that are very seismically active, such as Sichuanone of China's most heavily populated provinces. This underwhelming pace so far is despite the government's efforts to speed up shale gas development. China has enabled joint ventures with foreign partners, such as ConocoPhillips and Chevron, and granted permits to players outside the national oil companies. To encourage more private enterprises to participate in shale development, the Chinese government has designated shale gas as an independent resource type outside of conventional oil and gas. In addition, the government has provided subsidies of renminbi 40 cents/cubic meter to shale gas produced. However, based on the current pace of development, the government is likely to fall short of its ambitious target of 6.5 billion cubic meters (bcm) of shale gas by 2015 and 100 bcm by 2020. What's more, attracting the massive capital investment

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required to kick-start commercial development in China would be a huge task. One critical consideration is the lack of water in some of the shale basins. The northwestern basins are in dry areas. Even where water is relatively abundant, China's large population places enormous demands on resources. Further, hydraulic fracturing and wastewater disposal are believed to induce minor seismic activity, raising the risks of earthquake-prone shale areas. The fact that most of the basins rich in shale gas are in remote regions and the lack of gas pipeline infrastructure would also mean that transporting shale gas to markets would present a formidable challenge. Still, China is determined to ensure its energy security. It is not able to produce enough gas to meet domestic demand, resorting to importing LNG which comprises 30% of gas consumption. We expect that as China continues to urbanize, its demand for energy would remain robust. Extracting shale gas domestically is therefore a crucial strategic goal to reduce this dependence. The timing of this shift is uncertain though, and would take years to realize.
India takes initial steps with shale policy; Pakistan is still on the sidelines
India has the world's 17th-largest shale gas resources (see chart 1) with about 96 tcf. The assessed shale basins in India are mainly in the Cambay, Damodar Valley, Krishna Godavari, and Cauvery Basins (see chart 5). The Indian government has set the first two basins as priority areas for shale exploration. In fact, the Oil and Gas Corp. (ONGC) drilled its first pilot shale gas well in January 2011 in the Damodar. ONGC plans to partner with ConocoPhillips to explore further in other basins. Indian national oil companies are also partnering with other companies to tap their expertise in shale development. In addition, the Indian petroleum ministry is developing a shale and gas exploration policy. Apart from environmental concerns, water deficiency and land availability are pertinent issues. India's high population density places enormous strains on water and land use. The talent shortfall in shale gas technology is another constraint. Reliance Industries Ltd. has invested in stakes in U.S. shale gas assets with Chevron, Pioneer Natural Resources, and Carrizo Oil & Gas, which would enable Reliance to gain skills in shale gas technology.

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Meanwhile, Pakistan has the world's 15th largest shale basin with about 105tcf. The shale gas and oil are mainly found in the Lower Indus basin comprising the Central and Southern Indus basins. These basins also produce substantial volumes of conventional oil and gas in Pakistan. Despite this large potential, Pakistan has not publicly reported specific shale development. Nevertheless, electricity shortages continue to plague the country, underscoring the need to tap more resources, including shale gas and oil.
Mounting regulatory risk plagues Indonesia's resource development

Indonesia has the world's 11th-largest shale oil resources, with about 7.9 billion barrels and 4tcf shale gas. The reserves are mainly in the Central and South Sumatra basins, which have abundant conventional oil and gas, and Kalimantan's Kutei and Tarakan basins. Most of the deposits are nonmarine, constituting high clay content (see chart 6).

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Indonesia's upstream oil and gas policymaking body, the Ministry of Energy and Mineral Resources, initiated four shale gas joint studies in the Central Sumatra Basin in March 2012. These studies involve AWE Ltd., Bukit Energy Inc., and New Zealand Oil & Gas (NZOG) and include oil exploration. As of June 2013, the regulator has assessed and approved AWE's joint study submission, but the company has yet to sign a production sharing contract. In May 2013, PT Pertamina signed the country's first production sharing contract for shale development, in the Sumbagut block in North Sumatra. Pertamina is collaborating with Canadian oil and gas company Talisman Energy, which has expertise it gained from the Eagle Ford and Marcellus basins. Pertamina expects that most of the shale gas will feed the booming domestic market. Hydraulic fracturing technology is not new in Indonesia. Chevron Pacific Indonesia has applied the technology to the country's largest oil field, in Duri Sumatra, while Australia's NuEnergy Gas tested coal beds in West Java using fracking technology. As an archipelago, Indonesia faces distinct distribution challenges. Huge infrastructure costs would be needed to set up gas networks across the sea or LNG distribution capacity. The Central Sumatra basin appears most attractive, though, because of existing drilling and transportation infrastructure. Moreover, the country's complex regulatory environment and structural problems hamper the oil and gas industry. For

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example, the government influences gas prices rather than directly linking them to market forces, restricting financial incentives for oil and gas investors. Uncertainty remains over Indonesia's oil and gas law of 2001, and Indonesia recently dissolved the former upstream regulator, BPMIGAS. The government has yet to enact its shale gas legislation. This mounting regulatory risk has also deterred investors from developing the necessary infrastructure to tap Indonesia's natural gas and geothermal reserves.
In The Longer Term, Strong Economic Fundamentals Will Spark Commercial Shale Gas Production
Although Asia-Pacific has the second-largest shale gas potential among regions in the world, development is still in its infancy for several reasons. First, the Asia-Pacific has access to abundant conventional resources. Second, the economic viability of projects is a major question considering the significant investments required to explore tough terrains and develop infrastructure. As the U.S. experience has demonstrated, drilling for shale oil and gas is more costly because it requires new technologies and equipment. Additionally, shale gas wells' depletion rates are higher than for conventional ones, which also raises costs. Environmental regulations and concerns are another hurdle. However, most Asia Pacific countries haven't developed specific environmental regulations. We believe that the bulk of the oil and gas production in the region will continue to come from conventional resources in the next three to five years. However, Asia-Pacific countries have shown strong interest in shale oil and gas, and a few are looking at developing regulatory frameworks for shale development or have initiated draft policies. In addition, oil and gas companies from the region are investing in U.S. shale projects to gain first-hand experience on tapping these resources. What's more, the need to secure energy supplies and feed the region's rising power demand will propel the search for fuels, including shale gas and oil. We therefore believe Asia-Pacific oil and gas companies are likely to engage in commercial production of shale gas in the longer term. The expected increase in exploration of shale oil and gas in the region will spike demand for drilling companies and oilfield service providers. This will benefit companies with relevant technology and expertise. For upstream companies, greater development of these resources will benefit these companies' business risk profiles by diversifying their hydrocarbon resources and would significantly increase the amount of nonconventional reserves. Moreover, once companies develop these resources, it will improve their cash-flow generation and profitability. On the other hand, shale development inside or outside the region may adversely affect E&P companies currently benefitting from favorable oil-linked LNG prices. That's because the development of unconventional resources could ramp up competition among LNG projects and reduce LNG prices, or even lead to a transformational change in the way LNG is priced over the long term. However, we don't expect this to have an impact on the upstream sector's credit quality or to become key rating factors, at least not for the next five years.
Related Research
Articles published on RatingsDirect: Can Latin American Oil And Gas Companies Extract Profits From Unconventional Oil & Gas Resources?, July 23,

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2013 Oil From U.S. Unconventional Resources Is Unlikely To Displace Canadian Crude Oil Exports Any Time Soon, June 17, 2013 Game Changer: Industry Winners And Losers From The U.S. Shale Revolution, May 21, 2013 Liquefied Natural Gas Producers Will Likely Benefit From Regional Pricing A While Longer, Dec. 4, 2012 How Liquefied Natural Gas Markets Around The World Are Adapting To Changing Industry Dynamics, April 20, 2012 What's Behind The Boom In Global Liquefied Natural Gas Development, April 20, 2012 Other publications: Engineering Energy: Unconventional Gas Production, Australian Council of Learned Academies, May 2013 Energy Information Administration/Advanced Resources International World Shale Gas and Shale Oil Resource Assessment, May 17, 2013 BP Energy Outlook 2030, January 2013 Golden Rules For A Golden Age of Gas, World Energy Outlook, International Energy Agency, 2012 Prospects For Shale Gas Development In Asia: Examining Potentials And Challenges In China And India, Center for Strategic & International Studies, August 2012 Shale gas: Key Considerations For India, Ernst & Young, 2012
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Additional Contact: Terry E Chan, CFA, Melbourne (61) 3-9631-2174; terry.chan@standardandpoors.com

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Asia's Tough Terrain Delays Shale Gas Progress, But Latent Demand May Ignite Growth

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Asia's Tough Terrain Delays Shale Gas Progress, But Latent Demand May Ignite Growth

SEPTEMBER 12, 2013 1

SEPTEMBER 12, 2013 2

Asia-Pacific's Huge Shale Resources Can Feed Rising Energy Demand

Shale Gas Reserves In Asia-Pacific

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Shale Gas Reserves In Asia-Pacific (cont.)

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Gas is naturally the preferred transition fuel

Obstacles Impede Shale Extraction Across Asia-Pacific

Australia's large gas projects deter development of promising shale reserves

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Tough to tap shale resources slow China's development

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Mounting regulatory risk plagues Indonesia's resource development

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Additional Contact: Terry E Chan, CFA, Melbourne (61) 3-9631-2174; terry.chan@standardandpoors.com

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