Did China Just Win the Caspian Gas War?

While Washington and Moscow had their eyes on one another, Beijing stole the prize.

Natural gas is in the midst of a transformative moment. The advent of shale gas, the growth of seaborne liquefied natural gas (LNG), and a new "green" image for the old hydrocarbon brought more uses, attention and yes, even controversy, to global gas markets. But the world's most influential player in all this is neither the world's largest gas producer, Russia, nor the world's second-largest consumer, the United States. It's China. Despite being much more reliant on oil and coal, Beijing has nevertheless managed to become the most agile and active force in the global gas market.

The reason has just as much to do with geopolitics as geology. As China seeks to secure energy sources for its growing economy, it has expanded production at home and made strides at ensuring its access to gas abroad. That quest has displaced a two-decades-long shadowboxing match between the West and Russia -- a "Great Game" China is now poised to win.

China's recent reach into global gas opportunities is fueled by soaring domestic demand, as Chinese industry grows despite the global economic downturn. There are signs that Beijing's energy geopolitics ambitions cannot keep up: The onshore price of natural gas in China was just increased 25 percent. As a result, China is not only stepping up its own natural gas development, but also expanding its capacity to import LNG from places like Australia, Malaysia, Papua New Guinea, and Qatar.

Domestically, China's East-West pipeline brings gas from the energy-rich autonomous region of Xinjiang to the booming east coast. Xinjiang's proven reserves are about 700 billion cubic meters (about a tenth the size of U.S. reserves), but there might be a lot more. And PetroChina officials are exploring new shale gas and coal-bed methane opportunities all over the country. Eager to wean Beijing off of troublesome gas producers such as Iran, the Barack Obama administration recently signed a technology transfer agreement with the Chinese that would give Beijing the same revolutionary extraction capabilities that have created a shale gas bonanza in North America. One of Beijing's official goals is that China's coal-bed methane production should be 16 times higher in 2020 than it is today. Some analysts predict that China will reach 80 percent self-sufficiency in gas production by that time.

Further afield, Beijing has put into place infrastructure that would make Houston blush. Stretching 1,139 miles, the China-Central Asia pipeline connects Xinjiang with natural gas-rich Kazakhstan, Uzbekistan, and the biggest prize -- with potentially the world's fourth-largest energy reserves -- Turkmenistan. With the completion of this mammoth project, which was inaugurated in Turkmenistan by Chinese President Hu Jintao last winter, China became the most influential player in the struggle for resources in the energy-rich Caspian basin. Some analysts have even sounded the death knell for Russia's energy influence in Central Asia, Moscow's traditional back yard.

Then, in early June, Turkmenistan's president, Gurbanguly Berdimuhamedov, announced construction of a trans-Turkmen pipeline that will connect the China-Central Asia pipeline to the country's vast western resources -- the very same reserves traditionally exploited by Russia and earmarked for the U.S. and EU-backed trans-Caspian, Nabucco project planned to go west across the Caspian and through Turkey to Austria. Turkmenistan's $2 billion trans-Turkmen project is, according to the president, going to be built with Turkmen money, labor, technology, and expertise. But, sources familiar with the project's specifications say that there is little likelihood that it would have been undertaken without Chinese support, both financial and technical.

Both the Russian and Western ability to respond to this incursion on their pipeline plans looks weak. In April 2009, a major explosion damaged the main gas pipeline connecting Russia to Turkmenistan. Although Russian gas monopoly Gazprom denies any culpability, Turkmen officials accuse Moscow of shutting down the pipeline to avoid high payments for gas during a time when global gas prices were unexpectedly low. While exports to Russia have resumed, they are less than a third of what they once were.

Meanwhile, Western companies involved in the Nabucco project announced an open season for investment in the project this year. But serious doubts remain about whether the project will be able to get beyond its first stage of tapping into Azerbaijani and possibly Iraqi gas -- a crucial first step before expanding across the Caspian. Western private-sector actors are also working against each other: Nabucco competes for its Azerbaijani resources with the Trans Adriatic Pipeline (which just got a major new investor in Germany's E.ON Ruhrgas) and Interconnector Turkey-Greece-Italy, a smaller capacity pipeline that may well come to fruition because it is less ambitious than Nabucco.

Yet though Chinese state-controlled energy companies are riding high at the moment, nothing is assured. Chinese moves in the Caspian could well create a backlash, for example. Caspian gas producers welcome the cash and efficiency that comes with Chinese investment, but the attendant political influence is not always viewed favorably. Gas-rich Azerbaijan, Kazakhstan, Turkmenistan, and Uzbekistan are not interested in supplanting one imperial master in Moscow for another in Beijing.

What is certain is that the Chinese consumer's hunger for gas reserves has landed Chinese companies right in the middle of one of the world's most hotly contested geopolitical battlegrounds. If Chinese companies are not careful, they could drag Beijing into the region's hard security squabbles: Afghanistan, Georgia, Iran, and the Nagorno-Karabakh conflict. Deeply invested powers, such the United States and Russia, may not appreciate another cook in the Caspian kitchen.

Shale gas: Could it be a new energy source?

The world economy is recovering, and the price of oil too. It has crossed $70/barrel, and could return to $150/barrel, if the recovery continues. Can India do anything new to meet this energy challenge?

Yes, it can change its exploration policy to harness a new energy source — shale gas. No Indian has paid attention to the dramatic emergence of shale gas in the US, which has produced a gas glut. This has slashed the US price of natural gas by 75% from its peak in mid-2008. India must learn from this.

Shale is a common rock formation across the world. India has huge shale deposits across the Gangetic plain, Assam, Gujarat, Rajasthan, and many coastal areas. Gas has long been found in shale across the world, but its extraction has been viewed as uneconomic because of shale’s low permeability — gas does not flow easily through this rock. So, exploration for oil and gas has traditionally focused on limestone and sandstone, which have high permeability.

However, in the 1990s a new drilling technology emerged. A tight shale deposit could be cracked open by injecting water into wells at high pressure. When the water injection stopped, the cracks closed again. But then engineers hit on the idea of pumping water mixed with sand.

The sand kept cracks partially open when water injection stopped, increasing permeability and gas flow.

A sedimentary rock deposit has a limited depth but very wide area (sometimes hundreds of square miles). Traditional vertical drilling into a deposit 20 metres deep can yield gas production from a zone of just 20 metres. But new techniques have facilitated horizontal drilling. This makes possible horizontal wells running hundreds of metres long through shale strata, greatly increasing the production zone of each well. Horizontal drilling plus sand cracking have revolutionized the economics of shale gas in the US, and made it a boom industry.

Huge shale deposits lie at shallow depths across the world, and can be explored at a tiny fraction of the hundreds of millions involved in deep offshore wells (as in the Krishna-Godavari basin). The low cost per well compensates for the low yield per well. The share of shale gas in the US gas production has moved up from zero to 8%. One single deposit, the Barnett Shale in Texas, produced 1.1 trillion cubic feet of gas in 2008, and other deposits (Bakken, Haynesville) could be as productive. Anadarko Petroleum is ramping up drilling in the relatively lowyielding Marcellus Shale (stretching hundreds of miles from West Virginia to New York), aiming to achieve a 10% rate of return at a gas price of $2.50/mm British Thermal Unit. This is well below the current US price of $3.70, and a fraction of the $13 in June 2008. It is also well below the $4.20 the government has fixed for KG basin gas, and is close to the $2.34 Anil Ambani is demanding. So, at least some shale gas deposits look entirely economic.

Why has no company in India explored for shale gas despite several rounds of bidding for exploration blocks in the last two decades? The sad answer is that our exploration policy allows companies to produce only conventional oil and gas from their exploration blocks. If they find non-conventional energy — such as coal-bed methane or shale gas — they are forbidden to produce this! Why? Because, the petroleum ministry regards any non-conventional deposit as an unwarranted windfall for the exploring company, and wants separate bidding for non-conventional energy. For coalbed gas, it has called for bids and awarded exploration contracts in known coal deposits. But gas can also be found in deep coal deposits unknown today. When drilling for oil, Indian companies have already hit thick coal seams deep underground, but not bothered to test these for gas because they would not be allowed to extract it.

The same holds for shale gas. When drilling for oil, every company hits shale deposits, but ignores their gas potential since they are not allowed to harness it.

Clearly, two changes in exploration policy are urgently needed. First, the government needs to come out with a shale gas policy. It should facilitate seismic surveys that can quickly delineate potential shale gas deposits, and then invite bids for exploration.

Second, all future exploration contracts for oil should permit exploitation of shale gas as well as conventional gas. That will make it worthwhile for companies to investigate shale gas they may find while drilling for conventional hydrocarbons.

These policy changes will not cost the government a rupee. They will simply relax the boundaries of exploration. That alone can make a big difference.