Developing And Utilizing Natural Gas Resources: Focus On China

By Rob A. Lagaay, Managing Director of Asia New Ventures Business Unit
Chevron Overseas Petroleum Inc.

China Petroleum Conference 1999

Beijing, China

Today there's an unmistakable message being sent by China's leaders to the world's energy industry, and that message is "we need to develop China's natural gas resources and infrastructure to fuel our future growth."

In his state-of-the-nation address in early March, Premier Zhu Rongji declared that natural gas would play a leading role in helping China achieve its national objectives. He said the country would also undertake a strategy of sustainable development, and he set environmental protection as a high priority. He called for the closure of businesses that continue to pollute, and he underscored his support for the ongoing efforts to reduce air pollution, especially in Beijing. That comes as welcome news to anyone who has spent more than a few days in this city.

Increased use of natural gas is clearly a key element in reducing China's air pollution. Clean-burning natural gas doesn't emit sulfur oxides or particulate matter when it's burned. And its combustion can be engineered to reduce the emission levels of nitrogen oxides.

The World Bank estimates that the cost to human health from air pollution could reach 13 percent of China's gross domestic product (GDP) by the year 2010 if something isn't done to reduce pollution.

The good news is that replacing coal with natural gas can have a significant, positive effect on the environment. The improvement, in fact, can be dramatic. Look at Istanbul, Turkey, for instance.

Before 1994, Istanbul used lignite coal mostly for residential heating purposes. That's why the air was often badly polluted, especially in the winter months. Then, beginning in 1994, they began installing a natural-gas pipeline network for domestic heating and industrial use. By 1996, particulate matter had declined by 46 percent, and sulfur dioxide had dropped by 22 percent in one of the most polluted areas of Istanbul – an amazing improvement in just a short period of time.

In addition to reducing pollution, natural gas has many other benefits:

  • For instance, natural gas is now being used in a new generation of low-cost, high-efficiency applications. One example is combined-cycle gas turbines, which run on natural gas. They generate the same power as a conventional coal-fired power plant, but they use up to 40 percent less fuel. Gas-fired power generation capacity also costs about a third less to build than coal-fired capacity does.
  • Developing countries that use natural gas for new projects can qualify for Clean Development Mechanism credits, which can help offset the cost of development.
  • Natural gas is also an efficient and economic source of process heat for industry.
  • Natural gas is used to manufacture metals, paper, clay and glass, and it's also used in the food-processing and pollution-control industries.
  • In those countries where natural gas has been introduced, people find ways of using it to make high-quality products. These new applications help drive up demand for natural gas. India is a case in point. Industrial demand for gas along the HBJ pipeline, which runs from Bombay across to the north-central part of the country, currently exceeds available supply.

So far, I've discussed the positive impact that the use of natural gas can have on reducing pollution and how natural gas provides an economic energy source for industry. But using natural gas can also have a significant and positive effect on a nation's economy as a whole.

On this graph, we see a comparison of the economic development of Thailand and the Philippines between 1972 and 1998. Notice that the two countries had nearly identical GDPs in 1972 and continued on approximately the same pace of economic development over the next decade. Then in 1981, Thailand began producing natural gas in the Gulf of Thailand for use in generating electricity. After an incubation period of about five years, Thailand's economy began to take off. Today the Thai economy is more than double the size of the Philippines'.

I think the evidence shows that using natural gas can have multiple benefits for any country – China included. And luckily the Asia-Pacific region has rich deposits of natural gas. Only in the past 10 years, however, has natural gas established itself as a significant part of Asia's total energy picture.

China, Vietnam, Malaysia, Thailand, Myanmar, Bangladesh, India, Indonesia, Australia, New Zealand – all these countries have varying levels of domestic natural gas production. Japan, Korea and Taiwan currently import liquified natural gas (LNG) from other Asia-Pacific locations.

This graph shows, for each of the countries listed, how much of their primary energy supply consists of natural gas.

For China, the figure is currently 2 percent, or about 2.3 billion cubic feet per day. China's goal is to increase its natural gas usage up to 8 percent by the year 2020. This is a significant challenge – one that will take international, as well as domestic, resources to achieve.

Despite the slowdown in the Asian economies over the last few years, natural gas projects are continuing to move forward in several countries. For instance:

  • Singapore is moving ahead with its plans to import gas from Indonesia.
  • Papua New Guinea is working on a project to bring gas to Australia.
  • The Philippines is developing Malampaya, a large 3-TCF natural gas deposit, located offshore 400 kilometers (248 miles) southwest of Manila.
  • Thailand is increasing imports from Myanmar through a newly constructed pipeline.
  • India is moving forward with four LNG import projects and studying several more.
  • Korea is continuing the expansion of its national gas transmission system.
  • And finally, China has plans for a very ambitious domestic gas-transmission system.

This map shows how the gas pipeline system is beginning to develop in southern and eastern Asia. As you can see, few of Asia's existing gas pipelines cross international boundaries. That's because things like custody transfer and pipeline ownership still need to be worked out, and regulatory and legal guidelines aren't compatible, which they need to be before pipelines can cross international boundaries.

The areas of greatest population, such as the coastal regions of China and India, represent the greatest potential markets for gas pipeline projects. Because of their level of business activity, these areas are better able to provide the economies-of-scale that are essential for the success of large gas-infrastructure projects.

Although we know that several countries are pushing ahead with their gas projects despite the current economic environment, what – generally speaking – does it take to build a successful domestic gas project?

Basically you need four things.

  • First, your resource has to be large enough. By that, I mean the gas deposit you plan to develop must contain enough reserves to make it economically feasible to develop.
  • Second, you must have a workable transportation-and-distribution system for the gas.
  • Third, and very important, you must have a market for the gas.
  • And finally, you need to have the proper regulatory, fiscal, and institutional arrangements in place before you begin your project.

In addition to those four important elements, it's critically important to negotiate and sign foundation gas-delivery contracts with future customers before you start construction. These foundation customers can include power plants, petrochemical or fertilizer plants, or some combination. Industrial, commercial and residential customers can be added later to bring the project up to capacity and to optimize its economic return.

Development of a gas field and its supporting infrastructure can cost hundreds of millions, even billions, of dollars. Pipeline systems by themselves can cost as much as $1 million a kilometer. A single LNG tanker costs around $200 million. A LNG-receiving terminal costs somewhere between $500 million and $1 billion. One 450-megawatt power plant can cost as much as $300 million.

With so much investment at stake, gas development projects must be carefully planned and executed. All aspects of the project must be thoroughly evaluated to ensure that the investors can earn a reasonable return on their investment. Investors are very cautious about committing their capital to large infrastructure projects, especially domestic ones.

Such projects are expensive, they can have long payback periods, and they often don't generate foreign exchange like export projects do. Because of the long-term nature of these types of projects, potential investors are wary of contract uncertainties, untested legal systems, inconsistent pricing and tax issues.

You can see how important it is that the project permitting-and-approval process be as streamlined and hassle-free as possible. Conflicting interests and priorities among competing governmental agencies can result in unreasonable delays, which can deflate the investors' interest in a project as well as their confidence in the process.

I'm happy to say that China's leadership recognizes these legitimate concerns and has taken steps to address them. China, as a member of the APEC Energy Working Group, endorsed 36 recommendations last October to accelerate investment in natural gas supplies, infrastructure and trading networks. These recommendations are an important step in attracting investors for natural gas development and delivery projects in China.

How about LNG?

At the present time, LNG projects are being evaluated in both China and India, as I mentioned earlier. However, expansion of existing "brown field" projects and construction of new, "green field" projects are being delayed all over the Asia-Pacific region because of a lack of new customers.

There's tough competition for new business in the region, from as far away as the Middle East. Between 1990 and 1998, there have been eight new gas discoveries around the world – each larger than 10 trillion cubic feet – three of which are located in the Asia-Pacific region.

That's why, at least for the moment, it's truly a buyer's market for LNG. But that won't last. As regional economies recover, buyers will begin to sign contracts for long-term supplies of LNG. The lowest-cost suppliers, typically those with surplus capacity, or those able to add incremental production capacity to existing facilities, will be signed up first.

This graph shows Chevron's projection of Asian LNG demand. We expect demand to grow in all five of the major markets shown here. In the next 15 years, we predict that contracted supply will double. To meet this projected increase in demand, China is currently evaluating LNG-import projects at Guangdong, Fujian and Shanghai.

So far I've discussed the merits of natural gas, the status of various gas and LNG projects in the Asia-Pacific region, and what it takes to build and operate a profitable gas project. But what role can multinational companies like Chevron play to help develop China's domestic gas industry?

Since China first opened to outside investment, its leadership has come to appreciate the value of working with multinational companies. Once more we stand at a similar moment in China's history, the beginning of what many hope will be a great expansion of this country's natural gas industry. This moment offers yet another opportunity for China to seek out and develop partnerships with multinational companies, because multinational companies bring a lot to the table.

They bring advanced technology, project management expertise and worldwide experience in resource development. They bring development capital and experience in developing markets. With this expertise, multinational companies can help China accelerate the development of its natural gas resources. An experienced partner – one that understands China's vision and objectives and works well within its culture – can be a valuable asset to the future of China's energy industry.

One of the important things that multinational companies bring to the table, as I said, is project management expertise.

At Chevron, for example, we've developed something called the "Chevron Project Development and Execution Process" to evaluate the viability of all of our projects and to monitor their efficiency. By using this process, we're able to manage our risk, keep our projects on schedule and keep our costs down. We're also able to incorporate everyone's knowledge and experience in the decision-making. That's one of the most important aspects of the process, and it often results in innovative project solutions and options.

CNOOC already has some first hand experience with Chevron's Project Development and Execution Process. And the CACT partners have successfully used it to manage one of their recent projects in the Pearl River Mouth Basin. We're also using our Project Development and Execution Process in the South China Sea, south of Hainan Island, where we're currently exploring for gas.

So far, we've drilled one well in Block 63/15. We haven't completed our evaluation of the drilling results yet, but if it turns out that we've found commercial quantities of gas, we plan to develop a project that will bring the gas to market in Guangdong province by subsea pipeline. Our preliminary economics show that such a project would be economically viable with gas that's priced less than imported LNG. Even if the gas is priced the same as imported LNG, there's considerable incentive for China to encourage development of its domestic gas reserves like those south of Hainan. There's supply security, tax revenue and a share of the production and the profits if CNOOC decides to participate.

Up to this point I've mostly talked about developing China's domestic gas reserves. But how does imported LNG fit into China's energy picture?

LNG demand in China is projected to be 3 million tons per year, beginning with an import project in Guangdong in 2005. Demand is expected to rise to 8 million to 10 million tons per year by 2010. As luck would have it, Chevron is in a good position to satisfy this demand through our interests in northwestern Australia.

Chevron has access to some 20 trillion cubic feet of gas from the North West Shelf Project and several other undeveloped fields in the area. Along with other key players in the Australian LNG industry, we're pursuing new market opportunities in Asia through a new venture called Australia LNG.

Australia LNG has potential access to 100 trillion cubic feet of gas in the northwestern and northern parts of Australia. It offers a range of resource aggregation, project development and supply arrangements. And it also offers total energy solutions to customers, including regassification and power generation.

I hope I haven't left you with the impression that natural gas production in China is a brand new concept. In fact, China has long and amazing history of natural gas production.

Almost 2000 years before Colonel Drake drilled his first oil well in the United States, China was producing natural gas in the Sichuan Basin. They used a drilling technique back then that's comparable to cable-tool drilling that was used earlier this century. The rigs and the tubingwere made of bamboo. Several hundred wells, some up to 3000 meters deep, produced brine and gas. The brine was collected in large evaporation pans. The pans were then heated by the gas, which was piped in through bamboo tubing.

It wasn't until the end of the 19th century that the rest of the world recognized the value of the Sichuan experience and used it as a basis for the development of modern drilling-and-production techniques.

In my opening remarks I mentioned that natural gas would play a leading role in helping China achieve its national objectives. That is undoubtedly true. But achieving its goals of increased natural gas usage and environmental improvement will be tremendous challenges for China.

I think multinational business partners can play a useful role in helping to meet these challenges by offering expertise that can help China reach its goals more quickly and less expensively.

Chevron is proud to be involved in China's drive to develop its natural gas resources and to expand the nation's use of natural gas. From our Asian headquarters here in Beijing, we've set our sights on becoming China's partner of choice.

Thank you very much.

Updated: May 1999