By John Kemp
LONDON, March 18 (Reuters) - China's Huadian Corporation,one of the country's top power producers, which won fourlicences in the second shale gas licensing round last year, willtender for engineering and drilling services to meet itscommitment to prospect for gas in blocks across Hubei, Hunan andGuizhou provinces.
"We will be looking for professional services from seismicsurvey to drilling via a tender towards late this year," acompany official told an industry seminar on Monday.
The second licensing round, which closed in October 2012,has met with much scepticism from outside observers because fewof the winners had any experience with drilling for oil and gas.Licence holders will all need to contract with service companieslike Halliburton, Schlumberger and localequivalents like Anton Oilfield Service Group .
But the critics have missed the point. The purpose of thesecond licensing round was not to identify companies withexisting expertise.
Big established players like China National PetroleumCorporation (CNPC) and Sinopec are already prospecting inSichuan following an earlier licensing round, in partnershipwith international majors like Shell.
In addition, Chevron is prospecting in southwestern Guizhou.And ENI has recently signed a joint study agreement with CNPC todevelop Sichuan's Rongchang shale gas block.
However, existing license holders have been criticised formaking slow progress and not spending enough drillingexploration and appraisal wells. Only a couple of dozen pilotand exploratory wells have been drilled in total over the lastthree years.
"Since most licences for gas exploration have been allocatedto the three domestic companies CNPC, CNOOC and Sinopec, thesethree companies form an oligopoly in the upstream sector interms of licences and the bulk of domestic production,"according to the authors of a recent study on "Gas Pricing andRegulation" prepared by the International Energy Agency (IEA)with input from China's regulators.
"There is little room for small and medium-sized companiesas they own few licences, often with less competitive economics.As the threshold for exploration to be performed in order tokeep the licence low, these companies usually keep the licencespreventing new entry, and other companies have few chances toget 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 developmentprogramme, and must adhere to them or have their explorationrights taken away and given to another company.
"Drill or drop clauses may apply in the licence, stimulatingthe licensed party to keep up with the agreed upon workprogramme," according to the IEA.
WALLETS, NOT DRILLS
The central objective of the second licensing round was toaward licences to a broader range of companies and, crucially,to extract enforceable promises from them to invest heavily indrilling wells.
It doesn't matter that these companies have little or noexperience with oil and gas exploration. It has always beenassumed they would contract the work to domestic andinternational companies with the relevant expertise. The keypoint is that all the second round licence winners are cash richand can afford to invest heavily in drilling.
Huadian is a case in point. The second round winners areoften portrayed as small and inexperienced. But Huadian is oneof the country's largest power producers, with more than 100Gigawatts of installed generating capacity, which means it hasfar more potential output than the United Kingdom or the stateof California.
Huadian has been able to commit to spending 2.7 billion yuan($434 million) drilling 24 exploration and appraisal wells overthe next three years, mostly cheaper horizontal boreholes, withan additional 20 to be drilled if commercial volumes of gas arefound.
As a major power producer, Huadian has a strong interest infinding and developing its own sources of natural gas to reduceits reliance on gas purchased from others, or coal.
Coal producer Shenhua Corporation was another second roundwinner. Other licences have been awarded to companies withstrong backing from provincial governments in areas thought tocontain shale gas deposits, which therefore have a strongfinancial interest in developing them as quickly as possible.
It is far from clear that awarding exploration licences toinexperienced investors and then expecting them to contract withservice companies to do the actual drilling is the mostefficient way to run the domestic shale gas programme.
But existing gas producers have fallen far behind schedulewith their own work. The government probably sees a differentapproach as the best way to reinvigorate the country's domesticshale programme.
The new system is almost guaranteed to be highlyinefficient. But it could start to open up China's domesticshale gas sector to a much wider range of companies and startbuilding the critical infrastructure of drilling, fracking andother services firms that have been critical to the success ofthe shale revolution in North America.
Schlumberger Chief Executive Paal Kibsgaard told investorsat a conference on Monday that "the customer base in China is expanding quickly after shale activity opened up to a wide rangeof companies outside the traditional exploration and productionindustry."
"While we see solid activity growth in the shale basins inthe medium term, we still expect the strongest activity growthin 2013 to come from onshore areas and complex conventional landdevelopments," Kibsgaard noted.
China's shale sector faces a long development timeline. Butinvolvement of major engineering companies like Huadian suggeststhe sector is poised for substantial expansion by the end of thedecade, in line with Schlumberger's estimates for the take offof unconventional gas elsewhere.