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THE RISE OF CHINA AND ITS ENERGY IMPLICATIONS
ENERGYforumJames A. Baker III Institute for Public Policy • Rice University
Quantitative Analysis of Scenarios for Chinese Domestic Unconventional Natural Gas Resources and
Their Role in Global LNG MarketsKenneth B. Medlock III, Ph.D.
Peter R. Hartley, Ph.D.
JAMES A. BAKER III INSTITUTE FOR PUBLIC POLICY RICE UNIVERSITY
Quantitative Analysis of Scenarios for Chinese Domestic Unconventional
Natural Gas Resources and Their Role in Global LNG Markets
By
Kenneth B. Medlock III, Ph.D.
JAMES A. BAKER, III, AND SUSAN G. BAKER FELLOW IN ENERGY AND RESOURCE ECONOMICS, JAMES A. BAKER III INSTITUTE FOR PUBLIC POLICY, RICE UNIVERSITY
AND
Peter R. Hartley, Ph.D.
RICE SCHOLAR, JAMES A. BAKER III INSTITUTE FOR PUBLIC POLICY, AND GEORGE AND CYNTHIA MITCHELL CHAIR OF ECONOMICS, RICE UNIVERSITY
PREPARED BY THE ENERGY FORUM OF THE JAMES A. BAKER III INSTITUTE FOR PUBLIC POLICY
AS PART OF THE STUDY THE RISE OF CHINA AND ITS ENERGY IMPLICATIONS
DECEMBER 2, 2011
Scenarios for Chinese Domestic Unconventional Natural Gas Resources
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THIS PAPER WAS WRITTEN BY A RESEARCHER (OR RESEARCHERS) WHO PARTICIPATED IN THE
JAMES A. BAKER III INSTITUTE FOR PUBLIC POLICY STUDY. THE RESEARCH AND THE VIEWS
EXPRESSED WITHIN ARE THOSE OF THE INDIVIDUAL RESEARCHER(S) AND DO NOT
NECESSARILY REPRESENT THE VIEWS OF THE JAMES A. BAKER III INSTITUTE FOR PUBLIC
POLICY OR THE STUDY SPONSORS.
© 2011 BY THE JAMES A. BAKER III INSTITUTE FOR PUBLIC POLICY OF RICE UNIVERSITY
THIS MATERIAL MAY BE QUOTED OR REPRODUCED WITHOUT PRIOR PERMISSION, PROVIDED APPROPRIATE CREDIT IS GIVEN TO THE AUTHOR AND
THE JAMES A. BAKER III INSTITUTE FOR PUBLIC POLICY.
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ACKNOWLEDGMENTS
The Energy Forum of the James A. Baker III Institute for Public Policy would like to thank The Institute of Energy Economics, Japan, and the sponsors of the Baker Institute Energy Forum for their generous support of this program. The James A. Baker III Institute for Public Policy would also like to thank Deloitte MarketPoint LLC for its continued support of the Energy Forum’s natural gas modeling efforts. The Energy Forum further acknowledges contributions by study researchers and writers.
ENERGY FORUM MEMBERS
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Scenarios for Chinese Domestic Unconventional Natural Gas Resources
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ABOUT THE STUDY
The Rise of China and Its Energy Implications is a major research initiative to investigate the implications of China’s oil and natural gas policies and domestic energy market development on global energy markets. This study focuses on the influence of China’s energy development on U.S. and Japanese energy security and global geopolitics. Utilizing geopolitical and economic modeling and scenario analysis, the study analyzes various possible outcomes for China’s domestic energy production and its future import levels. The study considers how trends in China’s energy use will influence U.S.-China relations and the level of involvement of the U.S. oil industry in China’s domestic energy sector.
STUDY AUTHORS
JOE BARNES JAMES D. COAN
JAREER ELASS MAHMOUD A. EL–GAMAL
PETER R. HARTLEY AMY MYERS JAFFE STEVEN W. LEWIS DAVID R. MARES
KENNETH B. MEDLOCK III RONALD SOLIGO RICHARD J. STOLL
ALAN TRONER
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ABOUT THE ENERGY FORUM AT THE JAMES A. BAKER III INSTITUTE FOR PUBLIC POLICY
The Baker Institute Energy Forum is a multifaceted center that promotes original, forward-looking discussion and research on the energy-related challenges facing our society in the 21st century. The mission of the Energy Forum is to promote the development of informed and realistic public policy choices in the energy area by educating policymakers and the public about important trends—both regional and global—that shape the nature of global energy markets and influence the quantity and security of vital supplies needed to fuel world economic growth and prosperity. The forum is one of several major foreign policy programs at the James A. Baker III Institute for Public Policy of Rice University. The mission of the Baker Institute is to help bridge the gap between the theory and practice of public policy by drawing together experts from academia, government, the media, business, and nongovernmental organizations. By involving both policymakers and scholars, the institute seeks to improve the debate on selected public policy issues and make a difference in the formulation, implementation, and evaluation of public policy.
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P.O. BOX 1892 HOUSTON, TX 77251–1892 USA
HTTP://WWW.BAKERINSTITUTE.ORG
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ABOUT THE INSTITUTE OF ENERGY ECONOMICS, JAPAN
The Institute of Energy Economics, Japan (IEEJ), was established in June 1966 and specializes in research activities in the area of energy from the viewpoint of Japan’s national economy in a bid to contribute to sound development of Japanese energy supply and consumption industries and to the improvement of domestic welfare by objectively analyzing energy problems and providing basic data, information and the reports necessary for policy formulation. With the diversification of social needs during the three and a half decades of its operation, IEEJ has expanded its scope of research activities to include such topics as environmental problems and international cooperation closely related to energy. The Energy Data and Modeling Center (EDMC), which merged with the IEEJ in July 1999, was established in October 1984 as an IEEJ-affiliated organization to carry out such tasks as the development of energy data bases, the building of various energy models, and the econometric analyses of energy.
THE INSTITUTE OF ENERGY ECONOMICS, JAPAN INUI BUILDING
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CHUO-KU, TOKYO 104–0054 JAPAN
HTTP://ENEKEN.IEEJ.OR.JP/EN/
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ABOUT THE AUTHORS
KENNETH B. MEDLOCK III, PH.D. James A. Baker, III, and Susan G. Baker Fellow in Energy and Resource Economics James A. Baker III Institute for Public Policy, Rice University Kenneth B. Medlock III, Ph.D., is the James A. Baker, III, and Susan G. Baker Fellow in Energy and Resource Economics at the Baker Institute and an adjunct professor and lecturer in the Department of Economics at Rice University. Currently, Medlock heads the Baker Institute Energy Forum’s natural gas program and is a principal in the development of the Rice World Natural Gas Trade Model, which assesses the future of international natural gas trade. He also teaches energy economics courses and supervises students in the energy field. Medlock studies natural gas markets, gasoline markets, energy commodity price relationships, transportation, modeling national oil company behavior, economic development and energy demand, forecasting energy demand, and energy use and the environment. Medlock is a council member of the International Association for Energy Economics (IAEE), and a member of United States Association for Energy Economics (USAEE), The American Economic Association and the Association of Environmental and Resource Economists. In 2001, he won (with Ron Soligo) the IAEE Award for Best Paper of the Year in the Energy Journal. In 2011, he was given the USAEE’s Senior Fellow Award. Medlock also served as an adviser to the U.S. Department of Energy and the California Energy Commission in their respective energy modeling efforts. He was the lead modeler of the Modeling Subgroup of the 2003 National Petroleum Council (NPC) study of long-term natural gas markets in North America, and is involved in the ongoing NPC study North American Resource Development. Medlock received his Ph.D. in economics from Rice and held the MD Anderson Fellowship at the Baker Institute from 2000 to 2001. PETER R. HARTLEY, PH.D. Rice Scholar, James A. Baker Institute for Public Policy George and Cynthia Mitchell Chair of Economics, Rice University Peter R. Hartley, Ph.D., is the George and Cynthia Mitchell Chair and a professor of economics at Rice University. He is also a Rice scholar of energy economics for the James A. Baker III Institute for Public Policy. Hartley has worked for more than 25 years on energy economics issues, focusing originally on electricity, but also including work on natural gas, oil, coal, nuclear, and renewable energy. He wrote on reform of the electricity supply industry in Australia throughout the 1980s and early 1990s and advised the government of Victoria when it completed the acclaimed privatization and reform of the electricity industry in that state in 1989. Apart from energy and environmental economics, Hartley has published research on theoretical and applied issues in money and banking,
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business cycles, and international finance. He worked for the Priorities Review Staff, and later the Economic Division, of the Prime Minister’s Department in the Australian government. He came to Rice as an associate professor of economics in 1986 after serving as an assistant professor of economics at Princeton University from 1980 to 1986. Hartley completed an honors degree in mathematics and a master’s degree in economics at The Australian National University. He obtained a Ph.D. in economics at The University of Chicago.
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I. Introduction1
The past decade has yielded dramatic change in the natural gas industry. Specifically, there has
been rapid development of technology allowing the recovery of natural gas from shale
formations. This technology has been applied with much success in North America, and there is
much interest in seeing similar developments in other countries around the world. Since 2000,
production of natural gas from shale formations in North America has dramatically altered the
global natural gas market landscape. In fact, the emergence of shale gas is perhaps the most
significant development in global energy markets in the last decade.
Knowledge of the shale gas resource is not new as geologists have long known about the
existence of shale formations, and accessing those resources was long held in the geology
community to be an issue of technology and cost. In the past decade, innovations involving the
use of horizontal drilling with hydraulic fracturing have yielded substantial cost reductions,
making shale gas production a commercial reality. In fact, shale gas production in the United
States has increased from virtually nothing in 2000 to over 10 billion cubic feet per day (bcfd) in
2010, and it is expected to more than quadruple by 2040, reaching over 50 percent of total U.S.
natural gas production by the 2030s (see Figure 1).
Figure 1. U.S. Natural Gas Production through 2040 (Reference Case)
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To be sure, shale gas developments in North America have had a ripple effect across the globe
by displacement of supply in global trade and by fostering a growing interest in shale resource
potential in other parts of the world. Thus, North American shale gas developments are having
effects far beyond the North American market, and these impacts are likely to expand over time.
The state of knowledge regarding the portion of shale gas that is economically recoverable has
changed rapidly over the last 10 years. A simple chronology of assessments for North America,
where most development activity has occurred to date, is as follows:
• As recently as 2003, the National Petroleum Council2 estimated that about 38 tcf of
technically recoverable resource was spread across multiple basins in the North America.
• In 2005, the Energy Information Administration (EIA) was using an estimate of 140 tcf
in its Annual Energy Outlook as a mean for North American technically recoverable shale
gas resource.
• In 2008, Navigant Consulting, Inc.3 estimated a mean of 280 tcf of technically
recoverable resources from reviewable geologic literature, but a survey of producers
indicated up to 840 tcf.
• In 2009, the Potential Gas Committee4 put its mean estimate at just over 680 tcf.
• In 2011, Advanced Resources International (ARI) reported an estimate of about 1,930 tcf
of technically recoverable resource for North America, with over 860 tcf in U.S. gas
shales alone.5
Importantly, although each assessment is from an independent source, the estimates are
increasing over time as more drilling occurs and technological advances are made. Moreover, the
shift in the generally accepted assessment of recoverable shale resource has left producers,
consumers, and governments all grappling with the implications for markets as well as the
geopolitical repercussions.
Shale gas developments stand to exert enormous influence on the structure of the global gas
market. Throughout the 1990s, natural gas producers in the Middle East and Africa, anticipating
rising demand for LNG from the United States in particular, began investing heavily in
expanding LNG export capability, concomitant with investments in regasification being made in
Scenarios for Chinese Domestic Unconventional Natural Gas Resources
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the United States. But the rapid growth in shale gas production has turned such expectations
upside down and rendered many of those investments obsolete. Import terminals for liquefied
natural gas (LNG) are now scarcely utilized, and the prospects that the United States will become
highly dependent on foreign imports in the coming years are receding.
Rising shale gas production in the United States is also having an impact on markets in Europe
and Asia. In particular, LNG supplies whose development was anchored on the belief that the
United States would be a premium market are now being diverted to European and Asian buyers.
Not only has this immediately presented consumers in Europe with an alternative to Russian
pipeline supplies, it is also exerting pressure on the status quo of indexing gas sales in both
Europe and Asia to a premium marker determined by the price of petroleum products. In recent
rounds of renegotiations, Russia has had to accept far lower prices from many of its traditional
long-term customers and has accepted a partial link to gas on gas pricing.
Revelations about the potential for increased shale gas production are also occurring in other
regions around the world, with shale gas discoveries being discussed in Europe, China, India,
Australia, and elsewhere. To be sure, the enormity of global shale gas potential will have
significant geopolitical ramifications and exert a powerful influence on U.S. energy and
foreign policy.
In this study, we utilize scenario analysis to examine the role that China plays in the future of
global gas market developments. In doing so, we consider two cases, which we compare to a
reference case, where:
1. China’s technically recoverable shale resource base is dramatically larger; and
2. China’s economic growth falters, thus lowering natural gas demand growth.
We also expand on the effect of shale gas developments more generally by highlighting a recent
paper by Medlock and Jaffe (2011)6 in which no shale is developed anywhere in the world. This
highlights the overall importance of the shale gas resource to international gas markets.
Scenarios for Chinese Domestic Unconventional Natural Gas Resources
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Among the geopolitical repercussions of expanding shale gas production are:
• It virtually eliminates U.S. requirements for imported LNG for at least two decades,
reducing U.S. and Chinese dependence on Middle East natural gas supplies, lowering the
incentives for geopolitical and commercial competition between the two largest
consuming countries, and providing both countries with new opportunities to diversify
their energy supply.
• It substantially reduces Russia’s market share in both Europe and Asia, depending on the
amount of shale resource that is ultimately available in both regions.
• It lowers prices and stimulates greater use of natural gas, thereby having significant
implications for global environmental objectives to the extent it displaces coal.
• It reduces overall dependence on Iranian natural gas, which limits Iran’s ability to tap energy
diplomacy as a means to strengthen its regional power or to buttress its nuclear aspirations.
It should be pointed out that the sustained rapid development of shale gas is not a certainty. In
particular, environmental concerns regarding the use and potential contamination of water
resources are major issues that will need to be addressed before governments will allow full
realization of shale’s growth potential.7 In China, in particular, water availability for hydraulic
fracturing may considerably diminish the potential for domestic shale development.
According to a report by Gleick et al. (2008),8 China faces some of the most severe water
challenges in the world due to overallocation, inefficient usage, and widespread pollution, as
well as a fairly weak regulatory body. Moreover, the response to issues of scarcity from Beijing
and central water agencies has typically been one involving proposals for massive new
infrastructure to divert water from one region to another rather than new approaches to
management. One such massive project is the South-to-North Water Transfer Project, which
will funnel 45 billion cubic meters (bcm) of water to the northern part of the country through
the Yangtze River basin but will not be completed for several decades at the earliest. There are
also plans for investment in water distribution systems and the construction of more than 1,000
water and wastewater treatment facilities. Plans for coastal water desalination are also in their
early stages.
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Regional conflicts over water allocation have emerged from a national water policy that seems
centered around moving water from region to region via large infrastructure projects. This
national policy stance is not new. The intensity of the problem in some regions can be witnessed
by the fact that periodic clashes have occurred since the 1970s over water from the Zhang
River. The North China Plains also face fierce competition over water, as Beijing’s growing
population has led to the city’s exploitation of nearly all major rivers flowing through
surrounding provinces.
Figure 2 highlights the potential water availability issues and their intersection with potential
shale gas developments. Notice, with the exception of only a couple of basins, the coincidence of
shale gas resources and water stress is very high. Due to potential water constraints, we have
substantially reduced the technically recoverable shale gas resource base in China in our
Reference Case. However, we do compare this outcome to one in which any potential water
issues can be largely overcome, which results in a technically recoverable shale resource base
that is substantially larger. We describe all scenarios in more detail below.
Figure 2. China Shale Resource and Water Stress Map9
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II. Study Approach
In this study, we utilize the Rice World Gas Trade Model (RWGTM)10 to examine the market
implications and geopolitical consequences of potentially important supply and demand side
developments in China, namely rising supplies of natural gas from shale and changes in its
economic outlook. The RWGTM is a dynamic spatial general equilibrium model where supply
and demand is balanced at each location in each time period such that all spatial and temporal
arbitrage opportunities are eliminated. The model, therefore, proves and develops reserves,
constructs transportation routes and associated infrastructure, and calculates prices to equate
demands and supplies while maximizing the present value of producer rents within a competitive
framework. Thus, new infrastructures must earn a minimum return to capital in order for its
development to occur.11 By developing pipeline transportation routes and LNG delivery
infrastructure, the RWGTM provides a framework for examining the effects of critical economic
and political influences on the global natural gas market within a framework grounded in
geologic data and economic theory. Moreover, it provides insight as to the location and
conditions under which resources are competitive in a global market.
The RWGTM allows the examination of potential futures for U.S. and global natural gas in a
manner that allows quantification of geopolitical influences on resource development and export
flows. The RWGTM predicts regional prices, regional supplies and demands, and interregional
flows. Since geopolitical influences can alter market outcomes in many different ways, the non-
stochastic nature of the RWGTM allows an analysis of many different scenarios and allows the
model to characterize the impact of later economic outcomes on earlier investment decisions. In
this way, the inter-temporal nature of the RWGTM allows a complete analysis of the impact on
investment decision pathways of specific scenarios. This follows from the fact that capacity and
reserve expansions are determined by current and future prices along with capital costs of
expansion, operating and maintenance costs of new and existing capacity, and revenues resulting
from future outputs and prices. The RWGTM is a unique tool because it allows simultaneous
analysis of many different outcomes and is not sequence dependent.
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The RWGTM is a highly disaggregated representation of existing and potential resources,
demand sinks, and distribution networks. The extent of regional detail in the RWGTM varies
based primarily on data availability and the potential influence of particular countries on the
global natural gas market. For example, large consuming and producing countries, such as
China, the United States, India, Russia, and Japan, to name a few, have extensive sub-regional
detail in order to understand the effect that existing or developing intra-country capacity
constraints could have on current or likely future patterns of natural gas trade. In general,
regions are defined at the country and sub-country level, with extensive representation of
transportation infrastructure connecting over 290 regions with more than 135 supply regions.
U.S. demand is characterized at the state and sub-state level for the residential, commercial,
industrial, and power generation sectors. Demand in all other countries is less detailed at the end-
use level, as it is estimated for the power generation sector and all other sectors—a limitation
directly related to data availability.
Supply costs are present for each region in three primary categories—(i) proved reserves, (ii)
growth in existing fields, and (iii) undiscovered resources—and are present for both
conventional and unconventional resources. The resource data derives from sources including
the Oil and Gas Journal (OGJ), United States Geological Survey (USGS), National Petroleum
Council (NPC), Australian Bureau of Agriculture and Resource Economics (ABARE), and
Baker Institute research on unconventional resources in North America and globally. North
America finding and development (F&D) costs are based on estimates developed by the NPC
and have been adjusted using data from the Bureau of Economic Analysis KLEMS data to
account for changes in upstream costs since the early 2000s. These costs have been
econometrically related to play-level geological characteristics and applied globally to generate
costs for all regions of the world. In general, long-run F&D costs increase with depletion, and
short-run adjustment costs limit the “rush to drill” phenomenon. Technological change is
allowed to reduce F&D costs over the long run.
In a global natural gas market as develops in the RWGTM, events in one region of the world
influence all other regions to the extent trade can occur between regions. Thus, political factors
affecting relations between Russia and China, for example, will affect flows and prices
Scenarios for Chinese Domestic Unconventional Natural Gas Resources
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throughout the world, not just in Northeast Asia. This follows because transportation links
connecting markets transmit price signals as well as volumes of physical commodity. It is in this
manner that markets become increasingly connected over time, specifically as profitable spatial
arbitrage opportunities are exploited until they are eliminated. The costs of constructing new
pipelines and LNG facilities in the RWGTM are estimated using data on previous and potential
projects available from the EIA, International Energy Agency (IEA), and various industry
reports. Within the United States, Federal Energy Regulatory Commission (FERC)-filed tariff
rates are used to determine the cost of transporting natural gas via pipeline. For regions outside
the United States, a rate-of-return calculation is generally used to construct the tariffs on
pipelines, such that the present value of the tariff revenue at 50 percent capacity utilization just
recovers the upfront capital cost in 20 years. For LNG, facility throughput tariffs and shipping
rates are based on information obtained from various industry reports.
We compare results in an analysis based on the following three scenarios.
• Reference Case: This case posits a scenario in which all known global shale gas
resources can be developed given prevailing commercial technologies and open tendering
practices. This scenario includes all global shale resources that have been identified as
commercially viable in Europe and Asia and thereby present a full picture of the current
expectations for changing geopolitical and market implications of a full scale
development of known shale gas resources.
• High China Shale Case: This case assumes the quantity of commercially viable shale
resource available for development in China is substantially larger than in the Reference
Case. In fact, the estimated technically recoverable shale resource distributed across four
basins is 600 tcf, an increase by an order of magnitude over the Reference Case. The
dramatically larger resource assessment is still smaller than the resource identified in the
recent ARI/EIA study, but other issues related to development, which are outlined herein,
make this a reasonable upper bound assessment for this case.
• Low China Demand Case: This case posits a much slower growth rate of the Chinese
economy than the Reference Case. The average annual growth rate of real GDP in China
from 2010-2030 is 2.5 percent in this case, which is a reduction from 5.1 percent in the
Reference Case. This occurs due to an assortment of potential problems that might affect
Scenarios for Chinese Domestic Unconventional Natural Gas Resources
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the Chinese economy in the coming years (high inflation, problems related to
infrastructure constraints, etc.).12
III. Defining the Resource
Shale gas resources became prominent for its potential to provide large amounts of marketable
natural gas in only the last several years, centered primarily on developments in the United
States. Beginning with the Barnett shale in northeast Texas, the application of innovative new
techniques involving the use of horizontal drilling with hydraulic fracturing has resulted in the
rapid growth in production of natural gas from shale. Moreover, the production potential that has
been identified since the emergence of the Barnett shale—which until very recently was the
largest single producing natural gas play in North America, having just been surpassed by
production from the Haynesville shale in neighboring Louisiana—has dramatically altered
expectations for global LNG trade. Less than 10 years ago, most predictions were for a dramatic
increase in LNG imports to the United States, but shale production has turned this thinking
upside down. Today, growth opportunities for LNG developers are seen in primarily in Asia,
which could be threatened by a similar emergence of shale in those regions.
Knowledge of shale gas resource is not new as geologists have long known about the existence
of shale formations. However, the ability to access shale resources in a commercial manner is
new. In a study published in 1997, Rogner estimated over 16,000 trillion cubic feet (tcf) of shale
gas resource in-place globally with just under 4,000 tcf of that total estimated to be in North
America.13 At that time, only a very small fraction (<10 percent) of this was deemed to be
technically recoverable and even less so economically. But recent innovations have rendered this
resource accessible both by providing the technological capability and by reducing costs, thereby
providing economic feasibility. In fact, the IEA recently estimated about 40 percent of the
estimated resource in-place by Rogner (1997) will ultimately be technically recoverable.
Despite very large assessments of resource in-place, the commercial viability of shale is
determined as a subset of resource in-place. In particular, technically recoverable resources define
the boundary of those resources that can be recovered with existing technology, but economically
Scenarios for Chinese Domestic Unconventional Natural Gas Resources
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recoverable resource defines the boundary of what is commercially accessible. Thus, large
resource in-place estimates do not necessarily imply large-scale production is forthcoming
because technical innovations and cost reductions are critical to commercial viability.
As noted above, the application of horizontal drilling with hydraulic fracturing to create a
reservoir in virtually impermeable shale formations propelled the Barnett shale to becoming the
largest single producing natural gas play in North America. This subsequently altered producers'
expectations about the viability of shale resources in other locations, and triggered a virtual rush
to the shale resource. Innovations aimed at lowering costs continue, with longer laterals,
increased frac stages, and better proppants. For example, Schlumberger recently reported very
promising results in test wells from the use of its innovative new “HiWAY” fracing technique,
yielding up to double the daily production and greater expected ultimate recovery when
compared to standard slickwater fracs. Currently in North America, break-even prices for some
of the more prolific shales are estimated to be as low as $3 per thousand cubic feet (mcf), with a
large majority of the resource accessible at below $6/mcf. Ten years ago, costs were significantly
higher. As firms continue to make cost reducing innovations, greater quantities of the shale
resource will become both technically and economically viable.
Given the magnitudes of the assessments of shale resources reported in just the past couple of
years, modeling done at the James A. Baker III Institute for Public Policy (BIPP) at Rice
University indicates a relatively conservative estimate of North American technically
recoverable shale resource of 686 tcf. A detailed account is provided in Table 1. The “break-even
price” indicated in Table 1 is the average price needed for development of the average “type”
well for the associated technically recoverable resource.
Shale gas resources are not limited to only North America. In-depth studies are currently
underway to fully assess shale resource potential in Europe, Asia, and Australia, but a dearth of
commercial activity renders the current assessments in those regions highly uncertain. In Europe,
while some estimates exist, there is active research into assessing shale potential in Austria,
Sweden, Poland, Romania, Germany, Croatia, Denmark, France, Hungary, Netherlands, Ukraine,
and the United Kingdom, to name a few locations.
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Table 1. North American Shale Gas Assessments in the RWGTM
Currently, our work at BIPP indicates a technically recoverable assessment in Europe of roughly
220 tcf split between Sweden, Poland, Austria, and Germany, with the largest proportion (about
55 percent) in Poland, and entry costs in the $6-8/mcf range. Data for Asia and the Pacific is
generally even more preliminary, but potential has been identified in China (75 tcf of recoverable
resource) and Australia (50 tcf of recoverable resource), to name two. These estimates are very
Mean Technically Recoverable Resource (tcf) Breakeven Price
Antrim 13.2 5.50$
Devonian/Ohio 170.8
Utica 5.4 6.25$
Marcellus 135.4
Marcellus Tier 1 47.4 4.00$
Marcellus Tier 2 43.3 5.25$
Marcellus Tier 3 44.7 6.50$
NW Ohio 2.7 6.75$
Devonian Siltstone and Shale 1.3 6.75$
Catskill Sandstones 11.7 6.75$
Berea Sandstones 6.8 6.75$
Big Sandy 6.3 6.00$
Nora/Haysi 1.2 6.25$
New Albany 3.8 7.00$
Floyd/Chattanooga 4.3 6.00$
Haynesville 105.0
Haynesville Tier 1 42.0 4.00$
Haynesville Tier 2 36.8 5.00$
Haynesville Tier 3 26.3 6.25$
Fayetteville 36.0 4.25$
Woodford Arkoma 8.0 4.50$
Woodford Ardmore 4.2 5.75$
Barnett 54.0
Barnett Tier 1 32.2 4.25$
Barnett Tier 2 21.8 5.75$
Barnett and Woodford 35.4 6.50$
Eagle Ford 35.0 4.00$
Palo Duro 4.7 6.25$
Lewis 10.2 6.25$
Bakken 1.8 4.00$
Niobrara 1.3 6.50$
Hilliard/Baxter/Mancos 11.8 6.50$
Paradox/Uinta 13.5 6.50$ Mowry 8.5 6.50$
Horn River 90.0
Horn River T1 50.0 4.50$
Horn River T2 40.0 5.25$
Montney 65.0
Montney T1 25.0 4.75$
Montney T2 40.0 5.50$ Utica 10.0 6.25$
Total US Shale 521.5
Total Canadian Shale 165.0
Total North America 686.5
Scenarios for Chinese Domestic Unconventional Natural Gas Resources
20
preliminary and are thus full of uncertainty, but it is possible that estimates of commercially
accessible resources in these regions will grow over time, particularly as technologies are
developed to increase production rates and lower costs.
In fact, the shale resource is by most accounts very large. The previously mentioned studies by
Rogner (1997) and ARI (2011) are summarized in Table 2, where technically recoverable
resources from Rogner’s study have been inferred using the IEA’s recent assessment of a
reasonable recovery factor. Notice that the resources are quite substantial, especially when
compared to the assessments in the Reference Case, which are also included in Table 2.
Ongoing research will likely result in an increased assessment to be used in our own modeling,
but that is preliminary at the time this research was completed. Nevertheless, in order to
understand the implications of larger recoverable resources, we have constructed the High
China Shale Case for comparison.
Table 2. A Summary of Global Shale Gas Assessments**
Notable differences in the assessments in Table 2 center largely on the level of detail. For
example, the RWGTM has no shale gas assessment in Latin America, FSU, India, Middle East,
North Africa, and Other. This accounts for a difference in the total technically recoverable
Rogner (1997)* ARI (2011) RWGTMNorth America 1537 1931 686Latin America 847 1225 ---
Europe 220 639 220FSU 251 --- ---China 1275 75India 63 ---
Australasia 925 396 50Middle East --- ---North Africa 558 ---
Other 235 538 ---Total 6445 6625 1031
*- applies a 40% recovery factor to the estimated gas in place.
1411
1019
**- The assessments in the RWGTM incorporate an assessment of economic viability as well as a discount factor applied to reflect other constraints.
Scenarios for Chinese Domestic Unconventional Natural Gas Resources
21
assessment relative to the ARI assessment of over 2,300 tcf. It is important to point out, however,
that the economic viability of much of the resource identified in the Rogner and ARI studies can
be called into question due to the rock properties and other factors related to the geophysical
properties of the shale. Work is currently ongoing to assess the extent to which this is the case. In
addition, factors such as market structure and mineral property rights also will play a role in the
economic viability of shale around the world, a point that cannot be understated. Arguably, if the
current market structure in the United States did not exist, the shale gas boom would not have
occurred. This is due to the fact that the small producers who initiated the proof of concept had
little to no risk of accessing markets from very small production projects. A market in which
capacity rights are not unbundled from facility ownership does not foster entry by small
producers.
IV. Scenario Analysis—Reference Case
The repercussions of expanding shale gas production potential are profound. In the Reference
Case scenario, LNG exports originate from a wide diversity of sources instead of being
concentrated in any one geographical region, and no single supplier gains significant market
leverage (see Figure 3). Qatar remains the largest LNG exporter while Australia emerges as a
close second. Nigeria, Iran, and Venezuela eventually each grow to positions of prominence, and
they collectively account for about 35 percent of global LNG exports by 2040.
Importantly, it has been shown by Medlock and Jaffe (2011) that shale gas, by displacement, has
both spatial and temporal impacts on the global gas market. More specifically, they show that
shale gas delays for well over a decade the world’s reliance on regions that have historically been
volatile and greatly reduces the chances of decisive monopoly power being exercised by any
individual or grouping of producers. In the United States, in particular, growth in LNG imports is
put off by at least two decades.14 Nevertheless, global LNG trade grows, largely due to growth in
Asia. In fact, the Reference Case reveals very different reliance on LNG across regions, ranging
from very low in North America to very high in Asia (see Figure 4).
Scenarios for Chinese Domestic Unconventional Natural Gas Resources
22
Figure 3. Reference Case LNG Exports (by country) to 2040
We can see that Asia accounts for a massive 59 percent of global LNG demand, with China
leading the way at 24 percent of all global LNG imports. This compares to a European import
share of 22 percent and a North American import share of 16 percent.15 In sum, growth in
supplies of natural gas from shale is a catalyst for deepening of the global natural gas market,
and strong demand growth in Asia triggers significant growth in global LNG trade.
The deepening of the global gas market has distinct benefits. In particular, as shown in Hartley
and Medlock,16 growth in LNG trade implies growth in physical liquidity, which increases
arbitrage allowing for shocks in one region to be transmitted to others. While this may seem
undesirable, it actually mitigates the impact of any single shock. For example, greater ability to
import LNG provides European consumers a means of dealing with future disruptions in Russian
supplies, or U.S. consumers a means of coping with unexpected hurricane damage. Thus, the
impact of the shock on any one region is reduced through arbitrage.
Scenarios for Chinese Domestic Unconventional Natural Gas Resources
23
Figure 4. Reference Case LNG Imports (by country) to 2040
Brito and Hartley17 show that growth in physical liquidity also limits the ability of a single
supplier to price above marginal cost. The relative abundance of LNG, prompted by the dramatic
growth in shale, also puts downward pressure on demand for pipeline supplies, meaning Europe
and Asia see increased competition. Importantly, this has implications for the terms at which
existing and future supplies are negotiated. In fact, as the natural gas supply curve becomes more
elastic, as is the case with shale gas developments, it will become increasingly difficult to price
above marginal cost, meaning oil indexation is likely to lose some of its prominence.
Absent storage and physical liquidity, oil indexation provides an element of price certainty. But,
to be sure, oil indexation is a form of price discrimination. Figure 5 provides an illustration of
price discrimination. Note that oil indexation does not preclude the existence of spot
transactions, but market structures that do not easily allow resale can severely limit them. In
Figure 5, about 15 percent of the marketed volumes are sold on a spot basis, with the remaining
85 percent contracted above marginal cost.
In general, for a firm to be able to price discriminate (1) it must be able to distinguish consumers
and prevent resale, and (2) its consumers must have different elasticities of demand. Both of
these conditions are met in Europe and Asia. However, an increased ability to trade between
Scenarios for Chinese Domestic Unconventional Natural Gas Resources
24
suppliers and consumers (i.e., increased physical liquidity) leads to a violation of condition (1).
This is more likely to happen as the supply curve in Figure 5 becomes more elastic (flatter).18
Even now, evidence of diminished ability to price discriminate is emerging in Europe as there
have been multiple announcements of changes in contractual terms, with a propensity to index at
least a portion of sales to spot prices. Thus, by displacement, the increase in shale production in
North America has begun to have impacts on traditional pricing mechanisms in other markets. If
shale resources are proven to be commercially viable in Europe and Asia, this will accelerate,
and the “new normal” could very well be characterized by more intense competition and
increased pressure for departure from the traditional oil-indexed pricing paradigm.
Figure 5. Oil Indexation and Price Discrimination
As demonstrated in Medlock and Jaffe (2011), if the increased competition from shale had not
emerged, two producing countries in particular would be left with a dominant position in the
global gas market: Russia and Iran. Before the shale discoveries, these nations were expected to
account for more than half of the world’s known conventional gas resources. Notably, both
Russia and Iran have been more than just casual observers in the Gas Exporting Countries Forum
(GECF). The emergence of shale limits the near term possibility of a successful natural gas cartel
being formed by those countries involved in the GECF by increasing the elasticity of supply of
S
D
P@ P=MC
POIL INDEX
Oil Indexed Contract Volume
“Spot” Volume
Total Volume
P
Q
Rent earned from pricing supply above marginal cost
Marginal price
Scenarios for Chinese Domestic Unconventional Natural Gas Resources
25
natural gas in countries outside GECF, which reduces the potential for a small group of
producers to exercise monopoly power.
In fact, in the Reference Case, as can be seen in Figure 6, world dependence on Middle East
natural gas remains below 20 percent until the late 2030s as rising demand from Asia finally
makes its mark. But, as argued in Medlock and Jaffe (2011), reliance on Middle East natural gas
is significantly higher in a world without shale gas. Moreover, the Middle East country that is
disadvantaged the most as a result of rising shale gas production is Iran, whose exports are
effectively delayed by over a decade.
Figure 6. World Supply by Region, 1990-2040 (Reference Case)
In the Reference Case, China becomes a major importer of natural gas both via pipeline and
LNG. In fact, it is the largest driver of growth in LNG trade going forward. Figure 7 indicates
both the growth in demand for natural gas and the manner in which demand is met—via
domestic production (conventional and unconventional gas), LNG imports, and pipeline imports.
Among the domestic options, shale gas becomes an increasingly important source of supply, but
it largely acts to offset declines in conventional gas production. Almost all of the growth in
demand is balanced by imports of pipeline gas from Russia, Turkmenistan, and Myanmar (with
Russia being the largest supplier long term) and by LNG imports. In fact, LNG imports account
for over 50 percent of China’s gas supply longer term.
Scenarios for Chinese Domestic Unconventional Natural Gas Resources
26
Figure 7. China Natural Gas Balance, 2010-2040 (Reference Case)
Strong growth in LNG imports to China has implications for pricing in Asia, as might be
expected. In Figure 8, we see the prices for Asia, National Balancing Point (NBP), and Henry
Hub. Note that the Asian price remains strong relative to other global markers, being at parity
with NBP and well above the price at Henry Hub. Interestingly, demand growth in China
ultimately drives a strengthening of energy ties between Russia and China, a result that may, if it
eventuates, influence the balance of power in Northeast Asia.
Figure 8. Select Natural Gas Prices, 2010-2040 (Reference Case)19
Scenarios for Chinese Domestic Unconventional Natural Gas Resources
27
V. Scenario Analysis—High China Shale Case
As noted above, the recent assessment by ARI (2011) places China’s technically recoverable
shale gas resource at over 1,200 tcf, which is a stark contrast to the resource assessment used in
the Reference Case (75 tcf). However, there is tremendous uncertainty around the economically
recoverable assessment of shale in China. Challenges related to water access and availability,
infrastructure, resource ownership and market incentive, and market structure are all very
relevant issues that must be considered when formulating the amount of shale resource that may
ultimately be recovered. Given the tremendous uncertainty associated with resolution of these
types of issues, we consider a case in which the resource assessment in China is raised to 600 tcf.
Table 3 indicates the distribution of the shale resources in both the Reference Case and the High
China Shale Case. Notably, the resource is spread across multiple basins, where the distribution
is informed by the ARI study and historical gas production. Note that the largest concentration of
shale is in western (Tarim) and north central China (Ordos), which coincide with the regions
with the largest technically recoverable assessments for conventional natural gas (85 and 19 tcf,
respectively) and, in the case of the Ordos basin, coal bed methane (100 tcf).
Table 3. Shale Assessment Across Cases (Units: tcf)
Figure 9 indicates demand and the manner in which demand is met in the High China Shale
Case. As in Figure 7 above, sinks (demand and exports) are represented as negative values and
sources of supply are represented as positive values. A few things are of substantial note. First,
Reference High China Shale
Tarim BasinJunggar Basin
Tuja Basin
Sichuan BasinJianghan Basin
North Central Ordos Basin 30 150
Songliao BasinBohai Bay Basin
Total 75 600
250
45
---West
Central 120
Northeast --- 80
Scenarios for Chinese Domestic Unconventional Natural Gas Resources
28
even though shale gas production is substantially higher, resulting in lower import dependence,
China still imports natural gas via pipeline and as LNG. Second, China begins to export gas (to
South Korea) beginning in 2016, rising to almost a billion cubic feet per day. The overall impact
of lower import dependence and exports to South Korea substantially reduces demand for LNG
imports in Asia (see Figure 12).
Figure 9. China Natural Gas Balance, 2010-2040 (High China Shale Case)
Figure 10 indicates the changes relative to the Reference Case associated with the assumptions
regarding the technically recoverable shale resource base indicated in Table 3. The top panel in
Figure 10 indicates a very large increase in shale gas production, which results in a decline in
both LNG and pipeline imports. We also see that demand is higher due to lower prices (see
Figure 11), and that China begins to export gas (by pipeline to South Korea).
Higher shale gas production in China leaves it less exposed to potentially disruptive events in the
Middle East and Russia. This follows because in the Reference Case, China becomes
increasingly dependent on both the Middle East and Russia for both LNG and pipeline imports.
Thus, to the extent that natural gas supplies can instead be sourced from domestic production,
China is better off.
Scenarios for Chinese Domestic Unconventional Natural Gas Resources
29
Figure 10. Changes in Supply Sources and Disposition Relative to Reference Case
Sources of Supply
Demand
Exports
Scenarios for Chinese Domestic Unconventional Natural Gas Resources
30
The benefits extend beyond China’s borders as well. This is evidenced in Figure 11 through the
impact that greater Chinese shale production has on prices. Asian prices are reduced by the
greatest amount, but prices at both NBP and the Henry Hub are also reduced. This occurs as a
result of the large reduction in LNG demand in Asia, which reduces competition for LNG
imports. In fact, LNG imports to the U.S. and European nations increase (see Figure 13) in the
High China Shale Case.
Figure 11. Decadal Average Changes in Price Relative to Reference Case
Figure 12. Changes in LNG Exports by Country Relative to Reference Case
We also see that global LNG exports are generally lower as a result of greater shale production
in China, a result that reinforces the point that Asian demand is the driver of LNG growth in the
Reference Case. Figure 12 indicates that in 2040 about 85 percent of the reduction in LNG
Scenarios for Chinese Domestic Unconventional Natural Gas Resources
31
exports falls on Iran, Qatar, Russia, and Venezuela. This is analogous to the point made in
Medlock and Jaffe (2011) that shale resources tend to reduce the long-run market influence of
Iran, Russia, and Venezuela.
Figure 13. Changes in LNG Imports by Country Relative to Reference Case
VI. Scenario Analysis—Low China Demand
The recent experience of the Chinese economy has led many to predict very robust long-term
average annual growth rates of the economy. This, in turn, yields very robust outlooks for
Chinese energy demand, and more specifically, natural gas demand. Given the impact that such
strong growth has on global natural gas flows in the Reference Case, we examine a scenario in
which demand growth in China is much less robust. We affect this change by assuming much
slower economic growth. In the Reference Case, the average annual growth rate in GDP from
2010 through 2030 is 5.6 percent, but in the Low China Demand Case the average annual growth
rate in GDP is 2.9 percent.
Scenarios for Chinese Domestic Unconventional Natural Gas Resources
32
Figure 14. China Natural Gas Balance, 2010-2040 (Low China Demand Case)
Figure 14 indicates demand and the manner in which demand is met in the Low China Demand
Case. As above, sinks (demand and exports) are represented as negative values and sources of
supply are represented as positive values. Of note is the fact that the reduction in demand (see
Figure 15) results in lower import dependence, where the majority of the reduction occurs as a
result of lower LNG imports. The overall impact of lower import dependence and exports to
South Korea substantially reduces demand for LNG imports in China (see Figure 15). Lower
LNG demand in China, as in the analysis above, leads to higher LNG imports in the United
States and Europe (see Figure 18).
As in the High China Shale Case, China exports natural gas to South Korea in this case as well,
which reduces Korean demand for LNG in addition to the reduction in China (see Figure 18).
However, the source of supply for exports from China is different. In particular, Russian natural
gas is imported via pipeline and re-exported, meaning China is more likely to be a transit country
when demand growth is lower.
Scenarios for Chinese Domestic Unconventional Natural Gas Resources
33
Figure 15. Changes in Supply Sources and Disposition Relative to Reference Case
Sources of Supply
Demand
Lower demand also results in lower prices in Asia as well as in Europe and the United States.
This result owes itself to the reduction in competition for LNG from Asia, which allows supplies
to be redistributed at lower cost to other regions.
Scenarios for Chinese Domestic Unconventional Natural Gas Resources
34
Figure 16. Changes in Selected Prices Relative to Reference Case
Lower demand for LNG from China, and Asia more generally, results in lower global LNG
exports. From Figure 17, we see that the majority of the reduction in exports by 2040 falls to
Qatar, Iran, Russia, and Venezuela. In fact, about 85 percent of the reduction in LNG exports
falls to these four countries collectively.
Figure 17. Changes in LNG Exports by Country Relative to Reference Case
Scenarios for Chinese Domestic Unconventional Natural Gas Resources
35
Figure 18. Changes in LNG Imports by Country Relative to Reference Case
VII. Conclusion
This Baker Institute study on the role of China in the future of global gas markets has examined
some of the consequences of rising supplies of natural gas from shale in China and lower than
expected demand for natural gas in China. The study finds that development of shale gas
resources in China will have multiple beneficial effects for energy security in China, and in Asia
more generally. In addition, a reduction in import dependence in China has a ripple effect that
results in lower prices in Europe and the United States as well as in Asia.
Natural gas stands to play a positive role in the global energy mix, making it easier to shift away
from more polluting, higher carbon intensity fuels and increasing the near term options to
improve energy security and handle the challenge of climate change. Greater shale gas
production will lower the cost of improving local air quality in China by encouraging a switch to
natural gas in place of coal. In fact, the increase in demand that results in the High China Shale
Case is indicative of this occurring when the relative abundance of natural gas is greater. The
ample geologic endowment of shale gas in North America and around the globe means that
natural gas prices will likely remain affordable even in the face of rising oil prices, and that the
high level of supply insecurity currently facing world oil supplies could be eased by a shift to
Scenarios for Chinese Domestic Unconventional Natural Gas Resources
36
greater use of natural gas without fear of increasing the power of large natural gas resource
holders such as Russia, Iran, and Venezuela.
To tap this benefit, initiatives such as the U.S.-China Shale Gas Resource Initiative could serve
to ensure that Chinese development of its resources is done in a responsible and commercial
manner.20 But shale gas development, for reasons highlighted herein, are not certain. So it is
imperative that impediments to development be addressed in a timely manner in order for
Chinese shale gas production to grow in a robust manner.
Scenarios for Chinese Domestic Unconventional Natural Gas Resources
37
Notes
1. We would like to thank Energy Forum research associate Keily Miller for her
invaluable help gathering information on water resources in China.
2. National Petroleum Council, “Balancing Natural Gas Policy: Fueling the Demands of a
Growing Economy,” September 2003.
3. Navigant Consulting, “North American Natural Gas Supply Assessment,” July 4, 2008.
4. The Potential Gas Committee, “Potential Gas Committee Biennial Assessment,” June
18, 2009.
5. “World Shale Gas Resources: An Initial Assessment of 14 Regions outside the United
States” (report prepared by Advanced Resources International for the Energy Information
Administration, April 2011).
6. Kenneth B. Medlock III and Amy Myers Jaffe, “Shale Gas and U.S. National Security”
(working paper, James A Baker III Institute for Public Policy, Rice University, May 2011).
7. See Time Magazine cover story, “The Gas Dilemma,” April 11, 2011.
8. See “China and Water” in Gleick, Cooley and Morikawa, The World’s Water
2008:2009: The Biennial Report on Freshwater Resources, Island Press, 2008. Available at
http://www.worldwater.org/data20082009/ch05.pdf.
9. Map replicated from “Natural Gas Weekly Kaliedoscope,” Barclay’s Capital
Commodities Research, November 16, 2010.
10. The RWGTM has been developed by Kenneth B. Medlock III and Peter Hartley at
Rice University using the Marketbuilder software provided through a research license with
Deloitte Marketpoint, Inc. More details regarding the model is available upon request.
11. Note, the debt-equity ratio is allowed to differ across different categories of
investment (proving resources, developing wellhead delivery capability, constructing
pipelines, and developing LNG infrastructure).
12. We do not address these issues at length in this paper. Rather, we simply assume a
lower growth rate to provide an outcome that yields substantially lower Chinese demand for
natural gas. Note that we could also assume China, for a policy reason, chooses not to
aggressively pursue natural gas. In either case, the result is lower demand.
Scenarios for Chinese Domestic Unconventional Natural Gas Resources
38
13. H-H. Rogner, “An Assessment of World Hydrocarbon Resources,” Annual Review of
Energy and the Environment 22 (1997): 217-62.
14. Ultimately, LNG imports rise as declines in conventional resources continue and
domestic production growth begins to taper. More information on the model is available
upon request.
15. Note that North America includes Mexico.
16. “Political and Economic Influences on the Future World Market for Natural Gas”, in
Natural Gas and Geopolitics: 1970-2040, ed. D. Victor, A. Jaffe, and M. Hayes, Cambridge
University Press (2006).
17. Dagobert L. Brito and Peter R. Hartley, “Expectations and the Evolving World Gas
Market,” Energy Journal 28, no. 1 (2007).
18. This will also happen in a liberalized market where trading of capacity rights is
allowed, insomuch as the arbitrage allows price signals to clearly transmit. This promotes entry
and, to the extent that hubs develop, financial liquidity. Once that occurs, the means to use
capital markets to underwrite physical transactions increases and liquidity grows, thus making it
difficult to price discriminate.
19. Note the prices depicted in Figure 7 are spot prices, and do not reflect volumes sold
on a contractual basis at an oil-indexed premium.
20. “Statement on U.S.-China Shale Gas Resource Initiative,” The White House Office of
the Press Secretary, November 17, 2009, http://www.uspolicy.be/headline/statement-us-china-
shale-gas-resource-initiative.