CHINA

China is an ancient country at the foot of its industrial age. It is in the midst of a dynamic, rapid modernization-its overall economy grew 9.5% and industrial production grew 16% in first-quarter 2005, according to Bloomberg LP. Today, the People's Republic of China is the world's second-largest consumer of oil, behind the U.S. Last year, China's oil demand reached 6.4 million barrels per day, a startling 15.4% jump from 2003. This year, its demand may reach 6.8 million barrels a day, up 7.9% from 2004, forecasts the International Energy Agency (IEA). Like the U.S., China's oil need far outstrips its domestic supplies. Although the Sichuan Basin was the site of the world's first commercial hydrocarbon field, when the Chinese Communist Party came into power in 1949 the country had only minor production. Even after China made its great Daqing oil discovery in its northeastern Heilongjiang province in 1959, the nation was a negligible participant in the world's oil markets, producing and consuming less than 200,000 barrels per day. During the late 1970s, China launched a drastic expansion of its oil industry, but the anticipated discoveries of numerous fields the size of 8-billion-barrel Daqing did not occur. China began to open its petroleum sector to participation by foreign firms in 1982, when it was still a net exporter of oil. At first, major companies showed a strong interest, mounting a number of exploration programs in the South China Sea, the first area offered. These did yield several offshore discoveries, such as Arco's Yacheng Field in 1983 and Amoco's Liuhua Field in 1987, but the overall results did not meet expectations. Several onshore provinces were opened to foreign investment in 1985, tracts in the East China Sea were offered, and Bohai Bay concessions were made available in 1992. China became a net oil importer in 1993. Its dilemma is that it is only moderately prospective by world standards, with 18.3 billion barrels of reserves as of January 2004, says the U.S. Energy Information Administration. Natural gas potential is constrained as well, with reserves of 53.3 trillion cubic feet (Tcf). CBM OPPORTUNITIES While the natural gas business is still in its nascent stages in China, there's another resource that has the potential to add considerably to the country's supplies. China has vast coal reserves, and coal supplies two-thirds of its energy demand at present. According to the U.S. Energy Information Administration, China is both the largest producer and largest consumer of coal in the world. Much of its coal is gassy, and horrifying mine accidents often make the world news. As coalbed-methane (CBM) production has shot upward in the U.S., attention has increasingly turned to this resource in China. The government established China United Coalbed Methane Co. Ltd. (CUCBM) in 1996 to spearhead its development, and is offering a number of incentives to encourage CBM work, including exemptions from import and export duties and market pricing for the commodity. Several foreign firms are currently pursuing projects in such provinces as Shanxi, Jiangx and Anhui. Houston-based independent Far East Energy Corp. is one of these firms. The company has two projects in the works, in Shanxi and Yunnan provinces. The largest is a 1-million-acre production-sharing contract (PSC) in Shanxi province in east-central China. Far East has farmed into ConocoPhillips' Dragon project, which consists of the Shouyang Block, near Taiyuan City, and the Qinnan Block near Jincheng and Qinshui. The two blocks are each astride major pipeline projects. The route of the West-East pipeline, from western Xinjiang province to Shanghai, runs just five to 10 kilometers south of the Shanxi acreage. The Shanjing II pipeline to Beijing is being constructed about 40 kilometers north of the Shouyang Block. The Shanxi coals are semi-anthracite in rank and are similar to those found in the Arkoma and Appalachian basins in the U.S. To date, Far East has completed the first phase of exploration. It has fractured and tested one of the three existing vertical wells, and it is now moving into the second exploration phase. "We are shifting to underbalanced horizontal wells, and we plan to drill two in Shouyang, " says Bruce Huff, Far East chief financial officer. "We have received approval to drill horizontal wells in lieu of the vertical wells that were in the original commitment." These types of wells have proven very effective in tapping CBM in the Hartshorne coals in eastern Oklahoma and in the Pocahontas coals in southwestern Virginia, and Far East is anxious to apply the technology in China. The company plans to spud its first horizontal well in late June. It expects to drill a vertical hole to 550 meters, then drill laterals up to 4,000 meters in length. Each well should take between 35 and 60 days to drill. After the two wells are finished, ConocoPhillips can choose to participate as a 30% partner or take a royalty. Far East estimates that its share of potentially recoverable CBM from the Shanxi blocks could range between 3.2- and 5.3 trillion cubic feet (Tcf), depending on the option that ConocoPhillips chooses, and that the project has the potential to support a large number of horizontal wells. Its second venture is in Yunnan province, in southern China. Far East holds a 60% working interest in the 265,000-acre Enhong-Laochang PSC; the remaining 40% is held by CUCBM. The company has drilled three vertical wells, fractured one of those wells and drilled two slimhole vertical wells in its first phase of exploration. The wells encountered up to 42 meters of coal, with gas contents as high as 650 standard cubic feet per ton. For the second exploration phase, Far East plans a horizontal well in Yunnan prior to year-end. The company estimates that its share of the potentially recoverable resources in the block could be up to 1.6 Tcf. Prospectivity is limited because China's basins are filled mainly with non-marine sediments, which are not as desirable for petroleum generation as the extensive marine sediments found in other basins around the world. Today, the Middle Kingdom produces some 3.5 million of barrels of oil per day, with nearly a third of that volume coming from Daqing, which remains its largest field. That said, new technology and high oil prices have combined to deliver some very profitable operations for foreign companies that are active in China. The Chinese government supports and encourages foreign oil and gas exploration and production within its borders, and it has developed a comprehensive legal framework that supports those investments. With just 2% of the world's reserves but 20% of its population, China needs every barrel of oil it can find. Bohai Bay An early focus of international exploration effort was Bohai Bay, the arm of the Yellow Sea that reaches into northeastern China. The shallow-water bay, which is a key access point for inland China, is ringed by oil fields and is the offshore portion of the North China Basin. In the mid-1990s, the likes of Shell, Exxon, Texaco, Chevron and Phillips took on production-sharing contracts (PSCs) in Bohai Bay, along with such smaller firms as Murphy Oil, Union Texas Petroleum, Newfield Exploration, Pendaries Petroleum, Samedan Oil, Benton Oil & Gas, XCL Ltd. and Apache Corp. (For more on this, see "Bohai Bay," Oil and Gas Investor, February 1998.) Development of Bohai Bay has progressed in fits and starts since then, and today floating production, storage and offloading vessels (FPSOs) dot its waters, producing around 200,000 barrels of oil per day. Many of the original participants left the area after extensive drilling programs uncovered fields that averaged around 75 million barrels of oil apiece. The largest find is Peng Lai, a 260-million-barrel find that ConocoPhillips operates on Block 11/05. Altogether, some 1.2 billion barrels of recoverable oil have been discovered in Bohai Bay, mainly on basement highs. One early entrant that has flourished in Bohai Bay is Oklahoma City-based Kerr-McGee Corp. The independent has been active in China since 1994, initially partnering with Amoco. In 1996, it drilled its Cao Fei Dian 11-1 discovery on Block 04/36, and followed that with the Cao Fei Dian 11-2, 11-3, 11-5 and 11-6 finds on the same block. Project engineering for the Cao Fei Dian (CFD) development was kicked off in Houston in late 2001, and in June 2002 Kerr-McGee decided the development would go forward. Bohai Bay production is notorious for both high water volumes and problematic sand production. Kerr-McGee decided to use both extended-reach and horizontal wells and electric submersible pumps to recover the oil. It selected a hub-and-spoke development, with the hub designed to accommodate production from additional fields. This option was particularly attractive in light of the company's 1.7-million-acre position in the area, consisting of blocks 04/36, 05/36, 09/06 and 09/18. The CFD fields are quite complex, with many thin sandstone reservoirs occurring at depths between 1,000 and 1,300 meters. The sands are filled with waxy, heavy oil of between 12- and 14-degree API gravity. "Geologically, the Bohai Bay developments are challenging," says Michael Verm, Beijing-based vice president of China operations for Kerr-McGee. Kerr-McGee started producing oil in Bohai Bay in July 2004 and is currently making 36,000 barrels daily from two fixed platforms on its CFD 11-1 and 11-2 fields. The company operates and owns a 40.09% interest in Block 04/36; its partners are Houston-based Ultra Petroleum, with 8.91%, and CNOOC Ltd., 51%. CNOOC is a national oil company that handles most of the country's offshore assets. The two fields are flowing oil into Kerr-McGee's Global Producer VIII, an FPSO that was built in the Dalian New Shipyard on the east side of Bohai Bay. It is leased to Kerr-McGee by a subsidiary of CNOOC. The 909-foot-long vessel can handle 80,000 barrels of oil and 350,000 barrels of water per day, and store 1 million barrels of oil. As the water depth is 25 meters, the company uses a single-point mooring system. Currently, 32 producing and three water-injection wells have been drilled on two platforms, one a 48-slot and the other a 24-slot structure. "We have just begun our second phase of drilling at 11-1 and 11-2, and we will have a well count in the upper 40s by the end of the year," says Verm. At press time, a rig was drilling on each platform and the jacket was being set for an unmanned platform for the CFD 11-3 and 11-5 fields. The satellite fields will begin producing into the FPSO by year-end, which will grow Kerr-McGee's net daily production from China to between 19,000 and 20,000 barrels of oil per day. This year, the company will spend $100 million in China. In addition to its development program on Block 04/36, it has its 12-1 and 12-1S discoveries on Block 05/36, in which it holds a 50% predevelopment contractor's interest; Newfield Exploration and Ultra Petroleum are partners. Kerr-McGee's 11-6 discovery on Block 04/36 extends to the 12-1 accumulation, and it has applied for approval to develop the 11-6, 12-1 and 12-1S fields. If approval is granted shortly, first oil could flow in 2006. To date, 10 wells have been drilled in 12-1. There is also a particularly exciting appraisal well that it is being drilled on the CFD 14-5 discovery on Block 09/18, in which Kerr-McGee holds a 100% predevelopment contractor's interest. The initial well intersected 28 meters of net pay with 31- to 33-degree-gravity oil in the Eocene Shahejie formation, which is productive in the onshore Dagang, Shenzi and Jidong fields that rim the bay. "We're really pleased. Going into China, there were a lot of unknowns about development," says Verm. "We called on our North Sea experience, where we had people with good, offshore heavy-oil experience." Mark Wallace, who transferred from Aberdeen, Scotland, to take the job of development director, led the design and execution of the project. The company has focused on designing its wells for heavy-oi l production, and has not had any issues with solids or sand production to date. It has set several records: its 11-1-AS well flowed at more than 10,000 barrels of oil per day, achieving the highest flow rate recorded in China, and it has drilled the highest-ratio extended-reach wells in the country. Operating in China Doing business in China is unique, says Verm. "Negotiations take time, and there are complexities to the PSCs." Indeed, the PSC structure in China was originally designed for major fields, and is not as applicable to the smaller sizes that have actually been found. "However, once you have made a deal, things tend to move quickly." The most demanding parts of managing projects in China are understanding and getting through the approval processes, he says. Communication with CNOOC is key, and a successful business model in China will value relationships and contain a vigorous effort to keep communication open. It's also important to remember that the Chinese culture has a strong respect for hierarchical authority, and how Chinese people respond to surprise is different than the Western response. Kerr-McGee has relied heavily on Chinese manufacturers for its oilfield equipment and Chinese providers for its service needs. "The Chinese can deliver most of what we want," says Jim McRae, director of drilling. "Rigs have come a long way, and the crews are very good and comparable to Western standards." In its eight years in China, the company has drilled offshore wells in both Bohai Bay and in the South China Sea. "When possible, we use local suppliers and vendors, but there are projects that require us to look to other sources of expertise," he says. Kerr-McGee's horizontal wells are completed with gravel packs and use ESP artificial lift. The laterals tend to be 350- to more than 600 meters in length, with true vertical depths of about 1,400 meters. "About 87% of our wells have been completely gravel-packed, and only about 30% were successfully gravel-packed before we came in." Soon, the company expects to add another rig to the three it has running. "My biggest challenge right now is resources-everybody wants a rig and there are limited amounts of equipment, services and personnel." Other problems are posed by producing heavy, waxy crude oil in temperatures that range from -20 to -30 degrees Celsius in winter to 35 degrees in summer, says Brian Jobson, production manager. Additionally, there is very little gas in the oil, so the project's tremendous electricity needs are supplied from generators run on crude oil. The produced water, which is considerable in these wells, is treated and then discharged overboard or reinjected into the reservoirs. Eventually, the company plans to reinject all of its produced water. Furthermore, as is typical in a developing country, the health, safety and environmental challenges can be daunting. Kerr-McGee has worked hard, as have other foreign operators, to focus on safety and maintain international standards. "The challenge in building up the Bohai Bay infrastructure is to make sure it is sustainable and environmentally compatible, and we've been very pleased with our HSE performance here," says Verm. "We've been very successful in integrating two operational cultures," says Jobson. "We have been introducing the way we work and our safety and environmental standards to our contractors, some of whom are young and new to the rapidly expanding offshore industry." China has been a positive experience for Kerr-McGee, and the company is sharpening its focus on the country. "We have demonstrated that we can meet or exceed expectations in China," says Verm. "We have confidence in the commercial climate and we believe that projects here can be executed with low risk." And, the company is not deterred by China's relatively modest offshore discoveries to date. "In China, the offshore basins that have been explored and tested and are available to Western companies do not have great fields by international standards, but we have the management style and ability to create value, and we believe that there is still significant potential and undrilled areas that can contain big fields." South China Sea One of those areas with big-field potential is the South China Sea's deep water, where Kerr-McGee has recently signed a PSC for Block 43/11, covering 2.4 million acres in 1,600 to 3,300 meters of water. While the shallow waters of the South China Sea have been carefully explored, deepwater exploration is in its infancy. Kerr-McGee's new block is completely untested, and is on the edge of exploration activity. It plans to acquire seismic before the typhoon season, and could drill its initial well as early as 2007. The sea was the first area open to foreign upstream investment in China. There are currently a dozen projects on production there, and another eight in development. Last year, CNOOC produced 190,000 barrels of oil equivalent per day from the South China Sea and its foreign partners-including ENI, ChevronTexaco, ConocoPhillips, Japex and Statoil-accounted for another 110,000 barrels per day. The most prolific field currently producing is operated by Oklahoma City-based independent Devon Energy Corp. The Panyu project, which lies in 100 meters of water in Block 15/34 in the Pearl River Mouth Basin, consists of two fixed platforms, the Panyu 4-2 and 5-1, and an FPSO. The project is making 82,000 barrels of 28-degree-gravity oil per day. Devon owns a 24.5% working interest in Panyu; Houston-based Burlington Resources also owns 24.5%; and CNOOC owns 51%. The project's stellar performance has edged out ConocoPhillips' Xijiang complex, three fields that peaked at 147,000 barrels a day in 1997 but have since declined. The discovery well for Panyu 4-2 Field was drilled in 1998 by Houston-based Santa Fe Energy Resources, a company that was acquired by Devon in 2000. The well intersected 179 meters of oil pay in 39 sandstone intervals. The Panyu 5-1 discovery, drilled some 18 kilometers to the east the following year, saw 155 meters of net oil pay in 37 sands. (For more on this, see "The South China Sea," March 2001.) Devon received government approval to develop Panyu in December 2001, after submitting an offshore development plan that spanned 14 three-inch binders and delved into all the minutia of the $320-million project. It finished Panyu on time and under budget, and started producing oil in October 2003. "Devon is an independent company," says Greg Messner, president of Devon Energy China. "What we brought to China was a fresh beginning after the majors started to scale back their activities. Independents are known for aggressiveness and quick timing, and that's what we delivered." Devon was able to work with CNOOC and show it the way an independent develops an offshore field and facility, says Mike Griffin, Houston-based vice president of operations, international division. "We had a team of very technically competent people and we did things quicker and with a much leaner staff than the major oil companies did. CNOOC was very pleased with that." China offered Devon several advantages as well. "In China we don't have the bureaucratic hurdles that slow down international operations in other regions," says Messner. "It is so much easier to get things done. The business environment is stable and consistent-no one tries to change the rules on us." Griffin says that in China, in contrast to some other areas where Devon works, the national oil company participates in and pays its way on development. "That's important, because it gives very good alignment with the contractor and the NOC." In addition, China's environment is robust, and the country offers a large pool of well-educated, hard-working people. "What they lack is experience, and they are rapidly gaining that," Griffin says. The oil accumulations in the Panyu area are subtle structures that are draped with dozens of producing sands at depths ranging from 1,450 to 2,700 meters. The Miocene reservoirs exhibit excellent properties-average porosities are 23% to 24%, and average permeabilities are 2.1 to 4.8 darcies. Devon determined that the thin oil sands sitting on water were perfect applications for horizontal wells. The horizontals would minimize the drawdown on the formations and reduce the tendency to cone water, and deliver very high-rate wells. These are world-class reservoirs, and production rates on an individual well can reach 12,000 barrels of oil per day. Devon drills its laterals with rotary steerable technology to lengths ranging from 400 to 800 meters. "We run premium screens and isolation packers. The completions are very flexible downhole in the horizontal section, and we can shut off the toe or the heel and the toe of a horizontal. This was a new approach in China," says Griffin. This year, Devon plans to drill nine wells and spend $40 million in China, including drilling five wells on Panyu 5-1 and four wells on the 4-2 platform. At present, the company has 25 producing wells on the two Panyu fields. Production is pumped from the platforms to the Hai Yang Shi You 111 FPSO, which was built in Shanghai. The vessel has 1.1 million barrels of storage capacity, and can process 85,000 barrels of oil and 240,000 barrels of fluid per day. It features an internal, bottom-mounted turret. In addition to oil, the Panyu fields make about 100,000 barrels of water per day, with almost no associated gas. Devon estimates ultimate recoveries of 77 million barrels during a project life of eight years; last year alone, Panyu produced 27 million barrels of oil. Indeed, the development has been so successful that it has already reached cost recovery, and the company will hand over operations of fields 4-2 and 5-1 and the FPSO to CNOOC on January 1, 2006. Preparations for the switch are already under way. "We work very closely with CNOOC, and we have a large number of CNOOC people seconded into our office who have been with the project the whole way," says Griffin. "We have a transition plan in place, and after the change in operatorship we will have drilling, finance and procurement representatives on the joint management committee for the project." Devon will retain operations on the remainder of the block, and it plans to drill two and possibly three exploration wells there this year. Large structures still remain untested in the shallower portions of the South China Sea, but migration pathways have proved to be a significant exploration risk, notes Messner. "We're nearing the end of our license term, and we want to test the remaining prospects before we hand it back to the government. We'd love to find another Panyu." The company is also on the lookout for additional opportunities in the country, says Griffin. "We like doing business in China, and it has been a great success for us. We have an excellent relationship with CNOOC and we have an excellent team on the ground." Onshore gas Natural gas currently satisfies only about 3% of China's booming energy demands, with production levels during 2004 averaging 3.8 billion cubic feet (Bcf) per day, according to the IEA. The Chinese government is keenly interested in promoting gas exploration, development and transportation within its borders, as well as importing gas from other countries by way of pipelines and liquefied natural gas terminals. There are considerable obstacles, however: China's gas infrastructure is quite limited, regulations are complex and prices are controlled, currently at about half of U.S. wellhead prices. One U.S. independent engaged in helping China add to its domestic gas production is Houston-based independent Burlington Resources. In addition to its interest in the highly productive offshore Panyu project, Burlington operates a substantial natural-gas venture in Sichuan province in southwest China. Some 87 million people live in this remote province, which is a bit bigger than California. It is home to the Sichuan Basin, the largest gas-producing basin in China, which currently produces around 1 Bcf per day. Of historical note, the Sichuan Basin is the home of Chiliuching, the oldest commercial hydrocarbon field in the world. In 211 B.C., people drilled wells into shallow evaporite beds with bamboo rods that had been hardened in salt water, and used the gas to extract salt from the brines. A plethora of large fields were discovered in the Sichuan Basin during the mid-1950s by wells sited on surface anticlines. Today, much of the production is in the south and southeast portions of the basin, where wells tap deep carbonate reservoirs that also contain H2S. Burlington Resources' 580,000-acre Chuanzhong Block lies in the northern Sichuan Basin, about 160 kilometers northeast of the city of Chengdu. Here, thick, fluvial sandstones in the Triassic XiangXi formation produce sweet, dry gas. The company estimates that the block holds as much as 500 Bcf of resource potential. Burlington took on the project about three and a half years ago, acquiring the venture from Enron Oil & Gas, which had signed an agreement in 1997 with China National Petroleum Corp. (CNPC) to take a 100% contractor's interest in a broad area containing several old gas fields in need of rejuvenation. In a major government reorganization in 2000, CNPC transferred many of its onshore assets to PetroChina, including the Chuanzhong Block, so Burlington now works with PetroChina on the project, says Frank Yau, Beijing-based manager of Burlington Resources China Ltd. The Chuanzhong Block is divided into three sections: Bajiaochang Field and two exploratory areas called Jinhua and Qiulin. Bajiaochang Field received government approval for development last year, and is in its first phase of drilling with two active rigs. The plan for 2005 is to drill eight new wells; at present, seven wells are producing some 6 million cubic feet of gas per day and another six wells have been drilled or worked over. Burlington has a gas contract to sell CNPC up to 42 million cubic feet of gas per day, and the field could eventually support as many as 40 wells. In Jinhua, Burlington has drilled an exploratory well that is being evaluated, and in Qiulin it is testing another exploratory well. Burlington likes the project because it plays to its strengths. The company has built considerable expertise in tight-gas reservoirs in North America, which it has brought to China. The XiangXi sandstones are very similar to those found in parts of the onshore U.S., exhibiting porosities of 6% to 8% and permeabilities in the 0.1-millidarcy range. They are also geopressured, with gradients from 0.7 to 0.9. The XiangXi reservoirs occur at depths of around 3,000 meters and typical wells encounter about three intervals of pay sands, each around 10 meters thick. Individual wells can hold reserves of up to 6 Bcf, and cost $3.3 million to drill and complete. Each 3,000-meter well takes about 90 days to drill. Because of the importance of farmland in the local communities, the company directionally drills its wells from pads to minimize the surface disturbance. Indeed, the Chuanzhong area is reminiscent of the Appalachian Basin in the northeastern U.S. The topography is hilly, with terraces for farming cut into every hillside. "Every fall, we submit a program for the next year with a list of potential locations," says Andy Pfaff, the Chengdu-based director of exploration and production for Burlington Resources China Ltd. Permitting is handled by PetroChina, and approval is through the provincial government. "Everybody in the general area is affected, because land is removed from the communal pool and the local government reapportions the land." At Bajiaochang, Burlington has built four multi-well pad locations, and is starting a fifth. It employs a six-well production setup with a test separator, so that it can produce the completed wells on a pad while drilling additional holes. The XiangXi reservoirs must be stimulated, as they won't flow commercial rates on natural completions. The company usually performs a single-stage frac job on each well, says Pfaff, and it uses techniques honed in the U.S. "We started fracing with gelled water, then we used slick-water fracs. Now we use hybrid fracs, very similar to what people use in the Barnett Shale play in North Texas." One of Burlington's treatments used 700,000 pounds of sand, which set a record for the largest frac yet in China. The company is heavily focused on introducing more efficiency into the drilling and completion processes, and working with the Chinese contractors to ensure the levels of health, safety and environmental responsibility are in line with international standards. "We use a bonus and penalty clause for our wells, and we have a safety bonus also," he says. There are two parts to the performance bonus, one for the rig company and one for the crews. "It's a driver for the economics and an attempt to reinforce the safety culture." "China's service industry has made tremendous improvements in recent years. Understanding the strengths of the local service providers and knowing how to work with them are major factors for success," says Yau. "We have gained a great deal of experience and formed a good work team with the local service companies." Burlington's early participation in this emerging market will serve it well in the upcoming years, believes Yau. The company is demonstrating its technical capabilities and its commitment to China at Chuanzhong, and that effort is appreciated. "There is still a lot of exploration and development potential in China, and at the same time that we are expanding our current project, we are looking at more opportunities." PetroChina is eager to work with partners such as Burlington Resources that bring investment dollars and technical expertise to develop some of China's more difficult fields, says Frank Fu, PetroChina's chairman of the joint management committee for the Chuanzhong project. "We learn from each other and share ideas, which improves the entire operation." China takes the long view, he says. "We are as the U.S. was in the late 1960s and 70s. Natural gas is a controlled market that will go eventually to a free market. Demand is increasing rapidly and gas prices are opening up." Certainly, China's energy needs are formidable, and it offers immense and growing markets for oil and gas. For foreign firms, it is a safe and rapidly modernizing country that presents profitable investment opportunities. And, China welcomes and encourages their participation in its domestic upstream.