Could this derail China's shale gas plans?

The Hanjiang River during its dry season in Shiyan, central China's Hubei province.
AFP | Getty Images
The Hanjiang River during its dry season in Shiyan, central China's Hubei province.

Lack of water availability could curtail shale gas development in the world's largest energy producer, according to the World Resources Institute (WRI).

China has the world's largest source of recoverable shale gas but 61 percent of that is located in areas with high aridity and baseline water stress - the ratio of total annual water withdrawals to available annual renewable supply - the WRI outlined in a new report.

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"Limited or unpredictable water availability can jeopardize a project's financial viability. In areas with high demand relative to the available supply, added water withdrawals for drilling and hydraulic fracturing operations can deplete water resources and degrade the environment," the report said.

But leading energy producers PetroChina and Sinopec made no mention of water-related challenges when voicing a bullish outlook on the shale industry in August, citing declining costs and higher domestic gas prices as catalysts for increased investment.

Warren Gilman, CEO and chairman of investment firm CEF Holdings, told CNBC that while water is undisputedly a key issue, other factors play a greater role in China's shale potential.

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"Historically, China has significantly overpromised and undelivered on shale projects due to a combination of factors: Technology and the fact that geology in China is more complex than America, which leads to more difficulties in developing shale gas and results in lower returns for companies. There are also political issues to some extent, i.e. who's controlling the shale effort and who's responsible for it," he said in a phone interview.

Investors shouldn't hold their breath for major production breakthroughs, Gilman said, noting that PetroChina and Sinopec's forecasts echo those that companies responsible for shale development made over the past decade.

Beijing recently slashed its 2020 shale gas output forecast to 30 billion cubic meters (bcm) from its 2012 forecast of 60-80 bcm.

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Competition among users

Water is integral to the extraction of shale resources; large withdrawals are necessary for drilling and hydraulic fracturing - the pumping of fluid into the ground at elevated pressure. In most cases, freshwater is used, putting energy firms in competition with households and other users.

"High levels of competition among agricultural, domestic, and industrial water users could represent higher costs, reputational risks, and increased regulatory uncertainty for operators trying to access water for hydraulic fracturing and drilling operations," the WRI report said.

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China's northern regions, where the majority of national industrial production takes place, face the most acute water shortage. More than half of the country's water usage is for industrial purposes, according to the non-profit organization China Water Risk.

Even in areas with enough water, development on shale gas projects still hasn't progressed, Gilman of CEF Holdings said.

To minimize impact on freshwater availability, WRI urged companies to first perform through water risk assessments to understand local water availability. It also advocated companies disclose their water usage and management, creating a transparent relationship with local regulators and governments.