Energy Policy 85 (2015) 194–206

Contents lists available at ScienceDirect

Energy Policy

http://d0301-42

n CorrE-m

journal homepage: www.elsevier.com/locate/enpol

Policy recommendations to promote shale gas development in Chinabased on a technical and economic evaluation

Jiehui Yuan, Dongkun Luo n, Liangyu Xia, Lianyong FengSchool of Business Administration, China University of Petroleum – Beijing, 18 Fuxue Road, Changping District, Beijing 102200, China

H I G H L I G H T S

� We explore the economic feasibility of shale gas development in China.

� Current incentive policies cannot render shale gas development economically viable.� These incentives must be improved to effectively promote shale gas development.� We investigate the effect of the major policies available in China to light a path.� Recommendations are proposed to continually improve the incentive polices in China.

a r t i c l e i n f o

Article history:Received 21 November 2014Received in revised form12 May 2015Accepted 1 June 2015Available online 12 June 2015

Keywords:Shale gas developmentTechnical and economic evaluationDiscounted cash flow analysisIncentive policiesChina

x.doi.org/10.1016/j.enpol.2015.06.00615/& 2015 Elsevier Ltd. All rights reserved.

esponding author. Fax: þ86 10 69748024.ail address: dkluo@hotmail.com (D. Luo).

a b s t r a c t

Because of its resource potential and clean burning advantages, the development of shale gas can sig-nificantly increase the supply of cleaner energy while offering the associated benefits. To foster shale gasdevelopment, many policy incentives have been introduced in China. However, the current incentiveshave not been sufficiently aggressive, and the shale gas industry has been slow to develop. Existingpolicies thus need to be further improved. To provide effective support for decision makers in China, atechnical and economic evaluation is performed in this study to explore the profitability of shale gasproduction in pilot zones. The results show that shale gas production is subeconomic under the currenttechnical and economic conditions. Based on this evaluation, a policy analysis is conducted to investigatethe profitability improvement offered by the major policies available in China to elucidate a path towardimproving incentive policies. The results indicate that policy instruments related to gas prices, financialsubsidies, corporate income taxes or combinations thereof could be used as priority options to improvepolicy incentives. Based on these results, recommendations are presented to improve the current in-centive polices aimed at accelerating shale gas development.

& 2015 Elsevier Ltd. All rights reserved.

1. Introduction

In its pursuit of sustainable development, China has been in-creasing its efforts to generate cleaner energy. However, China’scurrent energy mix is still dominated by coal and oil, as shown inFig. 1 (BP, 2014). Natural gas, which is much cleaner, accounts foronly 5.4% of China’s energy consumption, a level far below theglobal average of 25% (National Bureau of Statistics (NBS) of China,2014). In recent years, the growth in natural gas consumption inChina has remained high (Zhang, 2014; Zhao et al., 2013), whilethe growth in natural gas production has slowed. As illustrated inFig. 2, the current natural gas shortage is substantial, increasingreliance on foreign gas and further diminishing China’s energy

security (China National Petroleum Cooperation (CNPC), 2014;Sandalow et al., 2014; Zhang et al., 2014). Although renewableenergy resources are widely recognized as the most efficient andeffective solution to sustainable development, progress in devel-oping these solutions has been slow due to technology and costissues as well as other risks (Jin et al., 2010; Wang and Lin, 2014).Achieving a transition from the current era, dominated by high-carbon fossil fuels, to a green and low-carbon future will be a long-term project for China. Shale gas, like all natural gases, has re-markable advantages, and increasing its use as a transitional en-ergy solution to help bridge this gap is one realistic option (Hu andXu, 2013; Melikoglu, 2014; Wang and Lin, 2014).

In addition to the resource endowment, some factors such ascompanies’ inefficiencies, lack of learning and economy of scaleexplain why it is currently not profitable to extract shale gas inChina. However, given its enormous potential, shale gas

Natural gas, 5.4%

Coal, 66.0%

Oil, 19.0%

Renewables, 8.4%

Others, 1.2%

Fig. 1. China’s primary energy consumption mix in 2013 (BP, 2014).

-1.8 -2.6 -2.4 1.3 1.0 4.3 12.1

27.8 39.1

46.1

-4.5 -5.5 -4.3

1.8 1.2

4.7

11.3

21.3

26.7

-10.0

-5.0

0.0

5.0

10.0

15.0

20.0

25.0

30.0

-20.0

0.0

20.0

40.0

60.0

80.0

100.0

120.0

140.0

160.0

180.0

Dep

ende

nce

(%)

Bill

ion

cubi

c m

eter

s

Year

Natural gas production Natural gas consumption

Gas shortage Dependence on foreign gas

Fig. 2. The worsening natural gas shortage in China and increasing dependence onforeign gas (CNPC, 2014; Sandalow et al., 2014; Zhang et al., 2014).

0 5 10 15 20 25 30Henan

JiangsuGuangxiShaanxi

HunanHubei

GuizhouChongqing

XinjiangSichuan

Shale gas resources (trillion cubic meters)

Prov

ince

s(m

unic

ipal

ities

)

Fig. 3. Top 10 provinces (municipalities) with shale gas resources in China (Zhanget al., 2012).

J. Yuan et al. / Energy Policy 85 (2015) 194–206 195

development should be encouraged by the government. For ex-ample, the government should provide reasonable incentive po-licies to make shale gas production profitable, thereby contribut-ing to the healthy development of this industry. Perhaps becausethe history of shale gas production in China is very short, very fewstudies have combined technical and economic evaluations with apolicy analysis to address improving incentive policies to promoteshale gas development in China. Guo et al. (2010) offered a simpleeconomic evaluation of shale gas development without clear de-tails such as model assumptions. In their study, the authors dis-cussed policy issues separately from their economic evaluation,and no specific policy measures were proposed. Compared withshale gas development in the US, Liao et al. (2012) reported thatshale gas development in China faces many constraints, such as alack of policy support, key technologies and pipeline networks,and they proposed several policy recommendations withoutquantitative analyses. Hu and Xu (2013) and Wang et al. (2014)recommended policy options related to key technologies and en-vironmental issues based merely on an analysis of the opportu-nities and challenges facing shale gas development in China.Moreover, in their work, Feng et al. (2013), Fu et al. (2012) andZhao et al. (2013) presented development strategies and policyrecommendations based solely on a SWOT analysis of China’s shalegas industry. Furthermore, these studies focused on common po-licies without highlighting incentives such as fiscal support.

The purpose of this paper is to provide details explaining whyshale gas development in China is not currently profitable and toconduct an analysis to demonstrate which incentive policies maybe more effective for improving profitability. The subsequent

policy recommendations are not based on a quantitative analysisof the social benefits or social costs of shale gas development inChina. Given existing incentive policies, a technical and economicevaluation model using the discounted cash flow (DCF) method iscreated to examine the current economic feasibility of shale gasproduction in China. This evaluation then provides a basis for thesubsequent policy analysis. This analysis investigates the effects ofthe major policies available in China on improving the profitabilityof shale gas production and provides guidance to improve in-centive policies. Based on the combination of technical and eco-nomic evaluations and policy analysis, potentially helpful ideasand approaches for improving incentive policies aimed at accel-erating shale gas development in China are proposed.

2. The current status of shale gas development in China

2.1. The progress of shale gas development in China

With its abundant shale gas resources (Fig. 3), China has vig-orously pursued shale gas opportunities (Zhang et al., 2012). Dueto technological advances and policy support, a series of break-throughs has been achieved in the development of shale gas re-sources. China has developed the necessary key technologies andcorresponding equipment for shale gas development, such as hy-draulic fracturing. Furthermore, several pilot zones for shale gasdevelopment have been established, for instance, in Weiyuan–Changning, Zhaotong, and Fuling (Table 1). Of these, the Fulingpilot zone is currently the most productive, with production to-taling over 3 million cubic meters per day (Mcm/d). As of 2012,apart from North America, China was the only nation producingcommercial quantities of shale gas (Energy Information Adminis-tration (EIA), 2013), with an annual production of approximately0.035 billion cubic meters (Bcm). In 2013, China’s shale gas pro-duction reached more than 0.2 Bcm (Ministry of Land and Re-sources (MOLR), 2014a), a fivefold increase over 2012. In 2014,shale gas production in China was approximately 1.3 Bcm, a fur-ther annual increase of 550% over 2013 (MOLR, 2014b; Qian et al.,2015). Nonetheless, given the current situation, China will struggleto achieve its annual production target of 6.5 Bcm in 2015 (Wanet al., 2014).

2.2. The role of incentive policies for shale gas development in China

Because shale gas is an unconventional, low-grade resource,advanced technologies and large capital investments are requiredto exploit it (Aguilera, 2014). Thus, shale gas development isusually not economically viable and includes high uncertainty andrisk. Without profitability, Chinese firms are not motivated to

Table 1Selected pilot zones of shale gas development in China.

Shale gas pilot zone Location Sedimentary facies Maturation stage Production (Mcm/d)a Operatorb

Weiyuan –Changning Sichuan Marine facies Development 70 CNPCZhaotong Sichuan, Yunnan Marine facies Development 20 CNPCFushun –Yongchuan Sichuan, Chongqing Marine facies Development 20 CNPC, ShellFuling Chongqing Marine facies Development 304 SinopecYan’an Shaanxi Continental Facies Demonstration N/A Yanchang PetroleumPengshui Chongqing Marine facies Demonstration N/A SinopecXishui–Qijiang Guizhou, Chongqing Marine facies Demonstration N/A SinopecQianjiang Chongqing Marine facies Demonstration N/A Chongqing government

a MOLR, 2014b; N/A, Not available.b CNPC, China National Petroleum Corporation; Yanchang Petroleum, Shaanxi Yanchang Petroleum Group.

J. Yuan et al. / Energy Policy 85 (2015) 194–206196

develop shale gas. Shale gas production is hence impossiblewithout government support, particularly during the early stages(Lozano Maya, 2013; Sandalow et al., 2014). It is noteworthy thatshale gas development in China can offer external benefits overincreasing supply from other fossil fuels. The social benefits ofshale gas development include the following (Bonakdarpour et al.,2011; Considine et al. 2011; Liao et al., 2012): (1) ensuring energysecurity, (2) reducing environmental pollution and greenhouse gasemissions, and (3) promoting economic development. Naturally,these benefits are accompanied by potential damage to local en-vironments (e.g., air, surface water, ground water, habitats, andland) during the development process; controlling this damagemay generate social costs (Chang et al., 2014; Krupnick et al.,2014). However, according to existing studies such as Considineet al. (2011) and International Energy Agency (IEA) (2012), thesocial benefits are much larger than the social costs, which meansthat the external benefits of shale gas development are positive.Positive externalities imply that Chinese firms lack the incentivesto conduct such economic activities themselves, and thus thegovernment must provide support, i.e., incentive measures, tostimulate shale gas development. In recent years, many policymeasures have been introduced to stimulate the development ofthe shale gas industry in China. These economic incentive mea-sures include the following: (1) providing financial subsidies,(2) granting tax concessions, (3) committing research funds, and(4) promoting price reforms (Table 2). In addition, most Chinesefirms engaged in shale gas exploitation are state-owned en-terprises that respond to political incentives; therefore, politicalincentive measures also can play a role in accelerating shale gasdevelopment (Tian et al., 2014).

Although these political incentives can promote shale gas de-velopment to some extent, their effect is limited; essentially, theycannot help shale gas production achieve economic feasibility orremain profitable. By contrast, economic incentives are effectiveinstruments and can help improve the economic feasibility ofshale gas production. Through efforts over several years, the

Table 2Overview of incentive policies to stimulate shale gas development in China.

Time Function References

Jul. 2011 (2) Ministry of Finance (MOF) et al. (2011)Mar. 2012 (1–4) National Development and Reform Commission (NRDC)

of China et al. (2012)Oct. 2012 (1–4) NDRC (2012)Oct. 2012 (2–3) MOLR (2012)Oct. 2012 (3) State Council (SC) of China (2012)Nov. 2012 (1) MOF and National Energy Administration (NEA) of China

(2012)Jan. 2013 (3) SC (2013)Oct. 2013 (1–4) NEA (2013)

Chinese government has created a favorable policy environmentfor the shale gas industry. However, whether these incentives haveeffectively improved the economic viability of shale gas develop-ment and whether these incentives will enhance the profitabilityof shale gas development over time remain unclear. Such in-formation is important because it can help identify ideas and ap-proaches to dynamically improve incentive policies aimed atmaintaining the profitability of shale gas production. To answerthese questions, it is necessary to conduct a technical and eco-nomic evaluation and policy analysis, which will help inform im-provements to current incentive policies.

3. Methods

3.1. DCF analysis

To be successful, shale gas development projects must offer apositive return on investment. Therefore, the economic value of ashale gas development project must be accurately evaluated. DCFanalysis (Kaiser, 2012a; Liu et al., 2013; Weijermars, 2013), a dy-namic evaluation method, is the most widely used and preferredmethod for the technical and economic evaluation of oil and gasdevelopment. DCF analysis reflects the time value of capital and issimple to perform; accordingly, the method is often used toevaluate the attractiveness of investment opportunities. A com-prehensive DCF model is developed and incorporated into atechnical and economic evaluation to explore the profitability ofshale gas development. This software tool was developed in theVisual Basic language and quickly and easily calculates results.

3.1.1. Financial analysisDCF analysis is used to project the future cash flows of a shale

gas development project over its producing life and to discountthem to determine the project’s present value. This calculatedvalue is then used to evaluate the investment potential so that adecision can be made. Several popular metrics, such as the netpresent value (NPV), internal rate of return (IRR), and discountprofitability index (DPI), are frequently employed to support in-vestment decisions (Gülen et al., 2013; Kaiser, 2012b).

In any operational year, the undiscounted net cash flow of aninvestment is the cash received less the cash spent. The annualundiscounted net cash flow associated with a shale gas develop-ment project in China in year t is computed as

NCF R CAPEX OPEX TAX 1t t t t t= − − − ( )

where NCFt denotes the annual undiscounted net cash flow inyear t, Rt denotes the revenue in year t, CAPEXt denotes the capitalcosts in year t, OPEXt denotes the operating costs in year t, and TAXt

denotes the taxes paid in year t.

J. Yuan et al. / Energy Policy 85 (2015) 194–206 197

The sum of the discounted cumulative cash flow is equal to theNPV, which is the most widely used economic indicator. The NPVis calculated as

NPVNCF

i1 2t

nt

t0

∑=( + ) ( )=

where i represents the discount rate and n represents the produ-cing life of the shale gas development project. The project time tstarts at year 0 and ends in year n.

An alternative method of NPV analysis known as IRR analysiscalculates the discount rate when the NPV is zero. The IRR can becomputed as

IRR i NPV 0 3= { = } ( )

The DPI, an economic indicator measuring the investment ef-ficiency ratio, is also commonly applied. The DPI normalizes theNPV of the shale gas development project relative to total in-vestment discounted to the present (t¼0) and adds 1. The DPI isdefined as

DPINPV

I i11

4tk

tt

0

=∑ *( + )

+( )=

−

where It denotes the total investment in year t, and k denotesthe total number of years of the investment, i.e., the time requiredto drill new wells. When tZk, there is no investment in year t.

Before the economic viability of a shale gas development pro-ject can be determined, the economic criteria must be established.If the NPV of the development project is positive or if the IRR ishigher than the discount rate, the shale gas project may be a goodinvestment. Additionally, when the DPI is higher than 1, the pro-ject may represent a good opportunity. Moreover, the DPI can beused to rank the profitability of different projects.

3.1.2. Sensitivity analysis and benchmark equilibrium analysisGiven the high degree of uncertainty and risk associated with

shale gas development, it is necessary to conduct a sensitivityanalysis and a benchmark equilibrium analysis after the financialanalysis. A sensitivity analysis is usually performed to investigatethe effects of key factors, such as the wellhead gas price, produc-tion, or cost, on the NPV, DPI, or IRR. Commonly, a sensitivitycoefficient, SCa, is introduced to measure this effect (Ministry ofHousing and Urban-Rural Development of China, 2010). The sen-sitivity coefficient is defined as the ratio of the rate of change ofeconomic indicators, such as the NPV and DPI, relative to that of anuncertainty factor, which is calculated as

SCA AF F

// 5

a = ΔΔ ( )

where ΔA/A denotes the rate of change of an economic in-dicator and ΔF/F denotes the rate of change of a particular un-certainty factor.

Performing a benchmark equilibrium analysis helps to identifythe important point for each key factor when a shale gas devel-opment project will become profitable. These points reflect thebenchmark values of key factors, such as the gas price, production,and cost, at which shale gas development will achieve an IRR equalto the discount rate. The benchmark value of a particular un-certainty factor is calculated as

V F IRR i 6= { | = } ( )

where V is the benchmark value of factor F (variable F) when IRRequals i.

3.2. Evaluation parameters and their estimation

Before a technical and economic evaluation model can be built,the evaluation parameters must be estimated. The estimation ofthese parameters not only refers to the economic rationality of theshale gas development project but also affects the determinationof a series of economic indicators. The accuracy of the parameterestimation directly relates to the accuracy of the results of thetechnical and economic evaluation and the accuracy of any in-vestment decisions about shale gas development.

3.2.1. Acquisition costsLand acquisition costs are often booked as sunk costs that are

separate from the economic assessment of shale gas development.However, these costs are included in the evaluation in this paper. InChina, land and shale gas resources are owned by the nation. Theacquisition costs are lease costs, which are paid to the land users orcontractors as land requisition compensation. The land acquisitioncosts of a shale gas development project are calculated as

C C L 7a a1= * ( )

where C1 denotes the average cost of leasing land in a target areaand La denotes the area of land occupied. The local governmentestablishes the standard of land requisition compensation.

3.2.2. Exploration costsIn many studies, exploration costs are also considered to be

sunk costs that are separate from the economic appraisal of shalegas development. Because the results of exploration affect theaccuracy of economic evaluations of shale gas development, thispaper incorporates exploration costs into the evaluation, empha-sizing the overall economics. Exploration costs are those costsassociated with searching for shale gas resources to develop. Thesecosts can be computed as

C C EUR 8e s2= * ( )

EUR Q9

st

n

t1

∑=( )=

where C2 denotes the average cost of determining the availabilityof shale gas resources in a target area, EURs denotes the estimatedultimate recovery of the project in the target area and Qt denotesannual production for the project in year t.

3.2.3. Development costsDevelopment costs account for the largest share of the inputs in

a shale gas development project. Development costs primarilyconsist of three parts: drilling engineering costs, fracturing en-gineering costs, and surface engineering costs. The well cost isdenoted by Cw, which is calculated as

C C C C 10w de fe se= + + ( )

where Cde represents the drilling engineering costs of a typicalwell in the target area, Cfe represents the fracturing engineeringcosts of a typical well, and Cse represents the surface engineeringcosts of a typical well. CdeþCse is also denoted as D&C or drillingand completion costs.

Including learning effects in the well cost, the capital costs of ashale gas development project can be estimated as

⎪⎪⎧⎨⎩

CAPEXC C t

N C r t

, 0

1 , 1 11t

a e

t wt

11( )

=+ =

* * − ≥ ( )−

where Nt represents the well count in year t (here, trk, where krepresents the time to drill new wells), and r1represents the

Table 3Key parameters used for the evaluation of shale gas development in Fuling.

Variable Notation Unit Value

Area of land occupied La km2 21.27Initial production IP Mcm/d 0.06Producing days per year b day 330Production decline factor j N/A 0.705Producing life n year 25a

Time to drill new wells k year 10Land acquisition compensation C1 $M/km2 0.37b

Exploration costs C2 $/cm 0.02Drilling engineering costs Cde $M 6.5Fracturing engineering costs Cfe $M 6.34Surface engineering costs Cse $M 1.92Learning factor of well cost r1 % 2c

Operating costs Cf $ 13008.13Cv $/cm 0.06

Initial gas price P1 $/cm 0.32Escalation rate of the price r2 % 2Commodity rate r3 % 95Financial subsidy Sg $/cm 0.07Value-added tax rate r4 % 8.6Resource tax rate r5 % 5Construction tax rate r6 % 7Education surcharge rate r7 % 5Corporate income tax rate r8 % 25Discount rate i % 10

a Consistent with the production characteristics (Baihly et al., 2010; INTEK,2011), the producing life is 25 years (Lake et al., 2013; Nome and Johnston, 2008).

b Determined by the Chongqing government (Chongqing Municipal Bureau ofLand Resources and Housing Management, 2013); $M represents millions USdollars in 2014.

c The learning effect of the well cost (Alexander et al., 2011; Wehunt et al.,2012).

J. Yuan et al. / Energy Policy 85 (2015) 194–206198

learning factor of the well cost. When tZk, no new wells aredrilled in year t.

3.2.4. Operating costsOperating costs are another vital input for shale gas develop-

ment. Such costs represent the expenses incurred during pro-duction and operation, and the two primary drivers of operatingcosts are the well count and the level of production. Operatingcosts, denoted by the value OPEXt, can be calculated as

OPEX C N C Q12

t ft

k

t v t1

∑= * + *( )=

where Cf denotes the fixed operating costs associated with wellcount Nt according to actual cost data in the target area, and Cvdenotes the variable operating costs associated with production Qt

according to actual cost data in the target area.

3.2.5. ProductionProduction is a key output parameter that refers to the market

value of the shale gas produced by the development project. Theannual production of the project is typically provided by the for-mulated development program. If there is no available develop-ment program, the annual production can be calculated based onwell count and the production of a single well. The initial pro-duction (IP) of a typical well is relatively easy to estimate for atarget area. However, because of the short production history ofshale gas, the profile for long-term shale gas production is difficultto identify. Given the history of shale gas development in thetarget area and the experience of North America, the productiondecline curve of a single well is described as

q b IP t 13tj= * * ( )−

where b is producing days per year, IP represents the initial pro-duction, and j is the production decline factor. The constant b isusually determined according to industry standards. bnIP re-presents the initial annual production, and the constant j reflectsthe laws of production decline.

3.2.6. PriceAnother key output parameter is the gas price, which has a

significant effect on the total revenue and economic benefit ofshale gas production. Nevertheless, many economic evaluations ofshale gas development use a fixed gas price for this calculation,which will usually lead to an underestimation of the true eco-nomic value of the development project. Given the increased un-certainty and risk of shale gas development, a price change factoris incorporated into the evaluation model. The price function isdescribed as

P P r1 14tt

1 21= *( + ) ( )−

where P1 denotes the gas price in the first year (initial gas price)and r2 denotes the annual escalation rate of the price. In China,current shale gas prices are partly market-oriented prices and aredetermined by both the government and the market.

Based on the production and price of shale gas, the total rev-enue of shale gas development in China is defined as

R r Q P Q S 15t t t t f3= * * + * ( )

where r3 denotes the commodity rate of shale gas, Sf denotes thegovernment financial subsidy (FS), r3nQtnPt denotes sales revenue(SRt) in year t and QtnSf denotes financial subsidy revenue in year t.The commodity rate represents the commodity production andaccounts for wellhead production, which is generally determinedby industrial standards.

3.2.7. TaxesThe Chinese government has introduced incentive tax policies

for the shale gas industry. Tax deductions and exemptions pri-marily include exploration and exploitation royalties, mineral re-sources compensation, and customs duties. In China, there are fiveprimary taxes, which are denoted as TAXt

TAX SR r SR r SR r r SR r r

R OPEX D r 16

t t t t t

t t t

4 5 4 6 4 7

8

= * + * + * * + * *

+ ( − − )* ( )

where r4 denotes the value-added tax (VAT) rate representing theproportion of the VAT accounting for SRt, r5 denotes the resourcetax (RT) rate, r6 denotes the construction tax (CT) rate, r7 denotesthe education surcharge (ES) rate, r8 denotes the corporate incometax (CIT) rate and Dt denotes depreciation in year t. SRtnr4 is theVAT, SRtnr5 is the RT, SRtnr4nr5 is the CT, SRtnr4nr7 is the ES, and(Rt–OPEXt–Dt)nr8 is the CIT. Depreciation depends heavily on thechoice of depreciation method, which is determined by thegovernment.

Additionally, a discount rate reflecting the time value of moneyis a very important parameter. The calculation of economic in-dicators is highly dependent on the selected discount rate. InChina, the benchmark discount rate is usually determined ac-cording to industry standards.

As mentioned previously, the Fuling shale gas pilot zone is themost active in China. To explore the prospects for shale gas de-velopment in China, the Fuling pilot zone is selected as the targetarea for the evaluation. This zone is located in the municipality ofChongqing, which is in the western region of China. The rationalityof the evaluation is ensured by using a typical development pro-ject in the target area as the object of evaluation. The primary dataused for the evaluation are obtained from the Fuling pilot zone viapersonal interviews and field investigations, as listed in Table 3.The cost in the pilot area for a typical well with an average vertical

0

5

10

15

20

25

0 5 10 15 20 25 30

Sing

le w

ell p

rodu

ctio

n (M

cm)

Year

IP rate at 0.05 Mcm/d IP rate at 0.06 Mcm/d IP rate at 0.07 Mcm/d

Fig. 4. Production profiles with different IP rates.

22 40 36 22 19 17 15 14 14 13

22

62

98

120139

156171

185199

212

0

50

100

150

200

250

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25

Wel

ls

Prod

uctio

n ((

billi

on c

ubic

met

ers)

Year

New wells per year The cumulative number of wells

Fig. 5. Deployment of shale gas drilling in Fuling (this project will drill new wellsevery year for the first ten years only).

0

5

10

15

20

25

1 3 5 7 9 11 13 15 17 19 21 23 25

Sing

le w

ell p

rodu

ctio

n (M

cm)

Year

j=0.905

j=0.805

j=0.705

j=0.605

j=0.505

j=0.405

Fig. 6. Production profiles for various decline factors.

y = 2185.3x2 + 5625.7x + 2777.1R² = 0.9995

-1000

-500

0

500

1000

-1.2 -1 -0.8 -0.6 -0.4 -0.2 0NPV

($M

)-j

Fig. 7. Effect of the production decline factor on the economic value of shale gas.

J. Yuan et al. / Energy Policy 85 (2015) 194–206 199

depth of approximately 2700 m and an average lateral length ofapproximately 1500 m is reported to be approximately 13.4–16.12million dollars, with an average cost of 14.76 $M. An average andtypical IP rate is provided by the reservoir engineers. The results ofnumerical simulations based on the production of the exploitedpilot area show that the IP rates for typical wells with laterallengths of approximately 1500 m are approximately 0.05–0.07 Mcm/d, with an average IP rate of 0.06 Mcm/d (Fig. 4). Fig. 5illustrates the drilling deployment of the shale gas developmentproject in the pilot zone. In addition, current incentive policies(MOF et al., 2011; MOF and NEA, 2012; MOLR, 2012) create severalfavorable conditions: (1) two types of mineral resource fees arereduced or waived, (2) financial subsidies can be received duringthe first two years, and (3) the CIT rate during the first seven yearsis 15% and subsequently changes to 25%.

-800

-600

-400

-200

0

200

400

600

-20 -10 0 10 20

NPV

($M

)

Change rate of uncertainty factors(%)

IPInitial priceCAPEXOPEX

Fig. 8. Effect of uncertainty factors on the NPV.

4. Results

4.1. Technical and economic analysis

4.1.1. Financial analysisBased on the key evaluation parameters specified in Table 3 and

Fig. 5 and the method described above, a financial analysis isperformed to evaluate the development of shale gas in the Fulingpilot zone. The main economic indicators are the following:NPV¼–100.57 $M, IRR¼9.07% and DPI¼0.96. Clearly, shale gasdevelopment in the Fuling play is currently not economically vi-able, as these economic indicators are slightly below the criticalpoints of 0$, 10%, and 1, respectively. If preferential policies can bestrengthened, shale gas development in the target area wouldlikely become economically feasible.

The primary source of uncertainty in the economic value of adevelopment opportunity is the uncertainty of the productionprofile, especially for shale gas resources (Haskett and Brown,2010). The production decline factor j controls the shale gas pro-duction decline curve. Based on the benchmark case (j¼0.705), anadditional 5 cases, depicted in Fig. 6, are incorporated into theeconomic analysis. The results, presented in Fig. 7, show a sig-nificant relationship between –j and NPV (R2¼0.9995). Consider-ing the advantages of Fuling’s resources, the results of economicanalysis might represent a more optimistic scenario in comparisonto other potential shale areas in China. However, there may not bea big difference because the well production in other potentialshale areas is low, and their well cost is low. Given the short his-tory of these shale areas, it is difficult to investigate this differencewhich needs to be further studied in future.

4.1.2. Sensitivity analysis and benchmark equilibrium analysisThe effects of key factors, such as the IP, initial gas price, CAPEX,

and OPEX, on the NPV of shale gas development in the target areaare plotted in Fig. 8. Fig. 9 illustrates the three factors with themost influence on the NPV: gas price, IP and CAPEX. Among thesethree uncertainty factors, gas price is the most sensitive and hasthe most significant effect on the NPV, with the highest SCa of 2.47.

-2 1 0 1 2 3

Initial Price

IP

CAPEX

OPEX

Sensitivity coefficient

Fig. 9. Sensitivity coefficient of four key uncertainty factors.

Table 4Benchmark values of key uncertainty factors used to evaluate shale gas develop-ment in the target area.

Notation Unit Actualvalue

Changerate (%)

Benchmarkvalue

IP Mcm/d 0.06 6.17 0.064Initial gas price (P1) $/cm 0.32 4.97 0.34Well cost (Cw) $M 14.76 �5.45 13.96D&C costs $M 12.84 �5.45 12.14Total CAPEX $M 3465.28 �5.45 3276.42Total OPEX $M 1361.42 �23.21 1045.43Operating costs (Cf) $ 13008.13 �23.21 9988.94Operating costs (Cv) $/cm 0.06 �23.21 0.05

0.880 0.900 0.920 0.940 0.960 0.980 1.000 1.020 1.040

25 25(base) 20 15 10 5 0

DPI

CIT rate (%)

Fig. 10. Influence of the CIT rate on the DPI.

J. Yuan et al. / Energy Policy 85 (2015) 194–206200

Subsequently, IP also has a very large effect on the NPV, with a SCaof 2.13, followed by CAPEX, with a SCa of –1.47. Notably, somefactors such as the gas price and IP, have a positive effect on theNPV, whereas other factors, such as CAPEX and OPEX, have a ne-gative effect.

Table 4 lists the benchmark values of key factors, such as thegas price, production, and cost, at which shale gas developmentcan achieve an IRR equal to the discount rate. Based on these re-sults, the risks associated with shale gas production can be easilyidentified. Given IP as an example, the actual value of the ex-amined shale gas project is 0.06 million cubic meters per day(Mcm/d), which is less than the benchmark value of 0.064 Mcm/d.This result indicates that the project faces some risk of not beingeconomically viable. From a different perspective, to render theproject economically feasible, the IP must be increased to be equalto the benchmark value of 0.064 Mcm/d.

0.600

0.800

1.000

1.200

1.400

0.00 0.02 0.03 0.05 0.07 0.08 0.10

DPI

FS ($/cm)

2 years 25 years

Fig. 11. Effect of FS on the DPI.

4.2. Policy analysis

Current economic incentive polices mainly consist of govern-ment financial subsidies and tax reductions and exemptions, suchas exploration and exploitation royalties, mineral resources com-pensation, and CIT reductions (only in the western regions ofChina). According to the technical and economic evaluation ofshale gas development in Fuling, these existing incentives are notsufficiently aggressive to support the economic development ofthe shale gas industry. In this context, a policy analysis is con-ducted to explore the validity of the major policy instrumentsavailable in China to improve the economic viability of shale gasdevelopment in the target area. To better measure the effects ofthese policy measures, they are divided into different scenarios,such as a single policy, two policies, and several polices. Based onthe results, options can be offered to provide direction for im-proving current incentive polices.

4.2.1. A single policy4.2.1.1. VAT, RT. Currently, there is no preferential VAT policy forshale gas development. However, to develop encouraged in-dustries in western regions of China, the RT rate for the develop-ment of low-quality oil and gas resources is 3.2% (MOF and SAT,2010). The Fuling shale gas pilot zone is also in the western part ofChina, and this policy could be applied to shale gas developmentin Fuling in the future. Given this possibility, the DPI for the pro-duction of shale gas in the target area is calculated for VAT rates of8.6%, 7%, 5.5%, 4%, 2.5%, 1%, and 0% and for RT rates of 5%, 4.1%,3.2%, 1.6%, and 0%. The results show that reducing the VAT ratesomewhat improves the profitability of producing shale gas;however, this measure alone does not render shale gas productioneconomically feasible. Although a preferential RT policy can helpimprove the economics of shale gas production, the effect is quitesmall.

4.2.1.2. CIT, FS. According to MOF et al. (2011), to accelerate thedevelopment of encouraged industries in western China, the CITrate (base case) during the first seven years is reduced to 15%, andafterward, this tax rate returns to 25%. Fig. 10 displays the DPIcalculated at various CIT rates of 25%, 25% (base case), 20%, 15%,10%, 5%, and 0%. With the introduction of a preferential CIT policy,the DPI increases, indicating increased profitability for shale gasproduction in the target area. More preferential CIT rates thusyield a higher DPI. Hence, a preferential CIT policy plays a sig-nificant role in improving economic viability. The DPI is alsocomputed at various FS scenarios, as shown in Fig. 11. Currently,shale gas development projects in the target area qualify forgovernment financial subsidies for only two years (MOF and NEA,2012). In this context, similar to a preferential VAT policy, thesmall improvement realized cannot make shale gas productioneconomically viable. Nonetheless, if the subsidy timeline is ex-tended from two to twenty-five years, financial subsidies will havea more pronounced effect that can render shale gas productioneconomically feasible in the target area.

0.870 0.920 0.970 1.020 1.070 1.120 1.170 1.220 1.270

0.32 0.34 0.35 0.37 0.39 0.40 0.42

DPI

Initial gas price($/cm)

Fig. 12. Influence of the initial gas price on the DPI.

-0.5 0 0.5 1 1.5 2 2.5 3

VAT

FS(2 years)

RT

CIT

FS(25 years)

Initial gas price

Sensitivity coefficient

Fig. 13. Sensitivity coefficients of the six major polices.

1.02

1.04

1.06

0.9930.9960.998 1 1.002 1.004

1.0111.0141.0161.018 1.02 1.023 1.024

1.0291.0321.0341.0371.039 1.041 1.043

J. Yuan et al. / Energy Policy 85 (2015) 194–206 201

4.2.1.3. Gas price. Additionally, the DPI for shale gas production iscalculated for an initial gas price of 0.32$/cm, 0.34$/cm, 0.35$/cm,0.37$/cm, 0.39$/cm, 0.4$/cm, and 0.42$/cm. The results are pre-sented in Fig. 12. For a 0.01$/cm increase in the gas price the DPIincreases by 0.0247, which indicates that the gas price plays a vitalrole in increasing the profitability of shale gas production in thetarget area. Increasing the gas price can thus help enhance theeconomic viability.

To identify which of these six major polices has the greatesteffect on improving the economics of shale gas production, thesensitivity coefficient for each is calculated. As shown in Fig. 13,the six major polices can be ranked according to their sensitivitycoefficients as follows: gas price, FS (twenty-five years), CIT, RT, FS(two years), and VAT. Thus, the three major polices with thegreatest ability to improve the economics are preferential policiesrelated to the gas price, FS (twenty-five years), and CIT. These threepreferential policies deserve increased attention, as they mayconstitute useful policy tools for stimulating the development ofthe shale gas industry.

Table 5 provides a summary of the benchmark values of severalmajor policies. As the table shows, because of the small effect fromthe VAT and FS (two years), these measures alone are insufficientto improve the economics under current conditions. Thus, otherpreferential policies associated with the RT, CIT, FS (twenty-five

Table 5Benchmark values of several major policies.

Notation Unit Actual value Change rate Benchmark value

VAT rate % 8.6 �(4100%)a 0RT rate % 5 �81% 0.95CIT rate % 25 �67.52% 8.12FS (2 years) $/cm 0.07 4100%b N/AFS (25 years) $/cm 0.07 �62.86% 0.03P1 $/cm 0.32 4.97% 0.34

a The VAT rate decreased by more than 100%; the benchmark value is notpositive.

b FS increased by more than 100%; the benchmark value is so high that it is notpractical.

years), and gas price should be adopted to improve economicfeasibility.

4.2.2. Two policiesBased on the single policy analysis, it can be concluded that not

all major policies are sufficient for improving the profitability ofshale gas production in the target area by themselves. Economicviability for shale gas production will thus remain elusive if onlyone of the major policies is adopted. Accordingly, the subsequentanalysis attempts to identify the effect of combinations of twopolicies on the economics of shale gas production. Furthermore,the sensitivity coefficient is calculated to measure the effect, whichis defined by modifying Eq. (5) as

SCN

N 17b

p

c=

( )

where Nc denotes the number of combinations of two policies andNp denotes the number of combinations of two policies that canhelp achieve economically viable shale gas production, i.e., thenumber of combinations of two policies with a DPIZ1.

4.2.2.1. Combinations with a relatively small effect. Under variouscombinations of two policies including the VAT rate and RT rate,the VAT and CIT rate, the VAT rate and FS (two years, the samebelow), the RT rate and FS as well as the CIT rate and FS, the DPI forshale gas production is calculated. The results show that the DPI ofmost combinations of these preferential policies is lower than 1.These combinations have a relatively small effect and do not ef-fectively improve the profitability of shale gas production. Apartfrom the combination of the VAT and CIT rate, which has a limitedeffect in helping render shale gas production economically viable(see Fig. 14), the combinations of other policies have little or noeffect.

4.2.2.2. Combinations with a larger effect. The DPI for shale gasproduction under various combinations of two policies, such asthe VAT rate and the initial gas price, the RT and CIT rate, the RTrate and the initial gas price, the CIT rate and the initial gas price aswell as the FS and the initial gas price, is calculated. The results,which are displayed in Tables 6–9 and Fig. 15, indicate that the DPIfor most combinations of preferential policies is higher than 1,which means that the policy combinations have a significant effecton improving the economics of shale gas production. These policycombinations with a larger effect can contribute to improving theDPI and achieving economically viable shale gas production.

25

20

100

0.88

0.9

0.92

0.94

0.96

0.98

1

8.6 7 5.5 4 2.5 1 0

0.939 0.941 0.943 0.945 0.947 0.948 0.95

0.96 0.962 0.964 0.966 0.968 0.969 0.9710.957 0.959 0.961 0.963 0.965 0.967 0.968

0.9750.977 0.979 0.981 0.983 0.985 0.987

1.005

CIT rate (%)

DPI

VAT rate (%)

Fig. 14. Effects on the DPI of combining VAT and CIT rates.

Table 6Effects of combinations of VAT rates and initial gas prices on the DPI.

VAT rate (%) Initial gas price ($/cm)

0.32 0.34 0.35 0.37 0.39 0.40 0.428.6 0.96 1.007 1.054 1.1 1.146 1.193 1.2397.0 0.962 1.009 1.056 1.102 1.148 1.195 1.2415.5 0.964 1.011 1.057 1.104 1.151 1.197 1.2444.0 0.966 1.013 1.059 1.106 1.153 1.199 1.2462.5 0.968 1.015 1.061 1.108 1.155 1.201 1.2481.0 0.969 1.017 1.063 1.11 1.157 1.204 1.250 0.971 1.018 1.065 1.111 1.158 1.205 1.252

When the DPI is higher than 1, the values are presented in bold.

Table 7Effects of combinations of RT rates and initial gas prices on the DPI.

RT rate (%) Initial gas price ($/cm)

0.32 0.34 0.35 0.37 0.39 0.40 0.425 0.96 1.007 1.054 1.1 1.146 1.193 1.2394.1 0.969 1.016 1.063 1.11 1.157 1.204 1.253.2 0.978 1.026 1.073 1.12 1.167 1.215 1.2621.6 0.994 1.042 1.09 1.138 1.186 1.234 1.2820 1.01 1.059 1.107 1.156 1.205 1.254 1.303

When the DPI is higher than 1, the values are presented in bold.

Table 8Effects of combinations of CIT rates and initial gas prices on the DPI.

CIT rate (%) Initial gas price ($/cm)

0.32 0.34 0.35 0.37 0.39 0.40 0.42

25 0.939 0.986 1.033 1.079 1.125 1.172 1.21825(base) 0.96 1.007 1.054 1.1 1.146 1.193 1.23920 0.957 1.007 1.057 1.106 1.155 1.205 1.25415 0.975 1.028 1.081 1.133 1.186 1.238 1.29110 0.993 1.049 1.105 1.160 1.216 1.272 1.3275 1.011 1.070 1.129 1.188 1.246 1.305 1.3640 1.029 1.091 1.153 1.215 1.277 1.338 1.400

When the DPI is higher than 1, the values are presented in bold.

Table 9Effects of combinations of FS values and initial gas prices on the DPI.

FS ($/cm) Initial gas price ($/cm)

0.32 0.34 0.35 0.37 0.39 0.40 0.420 0.928 0.974 1.021 1.067 1.113 1.16 1.2060.02 0.936 0.983 1.029 1.075 1.122 1.168 1.2140.03 0.944 0.991 1.037 1.084 1.13 1.176 1.2220.05 0.952 0.999 1.045 1.092 1.138 1.184 1.2310.07 0.96 1.007 1.054 1.1 1.146 1.193 1.2390.08 0.969 1.015 1.062 1.108 1.154 1.201 1.2470.10 0.977 1.024 1.07 1.116 1.163 1.209 1.255

When the DPI is higher than 1, the values are presented in bold.

5

3.2

0

0.85

0.9

0.95

1

1.05

1.1

0.9390.96 0.957 0.975 0.993 1.011

1.0290.948

0.969 0.967 0.9851.004

1.0231.041

0.9570.978 0.976 0.995

1.0151.034

1.053

0.9730.994 0.993

1.0131.033

1.0541.074

0.9891.01 1.01

1.0311.052

1.0731.095

RTrate (%)

DPI

CIT rate (%)

Fig. 15. Effects on the DPI of combining RT and CIT rates.

0 0.2 0.4 0.6 0.8 1

(VAT, FS)(RT, FS)

(CIT, FS)(VAT, RT)

(VAT, CIT)(RT, CIT)

(FS, Price)(VAT, Price)(CIT, Price)(RT, Price)

Sensitivity coefficient

Fig. 16. Sensitivity coefficients for ten combinations of two major policies.

J. Yuan et al. / Energy Policy 85 (2015) 194–206202

Sensitivity coefficients for these ten combinations of two majorpolicies are calculated to determine which has the greatest effecton improving the economic feasibility of shale gas production.Based on the sensitivity coefficients, the combinations of policiescan be ranked according to their effect (Fig. 16). The three com-binations of policies with the greatest improvement in the DPI, asindicated by a SCb higher than 0.8, are the combinations of the RTand initial gas price, CIT and initial gas price, and VAT and initialgas price. The combinations of FS and initial gas price, RT and CIT,and VAT and CIT can also be used to improve economic viability.However, owing to the small effect of the combination of the VAT

and FS, this particular combination cannot directly help improvethe economic feasibility.

4.2.3. Several policiesA combination of three or more major policies can also have a

significant effect on improving the DPI of shale gas production inthe target area. As with combinations of two policies, the sensi-tivity coefficients for combinations of several policies can be cal-culated according to Eq. (18). For example, the sensitivity coeffi-cient for a combination of the three major policies related to VAT,RT and CIT (Table 10) is approximately 0.94, which is much higherthan the sensitivity coefficients for a single policy or for thecombinations of two policies. Implementing several policy mea-sures can therefore further foster the development of the shale gasindustry.

5. Discussion

To pursue low-carbon development and create an en-vironmentally friendly society, China urgently needs to increase itseffective supply of cleaner energy resources, such as natural gas.As a type of natural gas, shale gas also has the distinct advantagesof offering resource potential and clean burning. Its developmentcan create three types of significant social benefits: (1) energysecurity benefits, including cost reductions associated with thecountry’s strategic oil reserve, which can be replaced to someextent by the increased natural gas supply; (2) environmentalbenefits, including the earnings from emissions trading owing toreductions in carbon and sulfur dioxide emissions resulting fromreplacing some coal combustion with natural gas and the lossesavoided due to reductions in other pollutions emissions; and(3) economic benefits, including the value of increased employ-ment, GDP, and tax payments that may arise (Agbaji et al., 2009;

Table 10Effects of combinations of VAT, RT, and CIT rates on the DPI.

VAT (%) RT (%) CIT (%)

15a 10 5 0

7 4.1 0.987 1b 1 13.2 0.998 1 1 11.6 1 1 1 10 1 1 1 1

5.5 4.1 0.990 1 1 13.2 1 1 1 11.6 1 1 1 10 1 1 1 1

4 4.1 0.992 1 1 13.2 1 1 1 11.6 1 1 1 10 1 1 1 1

2.5 4.1 0.994 1 1 13.2 1 1 1 11.6 1 1 1 10 1 1 1 1

1 4.1 0.996 1 1 13.2 1 1 1 11.6 1 1 1 10 1 1 1 1

0 4.1 1c 1 1 1

When the DPI is higher than 1, the values are presented in bold.a The DPI for the base case of the CIT rate is higher than that for the case in

which the CIT rate is 20% and lower than that for the case in which the CIT rate is15%.

b The DPI is denoted as 1 when DPIZ1.c If the DPI for the scenario in which the VAT rate is 0%, the RT rate is 4.1% and

the CIT rate is 20% is not less than 1, then the DPI for other scenarios must also notbe less than 1.

0.870 0.920 0.970 1.020 1.070 1.120 1.170 1.220

2 7 12 17 22 25

DPI

Year

Fig. 17. Effect of the duration of financial subsidies on the DPI.

J. Yuan et al. / Energy Policy 85 (2015) 194–206 203

Bonakdarpour et al., 2011; Duman, 2012). Although the impact ofviolations committed during the process of shale gas extraction onlocal environments, such as water, air and land, may create en-vironmental costs, these costs are relatively low compared to thebenefits (Considine et al. 2011; IEA, 2012).

As an emerging industry in China, shale gas development is stillat an early stage, although some production capacity currentlyexists. Policy support is urgently needed to help the industry’shealth and sustainable development because it is conducive toincreasing cleaner energy supplies with additional external ben-efits (Tian et al., 2014; Zhao et al., 2013). However, current in-centive policies cannot effectively help shale gas production be-come profitable. Based on the results of the technical and eco-nomic evaluation and policy analysis presented herein, some po-tentially helpful ideas and approaches have been identified to finda path to improve the current incentive policies. The followingoptions are recommended to promote the successful developmentof the shale gas industry in China with regard to policy instru-ments associated with gas prices, financial subsidies, and CIT.These recommendations can provide a foundation for policy for-mulation to promote the sustainable development of the shale gasindustry.

5.1. Increasing the gas price

According to both the sensitivity analysis in the technical andeconomic evaluation and the subsequent policy analysis, the gasprice is the most sensitive factor affecting the profitability of shalegas production, with a sensitivity coefficient of 2.47. A slight in-crease in the price of shale gas will generate a significant im-provement in profitability. Thus, shale gas price policies could havethe most significant effect on improving the economics of shalegas production in China. While shale gas price policies constituteeffective policy instruments to promote shale gas development,shale gas and natural gas prices in China are primarily determined

by the government. These fixed prices are usually lower than theactual value of the gas resources, and they cannot reflect the effectof supply and demand in the market. Thus, decision makers havetwo options to take full advantage of price policies to promote thedevelopment of the shale gas industry in China: (1) directly in-creasing the gas price and (2) implementing market pricing toincrease the gas price. Additionally, price policies can be adoptedalong with other support policies to further improve the profit-ability of shale gas production.

5.2. Increasing financial subsidies

Although producing shale gas is currently not economicallyviable in China, shale gas development increases the supply ofnatural gas, which offers external benefits. Additional externalbenefits can provide a basis for the formulation of financial sub-sidy policies. The lower bound of potential subsidies is the valuethat helps render shale gas development economically viable. Theupper bound is the value that equates to the external benefits. Inthis paper, the target for financial subsidies focuses on attainingthe lower bound, that is, rendering shale gas production profitable.Estimating the upper bound requires a detailed calculation that isbeyond the scope of this paper.

Because financial subsidies play a small role in improving theDPI, under the two-year subsidy scenario (base case), financialsubsidies should be used in combination with other incentives,such as price and CIT policies, to effectively improve the eco-nomics of production. From another perspective, preferentialsubsidy policies can be strengthened by offering local subsidies.Usually, the central government provides financial subsidies tofoster shale gas development. In view of the differences betweenthe regions pursuing shale gas development, the preferentialsubsidy policy will play a more effective role based on a combi-nation of central and local subsidies. In addition, the economicviability of shale gas production can also be improved by ex-panding the timeline of financial subsidy policies. Fig. 17 illustratesthe DPI for shale gas development in China under various subsidytimelines. The results show that this policy measure can have aremarkable effect on improving the DPI. Similar incentives in othercountries provide evidence of the efficacy of this measure. Forinstance, Section 29 of the US Internal Revenue Code has provideda tax credit for shale gas production in the US for a total of 28 years(23 years from 1980 to 2002 and 5 years from 2006 to 2010 with asmaller tax credit) (Hass and Goulding, 1992; EIA, 2004). In view ofthe long producing life of a shale gas well, the effect of a financialsubsidy will be undermined if the duration of a policy is too short.The Chinese government should consider expanding the timelineof financial subsidies in stages with different subsidies. Therefore,decision makers have two choice options with respect to financialsubsidy policies to promote shale gas development in China:(1) extending the duration of financial subsidies and (2) increasing

J. Yuan et al. / Energy Policy 85 (2015) 194–206204

the amount of financial subsidies in combination with other in-centive policies.

5.3. Reducing the CIT

After shale gas prices and government subsidies, preferentialCIT policies offer the next largest improvement in the economicsof shale gas development in China. The sensitivity coefficient ofthe CIT policy is –0.24, which indicates that a negative relationshipexists between the CIT rate and the DPI. Thus, to increase the DPI,the CIT rate must be reduced. Another way to reduce the CIT rate isto exempt financial subsidy revenue from the CIT. Currently, whentaxable income is calculated for the CIT, financial subsidy income isincluded, which reduces the subsidy’s effect to some extent. Thethird way to reduce the CIT rate is to provide preferential CITtreatment at early stages of development while levying the stan-dard CIT in later years. Such a policy would reduce the CIT in thesame manner as in the base case, which is not specific to the shalegas industry.

In addition, offering tax deductions can reduce the effective CITrate. Technological progress can play a vital role in production andcost and subsequently alter the economics of shale gas develop-ment. Furthermore, technology R&D and equipment purchasesrequire substantial investment. If a percentage of any investmentin technology R&D could be offered as a deduction from taxableprofits before the calculation of CIT or if any investment inequipment purchases could be deducted from CIT, such policieswould not only incentivize research and the utilization of ad-vanced technologies and equipment but would also improve theprofitability of shale gas production. Consequently, decisions ma-kers have four policy options to foster the development of shalegas in China: (1) directly reducing the CIT rate, (2) providing anexemption from the CIT for financial subsidy revenue, (3) reducingthe CIT rate at early stages of development and then levying thestandard CIT at later stages, and (4) offering a deduction on taxableprofits for investments in technology R&D and a tax deduction onthe CIT for investments in equipment purchases. Additionally, fa-vorable CIT policies can be adopted in combination with com-plementary policies to further improve the economics of shale gasproduction.

5.4. Reducing the RT

Preferential RT policies have a limited effect on improving theDPI of shale gas development in China and helping to achieveeconomic feasibility. However, if RT policies are applied alongsidecomplementary policies, such as price or CIT policies, the effect ismore significant. Although shale gas resources are abundant inChina, large quality differences exist between regions. Thus, dif-ferent RT policies must be formulated to reflect the varying qualityof resources by region. In areas with low-quality shale gas re-sources, strong preferential RT policies are necessary. In contrast,areas with high-quality shale gas resources require relatively lesspreferential RT policies. The Fuling shale gas pilot zone has rela-tively high-quality shale gas resources; hence, it can be offeredstrongly preferential RT policies during the early years of devel-opment and relatively less preferential RT policies at later stages.To foster economically viable shale gas production, the followingtwo RT policy measures can be implemented: (1) reducing the RTrate and (2) offering different preferential RT policies at differentstages of development based on regional resource variations.

5.5. Reducing the VAT

Notably, preferential VAT policies have little influence on im-proving the economic viability of shale gas production in China.

Therefore, this policy measure alone cannot render shale gasproduction profitable. However, combining preferential VAT po-licies with other preferential policies, such as price or CIT policies,can lead to an improvement in the profitability of shale gas de-velopment. To reduce the effective VAT, the simplest measure is toreduce the VAT rate. Another option is to reduce the VAT by le-vying no VAT or a low VAT during the early stages of developmentand then levying the standard VAT in later years.

Another way to reduce the VAT is to provide VAT reimburse-ment. In this case, part or all of the VAT paid is reimbursed to theshale gas operators as income. VAT reimbursement income shouldthen be excluded from taxable profits in the calculation of the CIT;otherwise, the effect of the VAT reimbursement would be reduced.Thus, with respect to preferential VAT policies, decision makershave three options for improving the economics of shale gas de-velopment in China: (1) directly reducing the VAT rate, (2) levyingno VAT or a low VAT rate during the early stages of developmentand then levying the standard VAT in later years, and (3) offeringVAT reimbursement. Preferential VAT policies should be im-plemented with complementary policies.

6. Conclusions and policy implications

Because of its abundant shale resources and the increasinglyurgent need for cleaner energy, China is actively pursuing shalegas development. Due to the distinct characteristics of shale gasdevelopment, supporting policies are very important to its eco-nomic production, particularly in the early stages of development.Without government support, it is difficult for shale gas ex-ploitation to achieve economic feasibility and remain profitable.Given the significant external benefits of shale gas development,the Chinese government has implemented a series of incentivepolicies to stimulate the development of the shale gas industry.

A company engaged in shale gas development will make in-vestment decisions based on the expected returns to the capitalinvested in the project. However, under current technical andeconomic conditions, shale gas development in China is marginal,indicating that current incentive policies are not sufficiently ag-gressive to support economically viable shale gas production. Ex-isting policy incentives hence need to be adjusted to promote thesustainable development of the shale gas industry. Accordingly, apolicy analysis is performed to explore the validity of the majorpolicies available in China and to identify the effects of differentpolicy measures on the economic viability of shale gas production,which can provide guidance to improve incentive policies. Basedon this analysis, recommendations are then presented as optionsfor improving incentive policies, such as gas prices, financialsubsidies, and CIT policies or combinations thereof.

At the early stages of shale gas development, strong policysupport is needed to incentivize shale gas production. At laterstages, because of technological advances, shale gas developmentmay not need such strong preferential policies to achieve eco-nomic feasibility or to remain profitable. Furthermore, when theshale gas industry reaches maturity, policy support may not berequired at all. Indeed, shale gas development is a dynamic pro-cess that requires dynamic evaluation and analysis so that in-centive policies can be adjusted according to the changing cir-cumstances at different stages of development. For instance, sub-sidy policy needs to be continuously improved, particularly re-garding value and duration. The DCF method applied in this paperprovides such a dynamic method of evaluation. The ideas andmethods presented in the technical and economic evaluation andthe policy analysis can thus be used in this dynamic process tooptimize incentive policies.

It is anticipated that the results of this paper will be a resource

J. Yuan et al. / Energy Policy 85 (2015) 194–206 205

for decision makers, as the evaluation and analysis in this papercan help decision makers identify the effects of and deficiencies incurrent policies. The policy recommendations herein can also helpdecision makers take steps to improve incentive policies. Finally, itis also anticipated that the results of this paper will offer valuableinsight for future researchers who are interested in improvingincentive policies aimed at promoting shale gas development.

Acknowledgements

Funding for this work was provided by a National Social ScienceFund Major Project (11&ZD164), a Beijing Higher Education YoungElite Teacher Project (YETP0688) and a Chongqing MunicipalityProject (CQGT-KJ-2012-4) of China. Additionally, the authors wishto thank the editors and reviewers of this manuscript for theirelaborate work.

References

Agbaji, A., Lee, B., Kumar, H., Belvalkar, R., Eslambolchi, S., Guiadem, S., et al., 2009.Sustainable Development and Design of Marcellus Shale Play in Susquehanna,PA. Available from: ⟨http://www.ems.psu.edu/�elsworth/courses/egee580/gas_final_2009.pdf⟩ (last accessed 11.09.14).

Aguilera, R.F., 2014. The role of natural gas in a low carbon Asia Pacific. Appl. Energy113, 1795–1800. http://dx.doi.org/10.1016/j.apenergy.2013.07.048.

Alexander, T., Baihly, J., Boyer, C., Clark, B., Waters, G., Jochen, V., et al., 2011. Shalegas revolution. Oilfield Rev. 23(3), 40–55. ⟨http://www.slb.com/�/media/Files/resources/oilfield_review/ors11/aut11/04_shale_gas_revolution.pdf⟩ (last ac-cessed 07.03.15).

Baihly, J.D., Altman, R.M., Malpani, R., Luo, F., 2010. Shale gas production declinetrend comparison over time and basins. SPE . http://dx.doi.org/10.2118/135555-MS 135555-MS.

Bonakdarpour, M., Flanagan, B., Holling, C., Larson, J.W., 2011. The Economic AndEmployment Contributions of Shale Gas in the United States. Available from:⟨http://theuticashale.com/wp-content/uploads/2012/06/shale-gas-economic-impact-dec-2011.pdf⟩ (last accessed 11.09.14).

BP, 2014. BP statistical Review of World Energy 2014. Available from: ⟨http://www.bp.com/en/global/corporate/about-bp/energy-economics/statistical-review-of-world-energy.html⟩ (last accessed 11.09.14).

Chang, Y., Huang, R., Ries, R.J., Masanet, E., 2014. Shale-to-well energy use and airpollutant emissions of shale gas production in China. Appl. Energy 125,147–157. http://dx.doi.org/10.1016/j.apenergy.2014.03.039.

CNPC, 2014. Development Report of Oil And Gas Industry Domestic and Overseas in2013. CPNC, Beijing.

Chongqing Municipal Bureau of Land Resources and Housing Management, 2013.Announcement on Land Compensation of Chongqing. Available from: ⟨http://www.cqgtfw.gov.cn⟩ (last accessed 11.09.14) (in Chinese).

Considine, T.J., Watson, R.W., ConsIdine, N.b., 2011. The Economic Opportunities ofShale Energy Development. ⟨http://www.manhattan-institute.org/pdf/eper_09.pdf⟩ (last accessed 07.09.15).

Duman, R.J., 2012. Economic Viability of Shale Gas Production in the MarcellusShale; Indicated by Production Rates, Costs and Current Natural Gas Prices.Available from: ⟨http://services.lib.mtu.edu/etd/THESIS/2012/Business&Economics/duman/thesis.pdf⟩ (last accessed 11.09.14).

Energy Information Administration (EIA) of US, 2013. North America Leads theWorld in Production of Shale Gas. Available from: ⟨http://www.eia.gov/todayinenergy/detail.cfm?id¼13491⟩ (last accessed 11.09.14).

EIA, 2004. Analysis of Five Selected Tax Provisions of the Conference Energy Bill of2003. Available from: ⟨http://www.eia.gov/oiaf/servicerpt/ceb/pdf/sroiaf(2004)01.pdf⟩ (last accessed 11.09.14).

Feng, X., Li, J., Wang, M., Zhang, X., 2013. A strategic evaluation on the developmentof shale gas in China based on SWOT model. Environ. Sustain. Dev. 2, 15–20.http://dx.doi.org/10.3969/j.issn.1673-288X.2013.02.005 (in Chinese).

Fu, B., Li, Z., Duan, Y., Li, Z., 2012. SWOT analysis on shale gas exploration and de-velopment in China and policy suggestions. Gas Technol. Econ. 6 (5), 7–9. http://dx.doi.org/10.3969/j.issn.2095-1132.2012.05.002 (in Chinese).

Gülen, G., Browning, J., Ikonnikova, S., Tinker, S.W., 2013. Well economics across tentiers in low and high Btu (British thermal unit) areas, Barnett shale, Texas.Energy 60, 302–315. http://dx.doi.org/10.1016/j.energy.2013.07.041.

Guo, H., Li, L., Yang, Z., Ji, W., 2010. Efficient development of shale gas in China. Nat.Gas Ind. 30 (12), 110–113. http://dx.doi.org/10.3787/j.issn.1000-0976.2010.12.027, in Chinese.

Haskett, W.J., Brown, P.J., 2010. Pitfalls in the evaluation of unconventional re-sources. SPE . http://dx.doi.org/10.2118/135208-MS 135208-MS.

Hass, M.R., Goulding, A.J., 1992. Impact of Section 29 tax credits on unconventionalgas development and gas markets. SPE . http://dx.doi.org/10.2118/24889-MS24889-MS.

Hu, D., Xu, S., 2013. Opportunity, challenges and policy choices for China on thedevelopment of shale gas. Energy Policy 60, 21–26. http://dx.doi.org/10.1016/j.enpol.2013.04.068.

INTEK, 2011. Review of Emerging Resources: U.S. Shale Gas and Shale Oil Plays.Available from: ⟨http://www.eia.gov/analysis/studies/usshalegas/pdf/usshaleplays.pdf⟩ (last accessed 11.09.14).

International Energy Agency (IEA), 2012. Golden Rules for a Golden Age of Gas:World Energy Outlook Special Report on Unconventional Gas. ⟨http://www.worldenergyoutlook.org/media/weowebsite/2012/goldenrules/WEO2012_GoldenRulesReport.pdf⟩ (last accessed 07.03.15).

Jin, H., Lior, N., Zhang, X., 2010. Energy and its sustainable development for China:Editorial introduction and commentary for the special issue of Energy – theinternational journal. Energy 35 (11), 4246–4256. http://dx.doi.org/10.1016/j.energy.2010.08.001.

Kaiser, M.J., 2012a. Profitability assessment of Haynesville shale gas wells. Energy38 (1), 315–330. http://dx.doi.org/10.1016/j.energy.2011.11.057.

Kaiser, M.J., 2012b. Haynesville shale play economic analysis. J. Pet. Sci. Eng. 82–83,75–89. http://dx.doi.org/10.1016/j.petrol.2011.12.029.

Krupnick, A., Wang, Z., Wang, Y., 2014. Environmental risks of shale gas develop-ment in China. Energy Policy 75, 117–125. http://dx.doi.org/10.1016/j.enpol.2014.07.022.

Lake, L.W., Martin, J., Ramsey, J.D., Titman, S., 2013. A primer on the economics ofshale gas production: just how cheap is shale gas? J. Appl. Corp. Financ. 25 (4),87–96. http://dx.doi.org/10.1111/jacf.12045.

Liao, Y., Luo, D., Yuan, J., 2012. A discussion on the relevant polices of stimulatingthe shale gas development. Nat. Gas Ind. 32 (10), 1–5. http://dx.doi.org/10.3787/j.issn.1000-0976.2012.10.001, in Chinese.

Liu, C.H., Martinez-Rahoe, B., Fleckenstein, W., Park, Y., Shi, F., 2013. Economicfeasibility analysis of the Marcellus shale, Pennsylvania. SPE 168886-MS . http://dx.doi.org/10.1190/URTEC2013-078.

Lozano Maya, J.R., 2013. The United States experience as a reference of success forshale gas development: the case of Mexico. Energy Policy 62, 70–78. http://dx.doi.org/10.1016/j.enpol.2013.07.088.

Melikoglu, M., 2014. Shale gas: analysis of its role in the global energy market.Renew. Sustain. Energy Rev., 37; , pp. 460–468. http://dx.doi.org/10.1016/j.rser.2014.05.002.

Ministry of Housing and Urban-Rural Development of China, 2010. EconomicEvaluation Methods and Parameters of Oil and Gas Development ConstructionProjects. Plan Publishing House of China, Beijing (in Chinese).

Ministry of Finance (MOF), General Administration of Customs (GAC), State Ad-ministration of Taxation (SAT) of China, 2011. Announcement on EnterpriseIncome Tax Policies Issues Concerning the Further Implementation of theWestern China Development Strategy. Available from: ⟨http://www.chinatax.gov.cn/n8136506/n8136593/n8137537/n8138502/11610269.html⟩ (last ac-cessed 11.09.14) (in Chinese).

MOF, National Energy Administration (NEA) of China, 2012. Announcement on theIntroduction of Subsidy Policy for Development and Utilization of Shale Gas.Available from: ⟨http://www.nea.gov.cn/2012-11/06/c_131953346.htm⟩ (lastaccessed 11.09.14) (in Chinese).

MOF, SAT, 2010. Announcement on the Provisions of Resource Tax Reform of Oil andGas in the Western China. Available from: ⟨http://www.shui5.cn/article/b0/48166.html⟩ (last accessed 11.09.14) (in Chinese).

Ministry of Land and Resources (MOLR) of China, 2014a. Oil and Gas Production inChina Hit Record High. Available from: ⟨http://www.mlr.gov.cn/xwdt/jrxw/201401/t20140109_1300450.htm⟩ (last accessed 11.09.14) (in Chinese).

MOLR, 2014b. Shale Gas Development in China Began to Enter the Large-scaleDevelopment of an Early Stage. Available from: ⟨http://www.mlr.gov.cn/xwdt/zsdwdt/201409/t20140918_1330247.htm⟩ (last accessed 11.09.14) (in Chinese).

MOLR, 2012. Announcement on Strengthening Relevant Work About Explorationand Exploitation and the Supervision and Administration of Shale Gas Re-sources. Available from: ⟨http://www.mlr.gov.cn/zwgk/zytz/201211/t20121122_1158928.htm⟩ (last accessed 11.09.14) (in Chinese).

National Bureau of Statistics (NBS) of China, 2014. China Statistical Yearbook 2014.China Statistics Press, Beijing (in Chinese).

National Development and Reform Commission (NDRC), MOF, MOLR, NEA of China,2012. Shale Gas Development Plan (2011–2015). Available from: ⟨http://www.mlr.gov.cn/xwdt/jrxw/201203/P020120316624004741256.pdf⟩ (last accessed 11Sep. 2014) (in Chinese).

NDRC, 2012. 12th Five-Year Plan for Natural Gas Development. Available from:⟨http://www.gov.cn/zwgk/2012-12/03/content_2280785.htm⟩ (last accessed11.09.14) (in Chinese).

NEA, 2013. Shale Gas Industry Policy. Available from: ⟨http://www.gov.cn/zwgk/2013-10/30/content_2517985.htm⟩ (last accessed 11.09.14) (in Chinese).

Nome, S., Johnston, P., 2008. From Shale to Shining Shale: A Primer on NorthAmerican Natural Gas Shale Plays. Available from: ⟨http://www.renewwisconsin.org/pdf/shaletoshiningshale.pdf⟩ (last accessed 11.09.14).

Qian, X., Jiang, X., 2015. Overview of international oil and gas industry develop-ments in 2014 and outlook for 2015. Int. Pet. Econ. 23 (1), 35–43. ⟨http://d.g.wanfangdata.com.cn/Periodical_gjsyjj201501015.aspx⟩ (in Chinese).

Sandalow, D., Wu, J., Yang, Q., Hove, A., Lin, J., 2014. Meeting China’s Shale GasGoals. Available from: ⟨http://energypolicy.columbia.edu/research/shale-gas-development-china⟩ (last accessed 11.09.14).

State Council (SC) of China, 2012. White Paper on China’s Energy Policy 2012.Available from: ⟨http://www.gov.cn/zwgk/2012-10/24/content_2250617.htm⟩

(last accessed 11.09.14) (in Chinese).

J. Yuan et al. / Energy Policy 85 (2015) 194–206206

SC, 2013. 12th Five-Year Plan for Energy Development. Available from: ⟨http://www.gov.cn/zwgk/2013-01/23/content_2318554.htm⟩ (last accessed 11.09.14) (inChinese).

Tian, L., Wang, Z., Krupnick, A., Liu, X., 2014. Stimulating shale gas development inChina: a comparison with the US experience. Energy Policy 75, 109–116. http://dx.doi.org/10.1016/j.enpol.2014.07.025.

Wang, C., Wang, F., Du, H., Zhang, X., 2014. Is China really ready for shale gas re-volution: Re-evaluating shale gas challenges. Environ. Sci. Policy 39, 49–55.http://dx.doi.org/10.1016/j.envsci.2014.02.007.

Wang, T., Lin, B., 2014. Impacts of unconventional gas development on China’snatural gas production and import. Renew. Sustain. Energy Rev. 39, 546–554.http://dx.doi.org/10.1016/j.rser.2014.07.103.

Wan, Z., Huang, T., Craig, B., 2014. Barriers to the development of China’s shale gasindustry. J. Clean Prod. 84, 818–823. http://dx.doi.org/10.1016/j.jclepro.2014.04.073.

Wehunt, C.D., Hrachovy, M.J., Walker, S.C., Padmakar, A.S., 2012. An efficient deci-sion framework for optimizing tight and unconventional resources. SPE162909-MS . http://dx.doi.org/10.2118/162909-MS.

Weijermars, R., 2013. Economic appraisal of shale gas plays in Continental Europe.Appl. Energy 106, 100–115. http://dx.doi.org/10.1016/j.apenergy.2013.01.025.

Zhang, D., Li, Y., Zhang, J., Qiao, D., Jiang, W., Zhang, J., 2012. The National Surveyand Assessment of Shale Gas Resource Potential. Geological Publishing House,Beijing, in Chinese.

Zhang, K., 2014. Natural gas supply-demand situation and prospect in China. Nat.Gas Ind. 34(1), 10–17. http://dx.doi.org/10.3787/j.issn.1000-0976.2014.01.002(in Chinese).

Zhang, X., Hu, H., Zhang, R., Deng, S., 2014. Interactions between China’s economy,energy and the air emissions and their policy implications. Renew. Sustain.Energy Rev. 38, 624–638. http://dx.doi.org/10.1016/j.rser.2014.07.002.

Zhao, X., Kang, J., Lan, B., 2013. Focus on the development of shale gas in China:Based on SWOT analysis. Renew. Sustain. Energy Rev. 21, 603–613. http://dx.doi.org/10.1016/j.rser.2012.12.044.