THERE was strong interest but little expertise on show at China's second shale gas auction.

The Ministry of Land and Resources last month announced 16 winning bidders - six from the power and coal industry, seven provincial and state investment firms, one miner and two private sector companies. The winning bids covered exploration at 19 shale sites.

A total of 85 companies participated in the auction, with 20 blocks on offer. In China's first auction in 2011, only six companies took part, and only half of the four blocks on offer were awarded.

In the latest round, neither of state-owned giants Sinopec and PetroChina was a bid winner because, according to analysts, they already control shale blocks within their existing fields.

"While participation and bidding levels highlight a strong level of interest in shale, the outcome of the licensing round was a disappointment," Neil Beveridge, senior analyst of Sanford C. Bernstein, wrote in a note.

The relatively few bidders with actual oil and gas exploration experience led some analysts to conjecture that China may fall short of achieving its production targets for shale gas.

Some suggested that the nation needs to rethink its approach to shale if it wants to effectively exploit what could be a significant resource.

Game changer

"With winning bidders from sectors outside of the oil and gas industry, we see this as more of a land grab than an effective policy to open up acreage," Beveridge said.

Shale gas is trapped in formations previously thought to be unreachable, but technologies known as horizontal drilling and hydraulic fracturing, or fracking, have successfully unlocked deposits in the United States, making the fuel a game changer there.

The US success has put the subject under the spotlight in China, which is believed to hold the world's largest shale gas resources.

The land ministry's auctions marked the start of commercial exploration of shale gas in China, with which the government is hoping to supplement the nation's robustly growing demand for gas. That's part of a broader strategy to cut reliance on coal and oil and to protect the environment.

China's State Council has also approved shale gas as a new type of natural resource that will be managed separately from conventional natural gas.

China aims to produce 6.5 billion cubic meters of shale gas annually by 2015, and 60 billion to 100 billion cubic meters by 2020, according to official targets.

The second auction was the first time that private-sector and Sino-foreign joint ventures were allowed to participate as the government wants to bring more investors into the industry.

The 16 winning bidders included two private companies but no foreign joint ventures, though five foreign firms bid.

Together, the winners plan to invest 12.8 billion yuan (US$2.06 billion) over the next three years to explore the blocks. That was seven times higher than the minimum bid required.

China Shenhua Energy Co, the nation's leading coal producer and a successful bidder, said there were "uncertainties in the exploration achievements and development prospects for shale gas resources" because the sector was in its preliminary stages in China.

Shenhua said it was entering the sector to broaden its presence in the energy market and optimize its business model as an integrated energy company.

Beveridge said he expected new joint ventures to form between holders of the blocks and experienced oil and gas companies seeking to explore for shale in China, although this would take time.

As a result, the government target of making 80 billion cubic meters of shale gas by 2020 was "unrealistic," he said, adding that 30 billion cubic meters was more likely.

Zhang Guobao, former director of the National Energy Administration, said at a recent conference that it would take a long time for China to boost its shale gas output. He cited bottlenecks in technologies and pipeline networks, though China is actively seeking technical and operational know-how from foreign companies via partnership or overseas acquisitions.

Unlike US formations, where most shale seams are at depths of less than 3,000 meters, the shale-bearing layers in many Chinese formations are between 3,000 meters and 5,000 meters deep, according to a recent report by Accenture.

Therefore, US shale gas development models cannot be simply replicated in China, and the complex geological conditions in China will increase drilling costs, the consulting firm said.

Production targets

Still, small-cap shale services companies would benefit from the 12.8 billion yuan capital expenditure promised by the winning bidders in the second auction, Beveridge said, as would LNG exporters to China if the country is unable to meet shale production targets.

"We continue to believe that the best way to play the natural gas theme in China is through LNG or small service companies," he said.

Analysts said the slow pace of deregulation of gas prices, access to water, gas pipelines and the need for advanced technologies could be a brake on China's shale development process.

"We believe in China there will be a shale evolution, not revolution, unless the government demonstrates stronger commitment to expedite free market pricing, taxes pollution and becomes more aggressive in taking over foreign oil field services firms with the right technologies," said Mirae Asset Securities analyst Gordon Kwan.

China also needs a clear, established fiscal structure for shale, Beveridge said.

The current "cumbersome" production-sharing contracts required for foreign investors won't create the right incentives because there are no subsidies or clarity in the pricing mechanism to encourage exploration and development, he said.

In March 2012, Royal Dutch Shell and China National Petroleum Corp, PetroChina's parent, signed an agreement to explore, develop and produce shale gas in China.

It was the first shale gas production sharing contract to be signed in China.