China is set to drill for shale gas in a big way, largely spurred by growing domestic energy demand and also encouraged by the US shale story, where producers are facing over-capacity.

The recently released Chinese White Paper on Energy calls to boost the use of natural gas, through LNG imports and bumping up domestic production.

The top energy user is looking to triple its natural gas use to meet about 10% of its total energy demand by the end of this decade, and cut greenhouse gas emissions from coal use and reliance on imported oil.

To boost domestic production, China has launched the second round of auctions for shale exploration blocks. To spur interest, the Chinese Ministry of Finance said earlier this month it would offer a subsidy of 0.4 yuan for every cubic metre of shale gas produced from 2012-15.

Additionally, local governments can also offer further subsidies to spur development.

Many in the industry see these measures as generous, and one that shows Beijing’s keenness to develop domestic shale assets.

“The shale gas subsidy exceeded expectations,” a China International Capital Corp research report said, highlighting Chinese energy policy goals for commercial production.

While these measures are seen as significant, there are others who underline the disconnect between production mandates and lack of progress in the ground.

According to the US Energy Information Administration, China is estimated to hold the world’s largest reserve of shale gas, which could support the country’s gas consumption for the next 200 years, making it gas independent.

The Chinese Ministry of Land and Resources also estimates that China has 25.08 trillion cubic meters of shale gas in its exploitable reserves.

To feed the growing energy demand, China plans to produce 6.5 billion cubic metres of shale gas annually by 2015 and to commercialise production by end of the decade.

Much of that ambition could remain unrealised because analysts believe the target is too hard to achieve, given the uncertainties over geology and shale technology in China.

A recent UBS research note pointed out that it would take at least a decade to get the costs down to a level where it would be economical to produce shale gas in China.

It notes China’s shale gas is suitable for commercial production only if the costs of development in the primary reserves can fall below 2.3 yuan per cubic metre.

However, the country has undertaken just two rounds of auctions for shale gas exploration blocks, with the latest one concluded last month.

About 83 bidders participated in the auction for 20 exploration blocks, which was open to foreign investment for the first time, though not directly. One third of the participants were private firms and foreign entities interested in bidding had to have tie-ups with local companies.

The previous round offered only two blocks and six state-owned enterprises were invited.

With such a limited exploration program, analysts doubt whether the goals will be met. A China Energy Research Institute study notes that the country will need to drill 20,000 shale wells by 2020 but so far has completed only 63 wells.

If the 6.5 billion cubic metre target set for 2015 is to be met, the country needs to drill for more than 100 well a year over the next three years.

There are other challenges that could put a damper in China’s shale ambitions.

Its reserves are buried twice deeper than American shale gas, and located in remote arid regions, that pose significant geological challenges.

Economies of scale are yet to be reached, too. A shale well can cost anywhere between 40 to 80 million yuan to drill in China, while the costs in the US are between 17 million to 23 million yuan.

Even if costs can be curtailed with better technological innovations, China’s shale ambitions can be derailed by the scarcity of water resources.

Shale gas extraction typically requires 20,000 cubic metres of water to fracture each well and in China many of the primary reserves are located in regions where scarcity of water is a major issue.

With geology and technology hindering potential shale development, China’s reliance on natural gas imports is set to stay.