Royal Dutch/Shell and the Unocal Corporation have withdrawn from one of the largest offshore gas exploitation projects in China.

The companies pulled out of joint exploration, development, and marketing of natural gas resources in the Xihu Trough of the East China Sea citing "commercial reasons," Shell and Unocal said yesterday.

The pull-out by their overseas partners leaves Sinopec and the China National Offshore Oil Corp (CNOOC) - the second and third largest domestic oil firms - the only players in the project.

Analysts said the move of the overseas partners casts doubts on the potential of the Xihu Trough, claimed to be one of China's top gas discoveries of recent decades.

It was the largest Sino-foreign gas exploration project so far.

In early August 2003, Shell, Unocal, CNOOC and Sinopec signed five contracts to explore three blocks and develop two in the Xihu Trough with an initial investment of US$85 million. The blocks, 500 kilometres southeast of Shanghai, cover 22,000 square kilometres.

The centrepiece of the project includes the development of the Chunxiao fields which supply gas to booming Shanghai and Zhejiang Province.

CNOOC and Sinopec each hold a 30 per cent share in the project, while Shell and Unocal each have 20 per cent. The terms of the agreements allow partners to make a final investment decision after a 12-month period of appraisal and analysis.

Barry Lane, spokesman for the United States based Unocal, said in a telephone interview: "After the first year of analysis, we found the resources do not meet our commercial requirements."

In a joint press release, CNOOC and Sinopec simply announced that Shell and Unocal have decided not to continue participating in the next phase, "since both sides have failed to agree on the existing development plan."

The Xihu Trough project is seen as an important move for China to increase gas consumption in coastal areas, in an attempt to diversify its energy mix and improve the environment.

Earlier this year the project attracted international attention after Japan protested that the development of Xihu Trough extends beyond the "median line" between the two countries. China refuted the claim, and rejected the validity of the line itself, arguing that the natural demarcation should be drawn further east.

Unocal's Lane yesterday dismissed suggestions that the company's decision had anything to do with political disputes.

Despite the pull-out of foreign companies, CNOOC said it remains optimistic.

"We are confident about the project's future. The change of partners has little impact on the ongoing project," Fu Chengyu, chairman and CEO of CNOOC Limited said.

Zhou Shouwei, president of CNOOC, said: "Significant progress has been made to optimize the Overall Development Programme (ODP) of the project.

"Meanwhile, gas marketing is progressing well. We... expect to complete the project on time."

CNOOC said the Chunxiao field, the first to be completed in the Xihu Trough, is set to come on stream in mid-2005 as scheduled.

Chunxiao is expected to produce 2.5 billion cubic metres of natural gas in the immediate two years after production begins.

Analysts yesterday said that the withdrawal of the overseas firms may cause difficulties for the project, although they agree CNOOC has sufficient technology and experience to carry the project through.

"CNOOC now has to raise additional funds to finance the project," said Liu Gu, an oil and gas analyst with the Guotai Gun'an Securities Hong Kong Ltd.

"In addition, Shell's excellent experience and technology in deep-water exploration may also have increased the possibilities of success, if they were in."

The Xihu Trough project is the second large project Shell has scrapped this year in China. Just two months ago, Shell, along with ExxonMobil and Russia's Gazprom, pulled out of the west-east natural gas transportation project after failing to reach commercial terms with Chinese companies.

Liu said it comes as no surprise that Shell is adjusting its policies in China as it seeks to calibrate its global strategy following a management reshuffle earlier this year.