Chinese Oil: An Evolving Strategy

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Op-Ed chinadialogue
Summary
Chinese National Oil Companies, while owned by the government, increasingly base investment decisions on market signals rather than state orders. Their efforts to access oil and gas resources are helping to meet the challenge of high petroleum consumption levels.
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China’s thirst for oil and gas, fuelled by its breakneck economic growth, has been the primary driver behind efforts to forge ties with any country or regime with abundant energy resources. The conventional wisdom views Chinese National Oil Companies (NOCs) as arms of the government that aggressively seek to enhance China’s energy security at the expense of other oil-consuming economies.

That view is too narrow. Chinese NOCs may be owned by the government, but they increasingly base investment decisions on market signals rather than state orders. Moreover, Chinese efforts to access oil and gas resources are helping to meet the challenge of high petroleum consumption levels and rendering the global marketplace more competitive.

In 1993, China lost its long cherished status of energy independence. The share of oil imports from the politically unstable Middle East increased from a mere 16% in 1993 to 61% in 1998, greatly concerning Chinese decision-makers. In 2002, China surpassed Japan as the world’s second largest oil-consuming economy. Since then, China’s net oil imports have grown at an astonishing 15% annually, reaching 254 million tonnes in 2010.

China’s dependence on imported oil increased to a record 56.5% in 2011, according to the National Energy Administration. In comparison, US dependence on imported oil fell below 50% in 2010 for the first time in more than a decade, thanks in part to the weak economy and more fuel-efficient vehicles. Making Chinese decision-makers more nervous, China began importing liquefied natural gas (LNG) in 2006 and pipeline gas in early 2010.

With rising oil consumption and increasing dependence on foreign imports, it’s no surprise that Chinese oil companies have been actively acquiring overseas assets. Chinese NOCs, along with other smaller Chinese companies, spent at least US$47.6 billion (300 billion yuan) on global oil and gas assets in 2009 and 2010, according to the International Energy Agency (IEA).

When Chinese NOCs first entered the already crowded global oil market in the early 1990s, they were still lightweight industry players, unable to directly compete with international oil giants at established oil-producing basins. It was no coincidence that Chinese NOCs made their first major breakthroughs in oil-producing countries with troubled relationships with western nations.

This was the case in Sudan, where China National Petroleum Corporation (CNPC) won the tender for the “Block 1/2/4” oil-production project in 1996. While American companies were prohibited from investing there, due to US designation of Sudan as a state supporter of terrorism in 1993, Beijing’s principle of non-intervention in other countries’ domestic issues allowed Chinese NOCs to freely pursue their business interests.

Ever since, Chinese NOCs have enjoyed a lucrative partnership with the Sudanese government. China’s oil imports from Sudan increased sharply from 270,000 tonnes in 1999 to 13 million tonnes in 2011. This major breakthrough is considered the beginning of Chinese NOCs’ active pursuit of a “going global” oil strategy.

Initially, each NOC focused on a particular segment of the petroleum industry: CNPC specialised in onshore oil and gas exploration and production, China National Petroleum & Chemical Corporation’s (Sinopec) operations centered on refining and distribution and China National Offshore Oil Corporation (CNOOC) concentrated on offshore exploration and production. But heavy welfare obligations to their bloated workforces, substantial revenue losses due to tightly regulated domestic oil market and relatively low crude prices in the international market limited NOCs’ financial, technological and managerial capacity.

In order to create “national champions” with the ability to compete with international oil giants, the central government reorganised most state-owned oil and gas assets in 1998, and converted CNPC and Sinopec into vertically integrated firms. The 1998 restructuring provided most Chinese NOCs with capacity to cover financial losses caused by price regulation with profits from other parts of their operations. Its results continue to be felt today.

While China’s “going global” strategy has been motivated by competition with other countries for petroleum access, it has actually helped to diversify the global supplier base, making it more competitive and ultimately benefiting all oil-consuming economies. A 2010 study by Theodore H Moran, nonresident senior associate at the Peterson Institute for International Economics, supports this assertion. Moran examined the 16 largest Chinese natural-resource procurement arrangements, and found that Chinese efforts fall predominantly into categories that help expand and diversify the global supplier system.

Moreover, as Chinese NOCs become increasingly market-oriented, a significant portion of their overseas production is ending up outside China’s borders. None of CNPC’s production in Azerbaijan and Canada flows to China, for instance. While Venezuelan officials say they shipped anything from 400,000 to 500,000 barrels of oil per day to China, customs data shows that only 150,000 barrels of Venezuelan oil arrived at Chinese ports in 2010. This wide discrepancy suggests Chinese NOCs sell most of their Venezuela-sourced oil in the open market in order to avoid the high logistic costs associated with long-haul shipping to China.

Access to advanced technology is another important consideration for Chinese oil companies looking abroad. In November 2009, CNOOC signed an agreement with Norwegian firm StatoilHydro to acquire working interests in four prospects in the Gulf of Mexico. With this deal, CNOOC has not only gained a foothold for future development in the oil-rich gulf, but also advanced its agenda of accessing state-of-the-art offshore exploration and production technologies.

Similarly, to help China’s vast shale-gas resources get off the ground, in October 2010, CNOOC purchased a one-third stake in the Eagle Ford Shale of southeastern Texas from America’s Chesapeake Energy and a 33% stake in Chesapeake blocks in Wyoming and Colorado in January 2011. Both deals provide CNOOC with access to Chesapeake’s expertise in extracting fossil fuels from hard-to-access deposits locked in shale rock.

Chinese NOCs’ increasingly market-oriented overseas investment strategy is best illustrated by their return to oil sands-rich Canada, which ranks third in the world, after Saudi Arabia and Venezuela, in terms of proven oil reserves.

Frustrated with the turbulent Sino-Canadian relationship after the Canadian conservative government came into power in early 2006, Chinese NOCs withdrew their plans for direct participation in Canada’s oil sands in July 2007. This was a clear indication of Chinese NOCs' preference for investments in politically friendly countries such as Venezuela.

But Canada's stable political environment, established regulatory system and vast oil-sand reserves, have again made Canada attractive to Chinese NOCs, resulting in US$15 billion (94 billion yuan) worth of Chinese capital pouring into oil-sands rich Alberta alone in 2010. As the Canadian Conservative government is still in power, this change clearly suggests that NOCs’ overseas investment has become less politically – and more market – motivated.

This, however  has not alleviated the concerns of the international community. Weak oversight and a lack of transparency have long plagued oil and gas projects in many parts of the world, and, with China’s rapid emergence in the global energy market, the business practices of its firms are coming under increasing scrutiny. The controversy surrounding Hong Kong-based China International Fund’s opaque operations in Angola and beyond demonstrates how overseas investment without adequate governmental oversight can negatively impact China’s national interests.

The overseas expansion of Chinese NOCs still faces challenges around transparency and reputation. And these will require joint industrial and governmental efforts to resolve.

There are signs of progress. The Chinese government has expressed support for the Extractive Industries Transparency Initiative (EITI), which sets a global standard for transparency in this sector, in several international fora, notably the UN General Assembly Resolution and the G20 Pittsburgh declaration. As a result, Chinese companies have reported under the EITI framework in countries such as Gabon, Kazakhstan, Mongolia and Nigeria. More of this would be welcome.

China is projected to account for about 40% of global oil demand growth by 2035, according to the IEA. China’s vast energy appetite is expected to put tremendous strain on the international petroleum supply chain. To ensure the peaceful integration of China’s rising demand with the world petroleum markets, Chinese NOCs should continue to pursue an increasingly market-oriented overseas investment strategy.

They can also work together. In the past, CNPC preferred to build integrated value chains and to be the operator of its main projects. Sinopec favored close relationships with its trading partners. And CNOOC’s strength lay in its experience with international cooperation, adoption of best practices and a world-class management team. To further improve China’s energy security, Chinese NOCs should consider strengthening their international collaboration and complementing each other’s expertise.

Finally, Beijing should continuously encourage Chinese NOCs to participate in initiatives such as the EITI. Transparent business practices will be key to alleviating the fears of other oil consuming economies in years to come.

This article originally appeared in chinadialogue. 

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Source http://carnegieendowment.org/2012/04/24/chinese-oil-evolving-strategy/agn4

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