THE world’s most-populous country, China, is also the second-largest consumer of oil; moreover, this huge country’s rapidly rising demand and imports have made it a significant player in global energy markets.
China’s oil & gas sector remains dominated by the country’s three national oil companies (NOCs) – China National Petroleum Corporation (CNPC or PetroChina), China Petroleum & Chemical Corporation (Sinopec) and the smaller China National Offshore Oil Corporation (CNOOC).
Each has listed business units on international exchanges, but these entities remain firmly under the control of the state holding companies. Recent government restructuring of the trio has increased the commercial incentives of senior management, although they continue to conform to the government’s energy policy objectives, both at home and abroad.
The opportunities for foreign companies to develop onshore acreage are rare, although the government’s attempts to boost domestic oil and gas production have allowed selected foreign companies to carve a niche in offshore basins and as partners to the NOCs in developing technically challenging onshore fields.
Importantly though, the need for the Chinese trio to develop new technical skills to enhance oil and gas recoveries and boost their competitive position has been the main driver behind recent increases in the number of production-sharing contracts (PSCs) signed with foreign partners.
China’s midstream and downstream sectors are both undergoing rapid expansion as they aggressively compete to win market share as domestic energy demand continues to grow.
Some foreign investors have been invited into the refining sector by China’s NOCs in return for providing long-term crude oil supplies or project management skills for new planned facilities, and foreign companies also benefit from selling LNG to the country’s growing population of re-gasification terminals.
China’s prodigious economic growth has led to a rapid rise in energy demand of all types over the last decade, driven by its booming heavy industry sector, its large commercial export sector and its rapidly expanding, energy-consuming middle class.
Oil and gas policy is heavily influenced by its growing dependence on imports, which accounted for more than 60% of total oil demand in 2010, with the majority of imports coming from the Middle East. Additionally, the Chinese are making substantial investment into development of the natural gas sector, in line with the government’s efforts to diversify the country’s primary energy mix away from coal.
As a result, Chinese policy response to this consumption growth and to the rising import dependence has primarily focused on ensuring stable and secure supplies of oil and gas for the domestic market.
Specific policy objectives include:
o Maximising the domestic resource base
o Encouraging overseas merger and acquisition (M&A) activities
o Increasing long-term gas supply contracting
o Accelerating investment in oil storage capacity
o Expanding regional trading
In order to maximise domestic resource potential and serve the state’s development objectives, China’s NOCs have been encouraged to carry out exploration for hydrocarbons in new areas of the country, such as in the far-western Xinjiang Province and in the South China Sea.
Increased exploration of unconventional gas, shale gas, along with coal bed methane (CBM) or coal seam gas (CSG), is also underway, with some foreign participation. With regard to natural gas, the government has set a target of making natural gas account for 10% of the energy mix by 2020, up from the current 3%.
With the aim of increasing access to equity oil or to production off-take rights from overseas fields, Chinese companies have been aggressively acquiring oil and gas assets and/or companies in all of the major producing regions.
Additionally, Chinese state banks have pledged large loans to oil producer states as part of package deals that also included long-term crude oil supply agreements.
A number of these types of deals, known as variable production payment deals or VPPs, have been signed with Russia, Kazakhstan, Angola, Venezuela, and Brazil, reflecting the government’s strategic aim of diversifying dependence away from the volatile Middle East region.
China’s NOCs have also been stepping up efforts to procure gas from overseas markets, given rapidly rising domestic demand.
Long-term LNG contracts have been signed with Qatar, Australia, Indonesia and Malaysia. Strategic pipeline projects from Myanmar and Central Asia, underpinned by long-term agreements, have been completed or are under construction to improve domestic supply availability.
China started constructing a strategic petroleum reserve (SPR) in 2003 and, following severe natural gas shortages in the winter of 2009/10, the country’s NOCs have been boosting investment into gas storage, with an eventual aim of bringing capacity to between 8% and 10% of total consumption.
Turning to the expansion of regional trading, to create more flexible markets that can better respond to domestic demand fluctuations, as well as to boost profits, the Chinese NOCs have been looking to increase such activities.
In addition to supply security, the government has also recognised the importance of preventing wasteful energy consumption that could undermine its own supply interests, and thus is taking efforts to make pricing systems more reflective of international markets, while setting new efficiency standards for the sector.
At the same time, China’s government has been mindful of the need to keep fuel and gas affordable for the domestic population and the industrial sector, so as not to significantly decrease purchasing power or increase operational costs for businesses.
So what does the emergence of China as an “energy giant” mean for non-Chinese oil and gas companies, and what opportunities and challenges does it present?
In short, oil and natural gas companies need to see their Chinese counterparts from three distinct perspectives: as potential partners, competitors and customers.
Overall, all segments of the industry will be impacted by China’s increasing need to obtain energy resources. And while the opportunities may be great, so will the challenges – and it will be those companies that can navigate the obstacles that will reap the greatest reward.
Ally Rule is an associate partner – transaction advisory services at Ernst & Young
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