China Eyes Pipeline Sale Plan

An analysis by Michael Lelyveld
2015-06-01
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A worker rides a bicycle at a Sinopec oil refinery in Wuhan, Hubei province, in a file photo.
A worker rides a bicycle at a Sinopec oil refinery in Wuhan, Hubei province, in a file photo.
AFP

China's government appears to be planning a major restructuring of its petroleum industry that would force state-owned giants to sell their pipeline networks.

The limited breakup of the oil and gas monopolies under consideration by the National Development and Reform Commission (NDRC) would establish pipeline operators as independent businesses to ensure competitive access, Bloomberg News reported on May 12.

In theory, state-owned industry leaders China National Petroleum Corp. (CNPC) and Sinopec could also benefit from the sales, which would raise cash for more profitable exploration and production activities.

Neil Beveridge, an analyst at Sanford C. Bernstein & Co. in Hong Kong, estimated that China's 120,000 kilometers (74,500 miles) of pipelines could be worth as much as U.S. $300 billion (1.86 trillion yuan), Bloomberg said.

The companies have not commented on the report.

On its face, the spinoff plan bears a resemblance to the reforms of the European Union's "third energy package" for gas and power regulation, which ordered "unbundling" of energy suppliers from networks starting in 2011.

The goal was to prevent producers from controlling access to pipelines and transmission systems to limit competition and keep prices high.

How far China's government will go with similar unbundling remains to be seen.

Officials are said to be discussing creation of a national pipeline company that would manage the infrastructure or a series of regional companies. Neither option suggests that the networks would be privatized.

Some preliminary steps have been underway for the past year.

In May 2014, CNPC sparked interest with a plan to transfer its first and second West-East gas pipelines to a subsidiary in preparation for an auction that would leave the company without any stake in the assets.

But two months later, industry sources told Reuters that the company had reconsidered the plan and would instead sell the pipelines to an affiliate that was 50-percent owned by its PetroChina subsidiary.

The latest report suggests that the government could go beyond half-measures to spur competition and production.

Growth of gas production is vital to China's efforts to improve air quality by reducing reliance on high-polluting coal.

But so far, it seems more likely that investment opportunities will be limited to the "mixed-ownership" model that the government has promoted to lure private capital into sectors that remain under state control.

Reform discussions

The pipeline plan is one of a series of reported reform discussions within government agencies that appear to be trial balloons.

In April, the official Xinhua news agency said that the State-owned Assets Supervision and Administration Commission (SASAC) was studying a "massive" merger and acquisition plan for its main state-owned enterprises (SOEs) that would cut their numbers from 112 to 40.

The proposal followed months of reports that the government was considering a CNPC-Sinopec merger to create a "national champion" that could compete with international oil majors. But both plans have faced criticism for reducing competition within China.

Philip Andrews-Speed, a China energy expert at National University of Singapore, said the issue of pipeline access is significant for China's efforts to develop new sources of unconventional gas, including coalbed methane and shale gas.

"In both industries, there are a number of local state-owned and private companies that cannot easily get access to pipelines, so third-party access has been an issue for several years," Andrews-Speed said in an email message.

"It is even more critical now with the perceived opportunities for shale gas and, in the future, for synthetic natural gas," he said.

Both CNPC and Sinopec opened new pipelines from their shale gas development projects last month, Platts energy news service reported.

China's unconventional gas production in 2014 reached 4.9 billion cubic meters (173 billion cubic feet), representing less than 4 percent of domestic gas output of 132.9 billion cubic meters (bcm), according to Ministry of Land and Resources figures. But the unconventional gas volume jumped 42 percent from a year earlier, making it a source of new growth, Platts reported in January.

Coalbed methane output climbed 23.3 percent to 3.6 bcm, while shale gas production rose by more than five times to 1.3 bcm, Platts said.

So far, there has been no word on whether the spinoff plan would affect CNPC's control over oil and gas import pipelines from Central Asia, which have been developed over the past decade with major long-term investments.

Change in ownership outside China seems unlikely, in part because it could require renegotiation of agreements with transit countries.

Potential investors in any future pipeline company within China may also be dealing with uncertainty over state regulation and control of the infrastructure.

“Even with 'independent' owners and operators of the pipelines, the government will need to regulate the terms of access, including quantity and price, which will be a new task," Andrews-Speed said. "Those who purchase the network will face an untested regulatory regime."

The government may already have a partial model in the power sector after having separated electricity generators from transmission with the creation of state grid companies over a decade ago.

Far from perfect

In practice, however, the model has been far from perfect.

Over the years, government regulators have frequently blocked market forces in the power sector by manipulating "on grid" and retail rates.

While the pipeline plan may still be in preliminary stages, it appears to be part of larger energy reforms that the government has promised to advance.

In March, the State Council, or cabinet, released a document on "deepening" reform in the power sector, focusing on distribution and changes in the pricing system. A final decision on allowing foreign investment in distribution and sales was expected, the official English-language China Daily said.

In April, the National Energy Administration (NEA) again pledged pricing reforms, suggesting reduced regulation but leaving details vague.

"The costs and prices of electricity transmission and distribution will be monitored, but the price determined by the market," the NEA said, according to Xinhua.

In May, the State Council also said it would "improve" natural gas pricing mechanisms as one of the items on its list of priorities for economic reforms this year.

Where the pipeline spinoff plan fits into the agenda is hard to predict. But successive Chinese governments have experimented with energy pricing reforms for years, and those policies may have to progress further before the economics of selling the energy networks become clear.

The government has been sending mixed signals about investment opportunities under its plans for mixed-ownership and public-private partnerships (PPP).

On March 25, the NDRC released a list of more than 1,000 projects that will be open for investment under the PPP model. The projects have a potential value of nearly 2 trillion yuan (U.S. $322 billion), Reuters reported.

But on the same day, the SASAC suggested it would keep a tight rein on asset selloffs under mixed-ownership that may limit restructuring and profitability.

The agency plans to "increase supervision to prevent losses" and "the draining of state assets during a mixed-ownership period," Xinhua said.

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