China's Oil Deals May Rise as Demand Falls

An analysis by Michael Lelyveld
2016-09-12
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Local residents ride bicycles past oil pumps in Daqing, Heilongjiang province, China's largest oilfield, May 2, 2016.
Local residents ride bicycles past oil pumps in Daqing, Heilongjiang province, China's largest oilfield, May 2, 2016.
AFP

China's state-owned oil companies are facing pressure to make major new investments overseas as profits and production fall sharply at home, according to recent reports.

Low oil prices and waning demand growth have devastated output and earnings at China's three national oil companies (NOCs) so far this year.

In the first six months, profits at top-ranked China National Petroleum Corp. (CNPC) plunged nearly 98 percent to just 531 million yuan (U.S. $79.5 million).

China Petroleum & Chemical Corp. (Sinopec) reported a 21.6-percent drop in earnings to 19.9 billion yuan (U.S. $3 billion), cushioned in part by refining of cheaper oil.

China National Offshore Oil Corp. (CNOOC) suffered a loss of 7.7 billion yuan (U.S. $1.1 billion), its first for the six-month period, compared with a profit of 14.7 billion yuan (U.S. $2.2 billion) a year before.

CNPC and Sinopec have both announced plans to trim production this year with cutbacks at higher-cost fields.

Over the first seven months, China's domestic crude output fell 5.4 percent to 117 million metric tons (4 million barrels per day), the National Development and Reform Commission (NDRC) reported.

In July, production dipped 8.8 percent to 3.9 million barrels per day (mbpd), the government planning agency said. The slump marked the second month since February that output dropped below the 4-mbpd mark, according to Platts energy news.

Imports surge

Meanwhile, China's oil imports have surged, hitting the second-highest monthly level on record in August, Reuters reported.

Crude imports jumped 23.5 percent last month from a year earlier to 7.7 mbpd in preliminary figures from China's customs agency, driving imports up 13.5 percent so far this year.

The decline in China's oil industry may mark a significant shift at a time when the country's economic growth has cooled.

Apparent oil demand rose 5.8 percent last year, according to Platts. In the first half of this year, demand was up only 0.6 percent.

While CNPC and Sinopec have announced they will shift their focus to natural gas, demand is also weakening for the cleaner-burning fuel.

The growth of gas consumption slowed to 2.3 percent in July, Xinhua said in a report that cited "economic restructuring" and oversupply. China's gas imports for the month fell 0.3 percent while production declined 3.4 percent, the NDRC said.

Several reports have focused on the depletion of China's oil resources and the poor profitability of production at high-cost fields in a low-priced market.

With China's average production costs estimated at U.S. $40 (267 yuan) per barrel, according to the official English- language China Daily, profits are marginal as long as prices remain in the U.S.$45-50 (300-334 yuan) range.

Declining output

Costs have already risen to U.S. $45 per barrel at CNPC PetroChina's standby Daqing oilfield after decades of pumping with enhanced recovery methods, forcing cuts to keep losses under control.

Production at China's three largest oilfields declined between 7 and 9 percent in the first half, Reuters reported, citing the London-based Energy Aspects consultancy.

The Chinese companies like CNOOC have been using up their available oil reserves more rapidly than their international competitors, The Wall Street Journal said.

"In short, the assets that long served as the cornerstone for revenue for companies such as PetroChina are drying up," the Journal said in a blog posting. "If China's energy giants want to be more profitable ... they're going to need to look to diversify revenue."

"One part of the drive might be trying to secure new oil production overseas," it said.

The NOCs are said to be shopping for opportunities.

But the prospect of new deals may not go down well after mixed returns from nearly two decades of the "go out" policy of foreign investments that the government promoted in the late 1990s.

The recent drop in oil prices has exposed some high-cost mistakes.

Expensive acquisitions

Most notable among them was CNOOC's U.S. $15.1-billion (100-billion yuan) buy of Canada's Nexen Energy in 2013, giving it access to high-cost and troublesome oil sands technology that is now priced out by the market. CNOOC took a hefty charge against earnings for the investment this year.

While pressure is rising for more foreign buying, the Nexen deal has given "go out" a black eye at a time when the strategy has morphed into the government's "belt and road" trade and investment push to expand opportunities and infrastructure throughout Asia to Europe and Africa.

The initiatives appear to be getting strong political pushback from those who see huge outflows of funds from state-owned enterprises (SOEs) for overpriced assets.

"In the past decade, almost no one has been held accountable for the losses China's state companies have suffered in their overseas acquisitions," said a commentary last month by Beijing Youth Daily.

"It is time for the government to tighten its monitoring over the overseas acquisitions by its SOEs and prevent any reckless decisions from causing unavoidable losses to state properties," the Communist Party-controlled paper said.

In response to the political pressures, the cabinet-level State Council said in a statement on Aug. 23 that it would establish an "accountability system" for SOE managers.

"Managers could be fined or sued for mistakes in operations such as project contracting, investment and mergers as well as risk control," the council said.

"The accountability system aims to prevent state asset loss while stimulating productivity," Xinhua reported. Similar statements have been issued in the past.

Trust in world markets?

The relative values of energy inflows and capital outflows may raise the question of whether China would be better off to just trust in the world market for the crude that it needs rather than keep investing to spread its NOC presence abroad.

Edward Chow, senior fellow for energy and national security at the Center for Strategic and International Studies in Washington, said China's domestic oil production was "destined to fall," propped up only temporarily by unsustainable high prices followed by government price support.

"This is coming to an end," Chow said.

"So now, the oil companies are gaming the government's belt and road initiative to allow them to invest overseas again," he said. "How successful such investments will be remains to be seen."

But Chow said the track record of the NOCs is "not encouraging."

"I have not seen any signs that they have improved their capacity to do smart foreign acquisitions," he said.

Chow said the decisions are not driven strictly by profitability and economics.

China's greater concerns have to do with control, foreign policy and "some vague notion of energy security through greater equity production overseas," Chow said.

Those concerns seem likely to be the biggest factor behind China's new wave of foreign acquisitions, rather than domestic production, price trends or the country's demand growth, which is now in decline.

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