China's state oil companies are suffering from the plunge in crude prices at a time when the world's largest importer should be celebrating lower costs.
The country's national oil companies (NOCs) are dealing with dilemmas on several fronts at once as international prices fall nearly 45 percent below the cost of domestic production.
The huge gap resulting from Saudi Arabia's price war with Russia and weakened demand during the COVID-19 crisis means that the NOCs are likely to lose money on the 3.9 million
barrels per day (bpd) that China produces at home.
The low import prices, which sank to U.S. $23 (163.3 yuan) per barrel at the start of this week, also threaten to raise import dependence far past the point that is considered strategically vulnerable.
The price slide has already slashed NOC profits and pushed the state giants to reduce capital spending on new domestic drilling and resource development.
The cuts come less than two years after the companies pledged big increases at the insistence of President Xi Jinping to enhance China's energy security.
Last week, the PetroChina subsidiary of state-owned China National Petroleum Corp. (CNPC), said it would "dynamically optimize and adjust" its capital expenditure after reporting a six-percent increase in revenue but a 14-percent drop in net profit for 2019.
The announcement added to "signals that the government's push to boost domestic production can't withstand the collapse in crude prices," Bloomberg News reported.
The cutback in capex follows a fivefold increase in CNPC's exploration budget last year in response to Xi's call to bolster China's energy security in August 2018.
"As commercialized and listed entities, the listed NOCs feel or know that they are obliged to take steps to avoid massive financial losses," said Philip Andrews-Speed, a China energy expert at National University of Singapore.
"My guess is that they will make most of the capex cuts in overseas projects and sustain those domestic projects that have relatively short-term and low-risk payback in order to heed Xi's call for domestic production," Andrews-Speed said.
Weakening demand and price pressures have been felt broadly across the Chinese petroleum industry for months.
Operating revenue in the oil and petrochemical sectors rose 1.3 percent last year to 12.27 trillion yuan (U.S. $1.73 trillion), but profits fell 14.9 percent to 668.37 billion yuan (U.S. $94.1 billion), the China Petroleum and Chemical Industry Federation (CPCIF) said.
Refined oil production rose 3.6 percent last year, the official Xinhua news agency reported. But profit margins in the refining sector dropped 42 percent from a year earlier, Reuters said, citing the CPCIF data.
China's crude oil output also gained 0.8 percent last year after losses since 2016, but the increase lagged far behind import growth of 9.5 percent. Last year, China relied on imports for nearly 73 percent of its oil, based on National Bureau of Statistics (NBS) figures.
The price and production war that broke out between Saudi Arabia and Russia on March 8 only made matters worse for China's NOCs, which were already stuck in the coronavirus standstill.
After failing to persuade Russia to cut output under the cooperation agreement known as OPEC+, Riyadh reversed tactics and announced a production increase to pressure Moscow and to protect its market share.
In one sense, the conflict was aimed at the Chinese market as the Saudis offered discounts to capture the top spot among China's suppliers.
In the first two months of the year, China's imports from Saudi Arabia climbed 25.8 percent from a year earlier to 1.79 million bpd, edging out Russia, which supplied 1.71 million bpd with a 10.6-percent increase, Reuters reported, citing Chinese customs data.
Last year, Saudi Arabia also topped Russia by striking deals with private refiners as its exports to China jumped nearly 47 percent to 1.67 million bpd, according to Reuters. Russian deliveries rose nine percent to 1.55 million bpd.
The lure of lower-priced imports has further marginalized China's oil fields, which already suffer from depletion, difficult geology, and state price controls.
The NOCs, including CNPC, China Petroleum & Chemical Corp. (Sinopec) and China National Offshore Oil Corp. (CNOOC), have responded to price pressures with plans to lower spending on exploration for new fields.
Sinopec plans to cut capital spending by 2.5 percent this year after net profits dropped 8.7 percent in 2019, Reuters reported.
"Without a doubt we will reduce this year's production levels and capital expenditure by a certain degree," said CNOOC's chief executive Xu Keqiang, according to the South China Morning Post.
The industry cutbacks may lead to lower domestic production in the future.
But the international price slump has left the NOCs to choose between lower production and losses in the near term.
The break-even price for new oil wells in China is U.S. $41 per barrel, said Parul Chopra, a vice president at consultancy Rystad Energy AS, quoted by Bloomberg. In the past, the break-even level for China's older oilfields has been estimated as high as U.S. $70 per barrel.
Xi has yet to respond to the NOC announcements or the implications for greater import dependence.
Reliance on foreign oil
While domestic production has stagnated for well over a decade, China's government has paid little attention to the country's growing reliance on foreign oil.
China's import dependence reached 50 percent for the first time in 2008. The country became the world's leading oil importer in 2017.
Despite an energy security strategy that has focused largely on diversity of supply and the buildup of a strategic petroleum reserve (SPR), China remains heavily reliant on maritime routes from the Middle East.
On Thursday, Bloomberg reported that China plans to take advantage of low prices to buy oil for its SPR. The effect on prices appeared uncertain, however, since "the current size of China's state reserves is unknown," Bloomberg said.
In recent years, the government has also undercut NOC exploration for domestic oil by directing the state-owned companies to shift more of their efforts to developing natural gas.
The government's high priority for gas has also proved to be short lived, as heating conversions from coal faded in 2019 with the economic slowdown after two years of double-digit growth.
Historically low prices and global surpluses for both oil and gas are now likely to put energy security concerns on the back burner at a time of economic uncertainty and disarray.
The government has yet to modify its mechanism for setting retail fuel prices, although world oil prices have fallen far below the range of the current policy.
On March 17, the government's top planning agency said it would cut retail gasoline prices by 1,015 yuan (U.S. $143.32) per metric ton and a similar amount for diesel, reflecting the minimum or "floor rate" of U.S. $40 per barrel of crude.
Under the policy, the government can change retail prices with a 10-day lag time if international crude prices vary, but there are no adjustments below a floor of $40 per barrel or above a ceiling of $130 per barrel.
With crude prices this week as low as half the floor level, the policy may allow NOCs and refiners more room for profit at a time of weak demand while drivers pay more than the market price for fuel.
At a press conference in Beijing, an official of the National Development and Reform Commission (NDRC) defended the policy, Xinhua reported.
Without it, "low prices could hurt domestic oil production, leading to higher dependency on imports," the official said.