TCA Apr 2014

Chinese Super Majors: Tilting the Global Oil and Gas Playing Field

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Buoyed by the country’s sustained economic growth, and its resulting need to secure stable energy supplies, Chinese national oil companies have been expanding their international reach by competing and partnering with foreign counterparts. The Chinese government has set a clear target of achieving China’s overseas oil equity production of 2.8 million barrels/day by 2020, indicating that Chinese national oil companies will continue to structurally shift the overall industry landscape with far reaching implications for global peers, EPCMs and oilfield service providers. By Ankit Khaitan

Starting from a mere 767 kg per capita in 1990, China’s energy consumption has nearly tripled to 2,029 kg per capita in 2013 with apparent oil consumption at 10.1 million barrels/day (b/d). This rate, however, still remains far lower than that of developed countries, such as the US, who consumed 7,069 kg per capita in 2012. This phenomenal increase in demand is fuelled by China’s sustained economic growth, rapid industrialisation and widespread urbanisation. As domestic oilfields age and domestic reserves-to-production ratios remain low, China’s rapid rise in demand for oil has also led the country to increase its reliance on imports. This is underscored by the fact that China surpassed the United States to become the largest oil importer on a monthly basis in September 2013.

With a push to secure and diversify China’s energy needs, Chinese national oil companies (NOCs) embarked on an all-out effort to acquire upstream oil and gas (O&G) assets overseas in the early 1990s. Since then, they have invested approximately USD 180 billion to expand their overseas oil equity production from a mere 0.15 million b/d in 2000 to a staggering 1.6 million b/d by the end of 2013. These investments have bolstered China’s importance in the global O&G industry, making it the world’s second-largest oil consumer, largest oil importer, and fastest-growing overseas O&G investor. This also catapulted the three largest Chinese players: Sinopec, China National Petroleum Corporation (CNPC) and China National Offshore Oil Corporation (CNOOC), to the global stage among the super majors, who today control roughly 27% of global reserves.

 

Chinese NOCs ‘go global’ – emerging dynamics and variability

On June 15, 1993, when CNPC acquired a 15% operating interest in China’s first overseas oilfield in Canada’s North Twining project in northern Alberta, critics referred to this acquisition as an audacious manoeuvre and raised questions regarding Chinese NOCs’ supposed inability to identify quality assets, overcome challenges in pursuing deals independently and the tendency to pay above market values. Today, with more experience in foreign markets and deep pockets, Chinese NOCs have established a successful track record in acquiring and managing assets of increasingly high-quality in complex and risky environments such as Angola, Niger and Sudan.

Over the years, Chinese O&G investments have begun to shift from being concentrated in a handful of developing countries – largely Sudan, Venezuela and Kazakhstan – to becoming a global phenomenon (see map below). Central Asia (Kazakhstan), the Middle East (Iraq and Yemen), Latin America (Argentina and Brazil) and Africa (Angola and Nigeria) continue to remain prominent, but more mature and stable destinations such as the US and Canada have recently started to gain traction as destinations for Chinese NOCs’ O&G investments. In fact, in 2012 alone, North America attracted more than 70% of the total value of deals pursued by Chinese NOCs, the largest share of any region around the globe. The nature of investments in the US and Canada differs from deals in other regions. The US and Canadian markets have seen some of the largest deals vetted by Chinese NOCs. On the other hand, developing markets across Southeast Asia, Africa and the Commonwealth of Independent States (CIS) have seen the highest participation from Chinese NOCs in terms of number of projects invested.

At the same time, rising uncertainty over new oil discoveries, largely in unfamiliar or ultra-deep territory (i.e. hard to extract, expensive, and politically unstable), limited foreign acreage and increasing competition from other emerging NOCs and super majors means that the era of ’easy‘ O&G period has ended. In light of evolving market dynamics, Chinese NOCs are adapting their overseas strategy to overcome these challenges.

Firstly, Chinese NOCs have become less risk-averse and more willing to invest in early-stage exploration projects and fields with no proven reserves, albeit with a more prudent approach and certain risk-management practices. Traditional exploration, production and stand-alone investments have become less viable options due to Chinese NOCs’ lack of experience in dealing with complex geological assets, oil fields with complex chemistry and, at times, complexity emerging from energy geopolitics. These restrictions have opened the door for various multi-level cooperation platforms.

The recent partnership model pursued by Chinese NOCs involve the forming of joint ventures (JV) with super majors and local NOCs to jointly develop projects and, in some cases, even form Chinese NOC consortiums to avoid head-to-head competition and allow for better competition in the international market. Chinese firms have invested in an estimated 140 O&G projects overseas, over one-third of which took place in the last five years. More than 50% of these projects have been in the form of JVs with oil majors or other NOCs. For example, China’s CNPC and India’s NOC, the Oil and Natural Gas Corporation (ONGC), recently collaborated to develop the Greater Nile Oil project in South Sudan. In another project, CNPC and Sinopec jointly invested USD 2.5 billion to acquire the private Peruvian O&G driller, Petro-Tech Peruana.

Secondly, market conditions have encouraged a major adjustment in their approach to ownership of such assets. Chinese NOCs have increasingly sought minority, passive stakes investments in strategic ‘learning’ assets, which contrasts with their historical practice of paying above market prices to own controlling equity stakes in projects to lock-in supply.

Lastly, Chinese NOCs have expanded from their traditional focus on upstream assets and begun to develop pipelines and refineries. NOCs now view strategic investments in mid-downstream as a mechanism to unlock access to key upstream resources, particularly in risky and politically unstable countries. This strategy is also driven by China’s need to diversify the supply routes of its petroleum reserves. Chinese NOCs are actively investing in transnational pipelines to diversify supply routes and reduce their dependence on the Strait of Malacca; this will alter the dynamics of regional energy supply patterns and future investments.

 

Fomenting China’s own shale gas revolution

At the same time, China hopes to develop its own untapped domestic source of energy, i.e. shale gas. According to the International Energy Agency, China holds reserves of at least 26 trillion cubic meters of recoverable shale gas, more than any other country in the world. Beijing has previously announced that it aims to produce 6.5 billion cubic meters (cm) of shale gas annually by 2015 and an ambitious 100 billion cm by 2020. However, China only achieved half of its announced 2010 target of 8 billion cm due to limited exploration success, drilling a fewer than expected number of wells and having a narrow focus on only the most attractive shale gas locations. While progress has been slow thus far, there are signs that a spike in shale gas production is on the horizon.

Chinese NOCs have invested billions of dollars in North America to acquire the hydraulic fracturing technologies that are driving the unconventional revolution. NOCs have established partnerships through JVs and acquisitions to gain access to these technologies. For example, CNPC recently announced a new joint venture with Encana, Canada’s largest producer of natural gas, to develop some of their holdings in Canada’s Montney Shale Formation and Horn River Shale Formation.

Leading the pack on the domestic front is Sinopec, which stated in March 2014 that its first commercial shale-gas field, in the Fuling district of Chongqing, will produce around 1.8 billion cm of gas in 2014, 5 billion cm in 2015 and 10 billion cm by 2017 – all ahead of schedule. Overall, far fewer than 100 shale-gas wells have been drilled in China, compared with around 40,000 wells in the US, underscoring the long road ahead before China realises its own shale gas revolution.

The development of China’s shale-gas industry has moved forward over the past few years, but far more remains to be done than has been accomplished if the nation’s ambitious production targets are to be met. The country must build-up its still nascent, countrywide feeder lines and pipeline network. Moreover, complex geology, water resource constraints near major shale fields and local exploration and drilling companies’ lack of adequate capabilities remain major hurdles. Whereas the development of PetroChina’s first shale gas exploration project in the Sichuan basin took 11 months, a similar-sized project in North America usually takes only two to three weeks.

China’s recent decisions to boost private-sector participation and implement reforms are expected to help the shale-gas industry, although a lot more needs to be done. NOCs will need to open the upstream and downstream to private capital in order to expedite the timeline for shale production.

 

Implications for global peers, EPCMs and oilfield service providers

The implications of China’s growing role in the global O&G market are profound. The synergies drawn from complementary needs (i.e. strategic capital, equipment from China and technological skills to venture into new markets and optimise recovery in mature fields back home) has opened up opportunities for further cooperation between international oil companies (IOCs) and Chinese companies to learn from, partner with and complement each other across core competencies. Additionally, China recently opened its domestic resource market to some of the world’s major oil and gas producers. For example, Royal Dutch Shell formed a shale gas JV with PetroChina to participate in a 15-well drilling program; ConocoPhillips signed a joint study agreement with Sinopec to explore, develop and produce shale gas at the Qijiang block in the Sichuan Basin; Total has firm plans to commence drilling this year for shale gas with Sinopec in Anhui province; and Chevron is exploring shale gas deposits in Qiannan Basin with an unidentified Chinese partner.

At the same time, cooperation with Chinese NOCs is spreading across the value chain. For instance, Saudi Arabia’s state-owned Aramco formed a joint venture with PetroChina for the construction of a refinery capable of producing 200,000 b/d in the south-western Chinese province of Yunnan while China’s Sinopec took a 37.5% stake in Saudi Arabia’s USD 10 billion Red Sea Refining Company.

Moreover, Chinese NOCs often tend to seek EPCM services from foreign players for their overseas projects. For example, in 2009, WorleyParsons was awarded the conceptual design, initial FEED contract and later integrated project management contract for the Rumaila oil field in Southern Iraq, the world’s second-largest oil field and jointly owned by BP, CNPC and Iraq’s State Owned Marketing Organization (SOMO). However, Chinese investors prefer foreign EPCMs to use cost-effective engineering capabilities available through their high-value engineering (HVE) centres in China/Asia, as well as procurement services out of China, in overseas projects in order to sustain a favourable cost profile. Most foreign EPCMs have only started to develop such capabilities, indicating that only a handful of them are likely to receive contracts from Chinese NOCs for overseas projects.

Furthermore, the Chinese market has been historically closed off to western service companies for the most part. Service activity is done primarily by the service entities of Chinese oil companies, but shale and deep-water projects demand the experience of traditional western services companies as many Chinese oilfield service providers lack the necessary capabilities. Foreign oilfield service providers, such as Schlumberger, Halliburton and Baker Hughes, have already announced cooperation plans with their Chinese counterparts, such as Anton, and Honghua. These collaborative efforts will allow Chinese companies to gain access to high-end technology and experience in integrated project management.

 

Looking ahead

Today, investments by China’s big three oil majors remain small in comparison to those of IOCs. Upstream endeavours, such as securing a diversified energy supply, will remain high on the agenda for these companies in the next decade. CNPC announced that it would seek to derive 40% of its crude oil from overseas by 2015 and 60% by 2020, which represents rapid growth from its current ratio of 28%. To achieve this goal, the firm plans to invest more than USD 60 billion in global oil and gas assets by 2020. At the same time, a number of private oil & gas companies in China have been quietly carrying out overseas asset acquisitions as well. For example, Zhenghe Group, a company based in Shandong province, acquired a Pre-Capsin basin block in Kazakhstan late last year for USD 526 million.

China’s funding capacity and consumption appetite paired with IOCs’ technical know-how and project management skills, especially for unconventional sources, presents the greatest potential for a valuable complementary relationship. Relationships and collaborations with Chinese NOCs will become even more crucial, complex, challenging and largely unpredictable for IOCs. The determinant then should not be whether or not to embrace shared resource ownership with Chinese NOCs, but how best to pursue an integrated strategy that captures the opportunity of China’s integrated position as a global consumer, importer, source of capital and supplier of equipment. 

 

Ankit Khaitan, Manager 
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