CHINA'S UPSTREAM OIL AND GAS INDUSTRY OPENS IN STEPS TO OUTSIDERS, AWAITS BIG DISCOVERY

China's upstream oil and gas industry has progressed more rapidly than might be expected in a country trying to bend communist dogma to suit capitalist practicality.

Oil and gas companies, service firms, and suppliers from around the world now perform work that not so long ago was the sole function of the state.

Since 1979, when the government began opening upstream projects to foreign capital, international companies have invested more than $4.2 billion in Chinese exploration and production, most of it offshore.

But the payoff, both to China and to its new international investors, has been limited.

The reasons are partly geological. China's offshore has failed to yield the world-class oil discoveries that early hopes held out for it.

Other constraints on success have to do with politics in a formerly isolationist communist regime having to learn its way in dealings with outsiders motivated by profit.

Non-Chinese oil companies complain that the government has withheld prime acreage from them, especially in the remote but highly promising tarim basin in China's Northwest.

And terms of participation and taxation offered to foreign companies, while far from onerous, remain less than perfect (see article, p. 61). Company negotiators sometimes grumble that Beijing expects outsiders to pay top prices for acreage that has vet to prove it's worth the money.

The trend, nevertheless, is toward more and better opportunities for companies from outside China.

The government wants the country to return to petroleum self-sufficiency, a status it lost in the past year.

It recognizes that economic growth of 810%/Year will keep demand rising steadily and make self-sufficiency increasingly difficult to reachieve and maintain.

What's most important, it recognized long ago that the capital and technology essential to the job can come only from abroad.

SHIFTING EMPHASIS

Last year, Beijing shifted the emphasis of its dealings with outsiders by offering much more acreage onshore than it had before.

The shift was important not Just because it gave foreigners access to hitherto off-limits areas in the country's interior but also because it signaled the government's recognition that it will have to rely on onshore fields to meet production targets.

Offshore oil production last year, while up 19.6% from the previous year and 129% of government quota, amounted to only 92,600 b/d. Onshore production averaged 2.79 million b/d.

The onshore-offshore production split was even more pronounced for natural gas in 1993: 28.13 MMcfd offshore vs. 1.54 bcfd onshore.

China National Petroleum Corp. (CNPC), which handles the onshore, hopes to raise total production by 2000 to 4 million b/d of crude oil equivalent.

The production target for crude oil alone is 3.2-3.4 million b/d, for natural gas 2.9-3.8 bcfd.

Onshore oil-equivalent production in 2000 is to account for 93% of the national total.

Until last year, the only onshore acreage available to foreigners covered mainly unexplored areas in China's southern 11 provinces. Since opening the region to foreign investors, the government has signed six production sharing contracts.

Last year, it opened acreage thought to have much greater potential in 10 other provinces and autonomous regions to outside investors.

It has signed two production sharing contracts and one geophysical agreement with international companies from five blocks offered in the Southeast Tarim basin.

It also opened a second round of bidding for onshore acreage in january.

Offshore, China National Offshore Oil Corp. (Cnooc) completed a fourth round of bidding last year and as of February this year had signed a total of 94 petroleum contracts and agreements, 39 of them still in effect, with 55 companies from 15 countries and regions.

SECOND ONSHORE ROUND

CNPC's second round of bidding for onshore tracts, which closed Oct. 28, offered 26 blocks for exploration in areas that include Heilongjiang, Inner Mongolia, Hebei, Henan, Shandong, Hubei, Gansu, Qinghai, and Tianjin.

In the same round, it offered 11 blocks for enhanced oil recovery projects in producing fields such as Shengli, Daganq, Hebei, Jianghan, Hena, Jiangsu, and Jilin.

Wu Yaowen, president of China National Oil & Gas Exploration and Development Corp., last month described a strategy aimed at balancing work between China's traditional producing region of the East and the less-developed West.

"If we can stabilize the oil and gas production in the East," he told the fall conference of the International Association of Petroleum Negotiators in Houston, "then we may put more capital and equipment into the West to improve the whole onshore petroleum economy."

China divides its offshore into four zones. The eastern zone covers areas east of Luliang Mountain in North China and the three main river valleys and north of the Yangtze River. The most-developed producing region, it includes Daqing, Shengli, and Liaohe oil fields.

The western zone, covering areas west of Helanshan Mountain and Longmenshan Mountain, is much less-explored but considered highly prospective, which is highly CNPC is focusing exploration there.

The central zone lies between the East and West and includes discoveries of natural gas in Shan Gan Ning basin. The southern zone, first area opened to foreign participation, lies south of the Yangtze River and includes extensive Paleozoic sedimentation ind scattered small oil and gas discoveries in Meso-Cenozoic pay.

For exploratory work in the second licensing round, foreign companies will assume all exploration risk, with CNPC participating in development costs once commercial discoveries have been mine.

Production split will be proportional to development investment, calculated after value-added taxes, royalty, operating costs, exploration and development expenses, and contract interests, according to Yaowen.

The parties will pay income taxes separately.

Contract term is 30 years, including a 7 year exploration period divided into three phases, a development period determined by the development plan, and a production period of 15 years.

The exploration blocks range in size from 308 sq km to 22,907 sq km and cover a resource that Yaowen estimated at 45.3 billion bbl of oil and 28 tcf of natural gas in place.

In EOR projects, foreign companies take all risks for pilot tests and bear development costs when the commercial value of incremental oil is defined. During the production phase, contracts determine allocation of production, value added taxes, royalties, operating costs, pilot test expenses, development costs, and contract interests paid.

EOR contract periods are 20 years, with 2 years for pilot projects, development period as defined by EOR plans, and production periods of 15 years.

Contractors can take their shares of production in kind or sell it to CNPC at international oil prices.

The EOR blocks cover an oil-bearing area of 190.2 sq km and a total of 541,024 production wells. They involve a resource estimated at 2.8 billion bbl of original oil in place.

For the southern 11 provinces opened in 1985, CNPC remains open to bilateral negotiations on work that may be conducted not only under production sharing contracts but geophysical and cooperative study agreements as well.

CNPC'S OPERATIONS

Yaowen said CNPC operates 300 geophysical crews, 260 of them shooting seismic surveys, and owns 1,000 large and medium-sized land drilling rigs. It also has five boats for shallow water work.

In the last 2 years, he said, the company has kept 800-900 rigs busy and drilled an average of 16 million m/year of hole.

It has acquired as much as 150,000 km/year of 2D seismic data, 10,000 sq km/year of 3D seismic data, and 60,000 km/year of gravity and electromagnetic survey.

The company also owns 182 logging, 76 production logging, 180 well testing, and 80 formation testing crews.

Yaowen said onshore exploration and development costs average $2.53/bbl, operating costs about $4/bbl.

At IS year old Daqing oil field, China's largest, CNPC has slowed the production decline to 7%/year. Last year, the giant field flowed 1.12 million b/d.

Yaowen also said CNPC has made progress in production of heavy oils. Thermal recovery operations pushed heavy oil production last year to 210,000 b/d, he said.

CNPC is reorganizing and, according to statements by officials, will evolve into a holding company. One reorganization step will separate operations from service company functions.

In his talk to the negotiators' group, Yaowen said CNPC had set up the International Exploration and Development Cooperation Bureau "to be responsible for management and overall planning for domestic and international petroleum exploration and development cooperation as well as the cooperative projects."

OFFSHORE OPERATIONS

Contracts signed in conjunction with the fourth offshore licensing round covered all but two of the blocks offered. All are in the East China Sea.

The contracts involved 15 companies from seven countries in nine bidding consortiums. They cover 64,246 sq km.

Cnooc also signed four other contracts and agreements with foreign companies a joint study of the 03/36 contract area in the Pearl River Mouth basin with BHP Petroleum (China) Ltd., two petroleum contracts for the Qiong Dong Nan 52/12 and 63/28 areas with ARCO China Inc, and a joint study agreement for the 24/36 contract area in Bohai Gulf with Shell Exploration (China) Ltd. and Pecten Orient Co.

Cnooc and its contractors last year shot 43,000 km of seismic survey including 25,000 km of 3D, and drilled 18 wildcats and 1 appraisal well. They recorded seven discoveries, representing an estimated 256 million bbl of oil and 530 bcf of gas in place.

Three offshore fields went on stream last year: Suizhong 36-1, a pilot project in Liaodong Bay; Wizhou 11-4 in Beibu Bay; and Lufeng 13-1 in Pearl River Mouth basin.

Seven fields were under development: Xijiang 24-3, Xijiang 30-2, Hiuzhou 32-2, Huizhou 32-3, Liuhua 11-1, and Jinzhou 9-3 oil fields and Jinzhou 9-3 and Yacheng 13-1 gas fields.

Yacheng 13-1, operated by ARCO south of Hainan Island, will produce as much as 330 MMcfd of gas beginning in 1996, most of which will be carried through a 480 mile pipeline to Hong Kong (OGJ, June 6, p. 41).

At Xijiang 24-3 oil field, Phillips Petroleum International Asian Corp. and Pecten Orient Co. were working toward production start this month. They plan to start flow at nearby Xijiang 30-2 field late next year. Both fields are in 100 m of water south of Hong Kong.

Amoco Orient Petroleum Co. let a series of contracts this year for development of Liuhua 11-1 oil field in the South China Sea, targeting production start in 1996 at an initial rate of 50,000 b/d, rising within a few months to 65,000 b/d (OGJ, July 18, p. 28).

Among other offshore developments, units of Exploration Co. of Louisiana and Apache Corp. this year tested 2,160 b/d of oil in the C-1 Zhao Dong, the first of at least three wildcats they plan to drill on their block in Bohai Bay (OGJ, July 4, Newsletter).

CHINA'S PROGRESS

Given the starting point, change has been dramatic in China's upstream oil and gas industry. If the major discovery that would put China in the world's exploratory forefront has been elusive, interest by international companies certainly has not.

James P. Dorian and Ruijun Zhang of the East-West Center's Program on Resources expect that interest to continue.

"In the short term, remaining restrictions on foreign investment into promising energy prospects will continue to affect investor attitudes," they wrote in an East-West Center paper in September. "However, recent reforms in the nation's petroleum sector have indeed sparked tremendous interest among the international investor community."

In his book Minerals, Energy and Economic Development in China, Dorian traces six stages in the development of cooperation between China and foreigners offshore.

The first stage, 1979-80, involved Geophysical reconnaissance surveys over 420,000 sq km in the South China Sea and southern Yellow Sea. Then, through 1982, Cnooc signed five petroleum contracts through bilateral negotiations with non-Chinese companies. The contracts covered blocks in Bohai Bay, Beibu Gulf, and the Yinggehai basin.

During 1982-84, the third stage, China issued its Regulations on the Exploitation of Offshore Petroleum Resources in Cooperation with Foreign Enterprises and other decrees. In this period, China awarded 19 exploration contracts to foreigners in the first bidding round.

The second bidding round began in November 1984. Nine contracts resulted, followed by five more plus a geophysical prospecting agreement in 1986. This stage, the fourth, lasted until 1989.

In January through April of that year, China completed its third offshore bidding round, continuing bilateral negotiations after the round closed, Cnooc and the Ministry of Finance provided flexible negotiations and royalty incentives to encourage bidding for the seven blocks on offer in the Pearl River Mouth basin.

The sixth stage, 1992-93, began when the fourth bidding round opened in June 1992. The 18 contracts that resulted covered investments totaling at least $300 million.

Progress thus has been steady, if incremental.

Problems for foreign investors in China, say Dorian and Zhang, include uncertainty about government policies and procedures, bureaucratic hurdles, difficulties in obtaining foreign exchange to repatriate profits, rising costs of materials and wages, shortages of and limited access to materials, and inadequate infrastructure.

"Barring any unforeseen political calamaties, the next decade will likely be one of increasing investment in the Chinese energy (and mineral) industries at a pace perhaps unmatched in most other countries worldwide," the East-West Center analysts wrote.

"Unlike nations in the former Soviet Union and Eastern Europe, China's reform process is already one and one-half decades old, and the country has achieved much in the establishment of a legal system and a more efficient economy.