CHINA STEPPING UP FOREIGN E&P INVESTMENT AS OIL IMPORTS SOAR

China has stepped up its involvement in the international upstream oil scene after entering it just a few years ago.

Faced with soaring domestic demand for oil and essentially stagnant crude oil production, China is casting about for new sources of crude outside its borders.

Although these first steps are modest by the standards of multinational major petroleum companies, it marks China's recognition that its status as a permanent net oil importer is inevitable and probably irreversible. China is expected to become a net oil importer as early as this year and is likely to remain one for the foreseeable future.

That increases the urgency for China's state owned companies, led by China National Petroleum Corp. (CNPC), to participate in foreign joint ventures in exploration and production.

CHINA'S OIL SHORTFALL

With one of the world's fastest growing economies, China is experiencing soaring growth in demand for oil.

Domestic consumption of oil products in China reached almost 2 million b/d in 1990 and is expected to jump to about 3 million b/d in 1995 (Table 1).

With each percentage increase in China's gross domestic product, consumption of oil products rises by a corresponding 0.7%. With a recent average growth rate of more than 10%/year, oil consumption then is growing at a rate of 7 8%/year. China's economy grew by 12.8% in 1992 and 13.4% in 1993. Currently, Beijing projects economic growth of about 9% in 1994 and remaining steady at 8 9%/year to 2000.

Chinese oil demand climbed to 2.78 million b/d in 1993 from 2.6 million b/d in 1992. It is expected to jump to 3.2 million b/d in 1995 and 4.14 million b/d in 2000. At the same time, projections call for China's refining capacity to leap 41% to 4.66 million b/d by 2000.

However, China's crude production posted increases of less than 2%/Year during 1990 92 and only 1.4% in 1993. Crude oil production was 2.84 million b/d in 1992, 2.88 million b/d in 1993, and is projected to climb to 2.94 million b/d in 1994, 3 million b/d in 1995, and 3.46 3.56 million b/d in 2000.

And official estimates of oil reserves have remained at the same level, about 24 billion bbl, since 1988. That presages a long term continuing domestic shortfall in crude oil supplies.

For a long time, China has been a crude exporter, although for most of that time only, bought small volumes of crude oil and refined products on the international market. Since 1965, the year China became self sufficient in crude and refined products, foreign crude was imported mainly via barter in small volumes. Exports peaked in 1985 at 612,800 b/d, and no crude was imported in 1985 87. China resumed crude imports in 1988, and exports have since plunged while imports have continued to grow at a rate sometimes exceeding 100%/year.

China National Chemicals Import & Export Corp. (Sinochem) estimated China's crude exports fell to 390,000 b/d in 1993 from 430,000 b/d in 1992. Sinochem projects crude exports will continue to decline this decade, albeit at a slower rate. Exports of refined products are expected to remain more or less steady at current rates.

China's imports of crude jumped to 313,000 b/d in 1993 from 227,000 b/d in 1992 and only 17,000 b/d in 1988. Products imports rose to 348,000 b/d in 1993 from 154,000 b/d in 1992.

China National Petrochemical Corp. (Sinopec) Pres. Sheng Huaren predicted China's crude oil imports will exceed its crude exports in 1994. Other estimates put that turnaround no later than 1995.

While China is rich in oil potential, it is considered oil poor on a per capita basis. With its vast population, mature fields, and recent economic reforms sharply stimulating demand, the pattern of minimal production increases, rising imports, and dwindling exports is not likely, to change in years to come.

DOMESTIC CRUDE SUPPLIES

China is struggling to boost domestic production to ease the crude supply shortfall (Table 2).

East China's five producing petroleum basins Songliao in Northeast China, Huabei in North China, Subei in northern Jiangsu province, Jianghan in western Hubei province, and Nanxiang straddling western Hubei and Henan provinces form the hydrocarbon energy cradle of China's economy.

They provide 90% of China's crude output and half its natural gas production. Accordingly, maintaining production in these regions has become a national priority. Most of the fields in East China have peaked and are in decline. Average water cut has risen to 70 80%, and the fields' decline rate averages 7 8% year. With a recent upsurge in infill drilling and workovers, production costs have skyrocketed.

In 1986, oil finding costs in China averaged slightly less than $1/ton of proved reserves. By 1993, that cost almost had tripled. The cost of adding 1 ton/day of crude productive capacity also has soared in recent years, reaching $217 in 1992. Additions to reserves continue to lag even the slight increases in production, with the reserves:production ratio plummeting to 15.9 in 1990 from 18.6 in 1985 and still in decline.

In China's remote western provinces and autonomous regions of Xinjiang, Tibet, and Qinghai, oil development is still in its early stages.

Western China, especially Xinjiang's Tarim, Junggar, and TurpanHami basins, features huge potential resources in a harsh, remote desert region with scant infrastructure. Although proved reserves there continue to show significant growth, substantial production still seems years away.

Offshore China oil production is expected to peak in the late 1990s. But offshore production has proven a disappointment, remaining at a small share of the nation's total only 5% in 1993.

FOREIGN JOINT VENTURES

The pressure to boost domestic supplies has spurred somewhat uneven efforts by Beijing to encourage an inflow of foreign investment and technology in China's upstream.

That was baited at first to China's offshore, where a North Sea potential was touted and Beijing recognized its own technological and capital limitations made foreign investment a logical option.

China has invited four rounds of international bidding since 1982, four offshore and one onshore. In the first three rounds in 1982, 1985, and 1989, concession areas included the Bohai Sea, southern part of the Yellow Sea, Pearl River Mouth basin, Yinggehai Sea, and Beibu Gulf.

A total of 76 exploration and development contracts and agreements for Sino foreign cooperation were signed in the first three bid rounds, with contract acreage covering 600,000 sq km. Concession areas for the fourth round of offshore bidding in 1992 included two blocks in the East China Sea totaling 72,800 sq km. A total of 13 contracts have been negotiated, with ten signed.

In onshore offerings, Beijing opened southern China's 11 provinces and regions in 1985 for Sino foreign oil cooperation: Guangdong, Guangxi, Hainan, Fujian, Jiangsu, Jiangxi, Zhejiang, Hubei, Hunan, Yunnan, and Guizhou. Six contracts have been signed.

In 1993, onshore Sino foreign E&P cooperation was expanded to another 10 provinces and regions in northern China: Heilongjiang, Hebei, Henan, Shandong, Hubei, Gansu, Qinghai, Inner Mongolia, Xinjiang, and Tianjin. As of yearend 1993, 12 blocks totaling almost 408,000 sq km have been parceled out for international bidding (see map, OGJ, Oct. 11, 1993, p. 23). At the same time, another 14 blocks in China's producing areas, with combined reserves pegged at 5.11 billion bbl, have been offered for Sino foreign cooperation in improved oil recovery: Daqing, Shengli, Liaoning, Zhongyuan, Huabei, Dagang, Jilin, Henan, Jianghan, and Jiangsu.

In Xinjiang, a number of companies have signed contracts to explore acreage in the Tarim basin one of the world's most prospective. The first round of bidding got under way in early 1993 for five blocks totaling 72,730 sq km in the southeastern part of the basin. In all, 68 companies from 17 countries have purchased Tarim data packages. The first block, covering 14,475 sq km, went to a group of Exxon Corp., Sumitomo Corp., and Indonesia Petroleum Ltd. (OGJ, Jan. 3, p. 29). Subsequent contracts covering Tarim exploration were signed with groups led by Agip SpA (OGJ, Feb. 14, P. 45) and British Petroleum Co. plc (OGJ, Mar. 28, p. 38).

There is likely to be a second Tarim bidding round this year, and other onshore biocks around China are likely to be included in a third round later this year.

CHINA'S OVERSEAS OPTION

Faced with the prospects of rising imports squeezing precious foreign exchange and increasing vulnerability to oil price spikes, China is embarking on a third approach to secure crude supply sources: foreign E&P investment (Table 3).

China's track record on exploration justifies the move into the international upstream arena. Reserves found per meter of wildcat drilling footage and per kilometer of seismic survey in China are a fraction of those in the Middle East, South America, and the former Soviet Union, among other areas. That's true even in a comparison with the aging basins of the U.S., where the number of exploratory wells in petroliferous basins is 60 times that of China's.

Another rationale for overseas E&P is China's scattered, thin infrastructure, especially with the likelihood of major new finds only in the remotest regions. In some cases, it may be less costy to ship crude from foreign sources than to transport China's western region crude to the east.

CNPC, formerly China's oil ministry, has 1.5 million employees and the technological expertise and an operating critical mass that enables it to compete in international E&P. Its operating costs are below average, another advantage in foreign E&P.

China invests huge sums in domestic E&P. Although China's overall E&P costs are lower than the international average, some of its oil fields have operating costs higher than the international average. So CNPC is high grading its various potential crude supply sources on the basis of how they stack up with higher cost domestic projects. If China put 1/30 of its oil E&P funds into the world market, it could participate in 20 30 projects without demonstrably affecting domestic E&P. In the event of a foreign discovery, development funds could be raised through a range of options.

INTERNATIONAL APPROACHES

Because of a lack of experience in international E&P, China's approach is one of "many channels, many blocks, and small shares." That means a broad portfolio of investments and an emphasis on sharing risk with international partners. CNPC's overseas focus, then, is to:

Purchase reserves the safest approach, which limits risk but also limits profit.
Purchase interests from concessionaires or operators of targeted license blocks.
Bid or apply for development rights in targeted blocks.

Since 1991 CNPC and its subsidiaries have studied E&P investment opportunities in Canada, Peru, Venezuela, Indonesia, Thailand, Russia, Mongolia, U.S., India, and Pakistan, among others.

CNPC units involved in foreign E&P are China National Oil Development Corp., CNPC International Ltd., CNPC Canada Ltd., CNPC Latin America Ltd., MC & CNPC Oil (Hong Kong) Ltd./CNPC Central Asia Co., and CNPC Asia Pacific Ltd.

China's foreign E&P activities began in spring 1991, when CNPC Pres. Wang Tao visited Alberta. In April 1991, CNPC and Alberta Oilsands Technology & Research Authority (Aostra) signed a letter of intent to pursue cooperation in oilsands development. CNPC unit CNPC Canada Ltd. later joined Aostra's commercial project for bitumen production using steam assisted gravity drainage developed at its underground test facility (OGJ, June 13, 1992, p. 29).

In addition, CNPC Canada last year acquired North Twining oil field in Alberta. In October 1993, North Twining yielded China's first overseas crude oil production.

CNPC Latin America last year won a bid to boost oil recovery in an old Peruvian oil field (OGJ, Nov. 8, 1993, p. 43). Its Peruvian unit, Sapet Development Corp., signed a contract with state owned Petroleos del Peru covering a 5 year, $25 million commitment on Block VII along Peru's northern coast. Work includes drilling 60 wells in the first 3 years and start up of secondary recovery operations in the first half of the third year from the block, which includes some of Peru's oldest oil fields. The company is bidding for another, similar project in Peru.

In the most recent development, Chinese state companies signed agreements covering exploration in Papua New Guinea, the first such accord by a Chinese firm outside China (OGJ, Apr. 11, Newsletter). The venture in Central Papua New Guinea, partly backed by Japan's Marubeni Corp., includes CNPC international, China International Trust & Investment Corp., Sinoil, and MC CNPC Oil (Hong Kong). The venture involves a 6 year exploration license on a 500 sq km block and likely outlays of $100 million. Drilling is to begin by yearend.

PITTFALLS

CNPC officials voice some concerns over pitfalls that lie ahead in China's new overseas E&P strategy.

Although the initial burst of activity has shown some positive results, the campaign has not gone as smoothly as Chinese industry officials had hoped. A lack of cash is a major concern.

At the outset, CNPC's overseas initiative lacks central government support. Advocates of foreign E&P call for more decision making authority for CNPC in overseas investments, effectively along two lines:

Simplifying approval procedures so that opportunities aren't missed while CNPC awaits government approval.
Giving foreign projects favorable tax treatment so that possible financial losses from exploration could be offset by reduced taxes.

Thus far, CNPC's foreign E&P campaign lacks unified management, scattered throughout the subsidiaries and affilate companies. Some of the subsidiaries have close relationships with the local agencies that operate China's domestic oil fields. The president of CNPC Central Asia is the former head of Liaohe oil producing complex in Liaoning province, and the president of CNPC Latin America is the former head of Shengli oil producing complex in Shandong province.

Some domestic oil producing agencies are taking the initiative for ventures in foreign E&P on their own. Daqing oil producing complex, China's oil production mainstay is negotiating for the rights to develop two oil fields in Russia's Irkutsk region.

Concerns over the scattershot approach have led Chinese industry officials to call for centralized administration of foreign operations. CNPC is preparing to form an international cooperation bureau to oversee its foreign projects. It will be responsible for project evaluation, negotiations, and final contracts, before selecting a domestic producing agency or affiliate to carry out the contract.