China accelerates shift in energy policy, restructuring of state petroleum firms

Jan. 10, 2000
China's energy policy has gone through major changes in the last a few years, from a strategy based on self-reliance to one of aggressively seeking oil and gas supplies abroad.

China's energy policy has gone through major changes in the last a few years, from a strategy based on self-reliance to one of aggressively seeking oil and gas supplies abroad. This shift has led to a number of strategic changes in the country's oil and gas industry in terms of raising funds for capital investment, cutting costs, and focusing on development of cleaner fuels.

The new policy centers on China's need for foreign oil to sustain a relentlessly growing domestic energy demand. According to government estimates, China will face a domestic shortfall of about 50 million tonnes of crude oil, or 30% of its oil needs, in 2000. Crude imports in 1999 jumped 43% on the year to an estimated 38 million tonnes.

China's refined products consumption in 1999 rose an estimated 10% on the year to 145 million tonnes. Accordingly, Chinese refiners' crude runs to stills for all of 1999 climbed 6.4% on the year to 167.6 million tonnes. The year-to-year rise in throughput peaked during January-September at 9.3% (134 million tonnes for the period).

China's natural gas production is low, despite a postulated resource of 38 trillion cu m. During the past 5 years, natural gas accounted for only 2% of the country's energy mix, compared with Asia's average of 8%. Although coal will continue to dominate China's energy consumption in the next 10 years, natural gas will play an increasingly greater role in meeting the country's energy needs. Coal reserves in China total 114.5 billion tonnes, or 11% of the world's total. In 1998, coal production fell 5.5% vs. 1997 to 1.235 billion tonnes due to the huge stockpile built in 1997.

Improvements

Beijing has begun to stress the efficiency of energy production instead of blindingly pursuing production increases. Beginning in 1999, China started to shutter small refineries, close inefficient coal mines, and shut in marginal wells, aggressively slashing work forces in order to protect the margins of energy companies. -

The efficiency of China's oil industry is pivotal to the well-being of the nation's economy. The government has targeted the sector to earn 20 billion yuan in net profits this year, which accounts for 60% of the combined profits the government expects from all state-owned enterprises this year. The sharp rise in international crude oil prices that began in 1999 and stepped-up measures to stop oil smuggling this year are likely to make this target a reality.

The oil industry made 18.9 billion yuan in net profits in the first 9 months of 1999, compared with 4.634 billion yuan in the same period in 1998. That total includes 9.961 billion yuan earned by China National Petroleum Corp. (CNPC), 5.043 billion yuan by China Petrochemical Corp. (Sinopec), and 2.09 billion yuan by China National Offshore Oil Corp. (CNOOC).

However, as China's oil industry needs a huge infusion of capital to give it a boost, China is rushing its state-owned oil companies to the global equity market for more international capital.

IPOs

As a stimulus package to revitalize the state-owned enterprises and ease a chronic shortage of capital, the Chinese government has urged CNPC, Sinopec, and CNOOC to launch initial public offerings on international equity markets this year (OGJ, Jan. 3, 2000, p. 19).

By the end of October, CNPC has restructured its 507 billion yuan worth of assets and reorganized them into a holding company, called PetroChina Co. Ltd.-with CNPC's current president, Ma Fucai, as president and its current chairman and vice-president, Huang Yan, as the chief executive officer-to float shares on stock exchanges in New York and Hong Kong before March.

PetroChina, with 500,000 employees to be cut from CNPC's total work force of 1.54 million, has total assets of 100 billion yuan. It has five business units: oil and gas exploration and production, oil refining and petrochemical production, oil sales and pipeline operations, foreign joint ventures, and research and development.

PetroChina accounts for 68% of China's total crude production-which in recent years has averaged close to 160 million tonnes/year. It has an oil resource totaling about 13.36 billion tonnes of original oil in place, or 70.2% of China's total. Its refining capacity stands at 105 million tonnes/year, accounting for 42% of the national total.

CNPC's IPO vehicle is targeted at raising $8-9 billion from overseas equity markets.

Sinopec is expected to own a 51% stake in its proposed holding company after its IPO, with foreign investors to hold the remainder. It hopes to raise up to 50 billion yuan. Sinopec has fixed assets worth 380 billion yuan. Its profit in 1998 came to 3.42 billion yuan.

CNOOC's assets are worth 32.67 billion yuan, and its profit last year amounted to 700 million yuan.

Sinopec and CNOOC have also pledged to reduce staff, with Sinopec to cut its workforce to 800,000 from 1.2 million and CNOOC to 23,500 from 25,000. Most of those laid off will be shuffled over to new companies created to provide special-purpose services, such as field engineering and fabrication.

Overseas investors are concerned over the efficiency of China's oil industry. They have noted that China's major oil fields have passed their peak production and that its refineries are also aging. Onshore crude output has stagnated at 145 million tonnes/year for the past 3 years. Lifting costs in onshore fields average $12/bbl, much higher than the international average of $8/bbl.

Another concern is political risk. US investors strongly oppose CNPC including its assets in Sudan in the IPO vehicle. This year, CNPC expects to net 2.4 million tonnes of equity oil production from Blocks 1, 2, and 4 in Sudan's Muglad basin as a partner in a development project led by Calgary's Talisman Energy Inc.

WTO

Improving prospects for foreign investment in China's energy sector and making life a bit tougher for its state-run enterprises is the pending admission of China into the World Trade Organization.

China expects to be a full member of WTO sometime in first half 2000, following the market-access deal signed with the US on Nov. 12.

China's entry into WTO poses challenges to the Chinese oil companies, which remain under government protection. The government has maintained bans on gasoline and diesel imports since September 1998 and set import quotas for other oil products.

The Chinese oil companies need 2 or 3 years to consolidate their operations in the domestic market before the WTO entry results in reduced tariffs, deregulation of domestic markets, and greater access for imports.

Industry sources said the deal will allow foreign companies to set up 30 gasoline stations every 3 years after China has joined WTO.

China will also allow imports of an initial volume of 19.8 million tonnes of foreign oil products in the first year of entry, expandable by 18%/year for 5 years, or until it abolishes the oil import quota system within 4 years of entry into WTO.

Industry sources said that diesel and gasoline imports will account for only 12% of the consumption of the two products in China after China's entry into WTO. Most of the import quotas will be for importing fuel oil.

Staring in 1999, Sinopec and CNPC have been aggressively consolidating their retail operations.

Sinopec has earmarked 2 billion yuan this year to build 300 gasoline stations and buy another 400-500 owned by local authorities. Sinopec hopes to raise its oil market share over the next 5 years to 50% from 10% in southern and eastern China.

Another measure to firm up the bottom lines of CNPC and Sinopec has been the government's campaign, begun in 1999, to close small refineries.

Plans call for closing refineries with crude distillation capacities below 1 million tonnes/year. China has 166 such refineries out of the total 220. China's small refineries have a combined distillation capacity of 30 million tonnes/year, with crude runs standing at 14 million tonnes in 1998.

Foreign investment

Foreign oil and gas companies have scaled back their investments in China's onshore exploration and production sector, largely because of disappointing results.

Foreign companies have few successful cases either in pure exploration plays or in enhanced and improved oil recovery operations in China due to often-complicated geology and a frequently big capital commitment for commercial development schemes.

Since 1993, CNPC has tendered foreign bid rounds for 54 exploration blocks in 13 basins, covering a combined area of 400,000 sq km. Exxon Corp., Agip SPA, Texaco Inc., and Japan National Oil Corp. are currently operating in the highly touted Tarim basin, but with no significant success reported to date.

Exploration Co. of Louisiana (XCOL) is the only foreign company that is producing commercial onshore oil in China. XCOL has sold part of its stake to Apache China Petroleum Ltd.

In 1998, CNPC signed only three petroleum production-sharing contracts with foreign companies vs. 11 signed a year earlier.

Foreign investment in the refining sector is scarcer, as China still restricts foreign companies from investing directly in building grassroots refineries.

The only foreign joint-venture refinery in operation is the 5 million tonne/year Dalian West Pacific Refining Co. Ltd. plant, jointly built by TotalFina SA, CNPC, and Sinochem.

Other refinery proposals from foreign oil companies have been either canceled or shelved. In fact, China's refining capacity features a surplus of about 100 million tonnes/ year.

Including plants owned by local authorities, China has 260 million tonnes/year of refining capacy, while crude runs to stills average about 160 million tonnes/year.

However, major opportunities are available to foreign investors in the petrochemical and natural gas sectors-areas in which foreign companies will be able to secure long-term interests and for which the Chinese government has targeted ambitious growth in the next 10 years.

Natural gas

China has embarked on an ambitious gas utilization plan, which calls for increasing gas consumption to 50 billion cu m (bcm)/year in 2005 and 80 bcm/year by 2010 from the current 23 bcm/year.

New foreign investment opportunities will arise and spin-off industries will emerge from this scheme.

The rationale for optimizing gas consumption is to meet domestic energy shortfalls and to address environmental concerns.

China is looking at three gas resources: domestic resources in northwestern China, LNG supplies from Asia or the Middle East, and pipeline gas from Russia. The last two resources will serve as supplementary to the domestic resources. The first shipment of LNG is due in 2005, while the Russian pipeline link is a more-remote prospect.

China has started a program to deliver natural gas from the west to the east, and it has approved a feasibility study for plans to use the western natural gas resources.

These plans call for China to build a 503-km pipeline to move gas from Sichuan's Zhongxian producing area in southwestern China to Jinzhou in Hubei province. The 2 billion-yuan pipeline, with a capacity of 3 bcm/year, will transport gas to industrial and residential customers in 10 cities along its route.

Construction started in 1999 and is slated for completion in third quarter 2000. The pipeline is going to be extended from Zhongxian to Henan in central China to Shanghai after 2002.

Foreign capital and technology are expected to help China boost development of its natural gas infrastructure-for E&P as well as for gas pipeline construction. In early November 1999, China lifted the ban on foreign investment in town-gas pipeline construction.

An official with the State Administration of Petroleum and Chemical Industries (SAPCI) said China is going to select some cities that will invite foreign companies to participate in town-gas construction on a build-operate-transfer basis.

Foreign investors have urged China to set up a regulatory framework to open up the gas market, spur competition, eliminate a system of gas allocation and market reservation, and create an efficient pricing system.

Domestic natural gas prices offer no incentive for either domestic or foreign investors. The prices are fixed for a large part of the market, ranging from 0.46 yuan/cu m to 1.4 yuan/cu m.

Because the bulk of China 's natural gas is used in the production of fertilizers, China seeks to maintain the price of natural gas fed to fertilizer plants low enough that farmers can afford to buy the fertilizer.

According to the SAPCI official, the government is working a new gas pricing regime based on a take-or-pay arrangement and allowing gas pipeline operators to set their own prices.

In addition to domestic gas, China will import LNG, with the first cargo expected to arrive in 2005.

The first LNG project, to be built in Guangdong, will soon get government approval. After approval, China will start the process of selecting a foreign partner to establish a joint venture for the construction of the LNG terminal and a pipeline from the terminal to the nation's pipeline network.

The bid for foreign LNG suppliers will follow. So far, seven countries have shown interest in supplying LNG to China: Australia, Indonesia, Malaysia, Qatar, Oman, Saudi Arabia, and Yemen.

CNOOC will take a 36% stake in the proposed 5 billion-yuan project, leaving a foreign consortium to take 35%, Shenzhen Municipal Government 15%, Guangdong Power Bureau 10%, and Guangzhou Gas Corp. 4%.

The project involves: building a 3- million-tonne LNG receiving terminal at Dapeng Bay in Shenzhen and two grassroots power plants fed by regasified LNG, one in Shenzhen and the other in Huizhou; revamping three existing power plants; and building a pipeline to tie the LNG terminal into the nation's grid.

Of the initial import of 3 million tonnes/year of LNG, 37% has been earmarked for the two new power plants and 17% for the three existing power plants; at least 8% has been earmarked to date for industrial consumption, and the remainder, after industrial market needs have been met, will go for residential consumption.

Ethylene

This sizeable refinery in Shanghai is one of many that is operating well below capacity. Part of China's petroleum sector restructuring involves the closure of dozens of small, inefficient refineries to help whittle away the nation's surplus distillation capacity. Photo courtesy of China Petrochemical Corp.
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China has revived its plan to increase its ethylene capacity, with the recovery of Asia's petrochemical market. China relies on imports for 50% of its petrochemical consumption.

Early in 1999, China decided to postpone its ethylene expansion plan amid low petrochemical prices.

In October 1999, China resumed the operation of a 150,000 tonne/year ethylene plant in Guangzhou following a 2-year suspension owing to the plant's heavy debt.

Also last year, China approved ethylene expansion plans by Beijing's Yanshan Petrochemical Corp, Shanghai Petrochemical Corp., and Nanjing Petrochemical Corp.

China's ethylene consumption is expected to rise to 7.5 million tonnes/ year in 2000, 10 million tonnes by 2005, and 13 million tonnes by 2010. Its ethylene capacity now stands at 4.3 million tonnes/year, to be expanded to 5 million tonnes this year. China produced about 4 million tons of ethylene in 1999, up 8.1% on year. Of that total, Sinopec produced 2.4 million tons, CNPC 1.27 million tons.

China has slated two phases for ethylene expansion.

In the first phase, China will add 2.7 million tonnes/year of capacity to existing plants by 2003. In the second phase, China will build new crackers under joint ventures with foreign companies during 2003-10. Six such crackers are in the planning stage, with a combined capacity of 3.85 million tonnes/year.

The joint-venture companies involved in the projects are: BASF AG with Yangzi Petrochemical; Dow Chemicals Co. with Tianjin Petrochemical Corp.; Phillips Petroleum Co. with Lanzhou Refining & Chemical Co. Ltd.; BP Amoco PLC with Shanghai Jinshan Petrochemical Corp.; Royal Dutch/ Shell with CNOOC; and Exxon Corp. with Fujian Petrochemical Corp.

Shell and CNOOC are working to set up a joint venture for the operation of their project, which has been approved. BP Amoco and Sinopec signed a contract to start a feasibility study of their proposed 650,000 tonne/year ethylene cracker, to be built in Shanghai. Sinopec and BP Amoco will each hold a 50% stake in the $2 billion ethylene plant.

In early November, BASF and Yangzi submitted to the Chinese government a feasibility study of their proposed 600,000 tonne/year ethylene cracker, to be built in eastern China's Jiangsu province.

Dow had planned to submit a feasibility study of a 600,000 tonne/year ethylene cracker to the Chinese government by yearend 1999.

Trading

Oil trading in China is under government control, with quotas and licenses limiting the number of trading houses and buying and selling activities.

China now favors the trend to import more crude oil instead of oil products to maintain the healthy operation rate of Chinese refineries and, with more refinery throughputs, China can justify to keep foreign oil products out of China.

The crude from Middle East origin is expected to increase by big margins, with the commissioning of more sour crude refining capacity and a decline in Asian crude supplies.

In 1999, China plans to treat 10 million tonnes of sour crude, up from 7.7 million tons in 1998 and 4.7 million tons in 1997.

To accommodate the increasing imports of high-sulfur crude oil from the Middle East, China plans to raise sour crude refining capacity to 36.5 million tonnes in 2000, up from 18.5 million tonnes, largely by expanding the current capacities at major coastal refineries including Zhenhai Refining & Chemical Corp., Maoming Petrochemical Corp., Qilu Petrochemical Corp., Tianjin Petrochemical Corp., Jinling Petrochemical Corp., Shanghai Petrochemical Corp., and Yangzi Petrochemical Corp.

In 1998, China imported 27 million tonnes of crude, of which the Middle East supplied 61%. The Middle East's market share is likely to increase to 70% this year. Chinese imports of Middle East crudes grew about 49% annually during 1993-1998. China's major overseas crude suppliers now are Indonesia and Oman, which produce low sulfur crude suitable for most Chinese refineries.

Chinese imports from Indonesia averaged 5.85 million tonnes/year during 1992-98, accounting for 24.7% of China's total imports during the period.

Oman's exports to China peaked at 9 million tons in 1997 but dropped 36% to 5.8 million tons in 1998.

Strong momentum for oil products export has prompted China to import more crude oil in 1999.

Crude import in 1999 is expected to increase 39% on the year to 38 million tonnes, while exports will drop 47% to 8.31 million tonnes.

The import in the first 9 months of this year rose 18% on the year to 27.1 million tonnes, with imports in September reaching 4.286 million tonnes compared with 2.156 million tonnes in 1998.

Oil products exports for 1999 are expected to rise 47% vs. fiscal 1998 to 6.23 million tonnes. Of the total, 4.53 million tonnes will be gasoline, compared with 1.8 million tonnes in 1998. Import of oil products in 1999 is expected to fall by 13.5% vs. 1998 to 18.8 million tonnes.

The drop is attributed to the government's ban on diesel and gasoline imports, which has been in effect since September 1998. China is unlikely to lift the ban before it is allowed entry into the WTO.

Now China can't afford to allow an influx of foreign diesel and gasoline, because this would hurt sales of domestic oil products (which are sold at prices higher than on the international market), idle more refining capacity, and, worse, leave millions of workers unemployed.

Overseas strategy

With investments or other business interests in nine countries outside China, including Sudan, Peru, Canada, Thailand, Venezuela, Kuwait, and Kazakhstan, CNPC has aggressively expanded its overseas upstream operation over the past 6 years to become a global oil player.

A tank farm in the desolate Tarim basin of Northwest China is a repository for the meager volumes of oil being produced in a region that once was touted as China's oil future. The lack of progress in increasing its domestic oil production capacity has led China to undertake a major shift in its energy policies and a massive restructuring of its state-run oil and gas companies. Photo courtesy China National Petroleum Corp.
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Last year, faced with financial constraints, CNPC suspended its hunt for new overseas petroleum interests but continued to maintain its existing operations.

CNPC prefers to buy oil fields with proven reserves rather than going for risky exploration opportunities, because the company cannot afford dry holes and is in a hurry to secure more oil supplies abroad to meet a domestic shortfall.

The equity oil production from CNPC's overseas fields totaled 1.98 million tonnes in 1998; that is expected to grow to 10 million tonnes in 2000 and 50 million tonnes by 2010.

Most of CNPC's overseas fields are those that are deemed marginal by the host countries. Fields such as those CNPC acquired in Peru might have value to CNPC because of their low costs-the result of its technical advantages and low staff costs-but might not be worth the bother by international standards.

For example, Talara, Peru's oldest field, has been producing for about a century, and the field's production peaked in the 1950s. When taken over by CNPC in January 1994, Talara had 1,800 shut-in or abandoned wells. CNPC invested several million dollars to restore 100 of them, leading to a production increase of only 80 tonnes/ day.

CNPC signed two production-sharing contracts with Iraq to develop the Ahdab-area oil fields in 1997. The contracts, covering projected combined production of 15 million tonnes/year, will take effect when the United Nations lifts sanctions imposed on Iraq.

In Kazakhstan, CNPC's interest in building a pipeline to move crude oil from the western Caspian shelf east to China's Xinjiang region is dwindling. China recently announced that there isn't enough crude resources at Kazakhstan's Uzen and Aktyubinsk oil fields to justify the pipeline (OGJ, Aug. 30, 1999, p. 44). The commercial production volumes in these fields available for the pipeline are estimated at less than 7.6 million tonnes/year, below the pipeline design capacity of 25 million tonnes/year.

Offshore

Offshore China E&P over the past few years has been distinguished by a lack of major discoveries. The only major discovery off China was made by Phillips Petroleum Co. in the northern Bohai Sea in 1999; Penglai 19-3 holds an estimated 200 million tons of crude oil reserves and covers 50 sq km in 20 m of water 70 km off the northern coast of Shandong.

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The E&P focus for Offshore China is shifting to the Bohai Sea from the Pearl River Mouth Delta basin in the South China Sea. CNOOC's Bohai oil operations are expected to increase crude oil production to 10 million tonnes this year from 2.65 million tonnes in 1998. The bulk of the increase will be from the QHD 32-6 and Nanbao 35-2 discoveries, where CNOOC is developing 4 million tonnes/year of crude oil production capacity. In November 1999, CNOOC was expected to add 1 million tonnes/year of crude production capacity from the Jinzhou 9-3 find in the Bohai Sea.

With recoverable crude reserves of 700 million tonnes, the Bohai region has five producing fields, with another seven expected to join the roster soon.

Tarim

With most fields in eastern China already at the peak of their production and some of them even declining, the Tarim basin is still expected to offer hope for the country's oil future despite its daunting geological complexities.

The basin, with a postulated resource in place of 10.75 billion tonnes of oil and 8.4 trillion cu m of gas, has kept a low profile over the last few years, as CNPC has not been especially successful in its E&P efforts there.

China had earlier called for the Tarim basin operations to prove 1 billion tonnes of original oil in place (OOIP) and 8 million tonnes/year of production capacity by the end of 2000. However, by the end of 1998, proven OOIP totaled only 330 million tonnes, with production capacity reaching 5 million tonnes/year. The basin's production in 1998 fell 11% on the year to 3.85 million tons.

At the end of September 1999, China National Star Petroleum Corp. announced it had proven 120 million tonnes of OOIP in its Tarim basin Tahe field. CNSPC plans to expand that figure to 500 million tonnes in the next 3 years; it also plans to produce 1 million tonnes of crude from Tahe in 1999, up from 574,600 tonnes in 1998.

A basin that covers an area of 560,000 sq km in some of the most forbidding terrain in the world, Tarim hosts many medium and small-sized, geologically complex oil reservoirs.

The basin is underexplored, with only one wildcat well drilled on every 1,400 sq km, which is far from sufficient for determining its ultimate potential.

CNPC acquired 5,903 line-km of 2D and 635 sq km of 3D seismic in 1998, up 31% and 90% on the year; combined seismic surveys in the last 10 years total 158,000 line-km of 2D and 7,600 sq km of 3D, leading to the discovery of 28 oil and gas-bearing structures.

Of the total 36 exploration wells drilled in 1998, only 16 found hydrocarbons. That brought the basin's proven crude oil reserves to only 80 million tonnes, far short of the year's target of 350 million tonnes.