Friday, February 25, 2011

China: Taking Oil Home

by Song Yen Ling and Jason Fargo, Energy Compass, Feb 11, 2011
As China pushes deeper into the global upstream industry, it's widely assumed that the expanding portfolio is being used to funnel oil supplies back home -- feeding the country's insatiable appetite for energy. Yet the reality is not so simple: The strategy of energy security is more complex, faces competing pressures from other policy goals, and can bump into infrastructural and commercial constraints, Energy Compass analysis shows.

What's not in doubt is that Chinese companies have spent tens of billions of dollars acquiring large volumes of production overseas. Foreign equity oil and gas output averaged 1.4 million barrels of oil equivalent per day in 2010, an increase of 40% on the previous year, according to a new report by state China National Petroleum Corp. (CNPC). Oil accounted for the lion's share, at 1.2 million barrels per day.

Energy security was the original driver of overseas expansion, with Beijing instructing companies to amass sources of supply. But in recent years this has become intertwined with a parallel objective of turning state oil giants into global, commercially driven entities capable of competing with Western oil companies. Beijing has also become preoccupied with its rising energy import bill, as oil prices and Chinese demand growth feed off each other. The government now sees overseas investments as important in bolstering global oil production to meet the growing needs of its economy, while acting as a hedge against higher prices.

CNOOC [China National Offshore Oil Corp.] Chairman Fu Chengyu recently spelt out these overlapping goals, telling local media that his company's overseas drive was designed to increase world oil supply and fulfill the needs of the host market, rather than to ship crude oil back to China. "Our expansion strategy overseas is based on grabbing good opportunities. But more importantly, commercial value must be realized," he said. The strategy not only helps China's economy, Fu said, but also contributes to the global economy.

The government increasingly recognizes that China's large upstream footprint does not necessarily translate into supply security, says one Chinese oil insider. Chinese companies tend to operate in politically unstable parts of the world, increasing the risk of nationalization or domestic controls, and may be limited by fiscal regimes.

Cash-for-oil deals -- where Beijing extends huge loans to oil-producing governments in exchange for a fixed volume of oil supply -- are viewed as a stronger bet in this regard, and have been embraced in the past couple of years. Such deals are now in place with Venezuela, Brazil, Kazakhstan, Russia [please see remarks below -- D.R.] and Ecuador, and account for some 1.1 million b/d, according to Energy Intelligence calculations (EC Jul.9,p5). With equity oil and domestic production, China now effectively controls some 6.4 million b/d of global oil production.

Tacit Understanding

Industry sources say there still is an understanding that, in a crisis, national interests will trump all commercial or other objectives. In the event that Mideast crude supply to China is interrupted, for example, state companies would be expected to send as much oil home as possible. This has already played out in other markets: Beijing put pressure on CNPC to increase natural gas supply this winter, which the company did at a loss. Similarly, refiners were compelled to suspend diesel exports during recent domestic shortages (EC Dec.3,p7).

In a global oil crisis, China's new strategic stockpile would be the first line of defense; this already has capacity of almost 250 million bbl and is due to hit 500 million-600 million bbl by 2020. There would also be limits on how much crude could easily be shipped back to China. Older refineries were built to run local [relatively] light, sweet grades Daqing [...], and only 30% of the country's [...] capacity can process sour grades. And companies may be constrained by contractual obligations to existing customers or the politics of the situation, Chatham House's John Mitchell wrote in a recent report (EC Jan.14,p10). Indeed, if the host country is involved in the crisis, equity oil investments could become "hostages" that limit the importer's foreign policy options "in exactly the way that energy security policy is supposed to avoid," Mitchell wrote.

Sudan, for one, provides large volumes of equity oil for the Chinese market, but also offers some of the highest risks of disruption, especially after the south's vote for independence (EC Jan.21,p6). CNPC has equity stakes of 40%-95% in the country's three largest production ventures, equivalent to about 205,000 b/d of Sudan's 475,000 b/d production. With marketing options limited by crude quality and US sanctions, some 253,000 b/d of Sudan's oil was exported to China last year. CNPC has built a special 200,000 b/d refinery at Qinzhou to process Dar and Nile Blend crudes.

At the other end of the spectrum is Ecuador, where China has again built a dominant position in export trade -- but takes hardly any oil back home. Andes Petroleum and PetroOriental, both partnerships of CNPC and Sinopec, produce a total of about 50,000 b/d. In addition, China is entitled to lift 96,000 b/d of state Petroecuador's crude under a two-year, $1 billion loan signed in mid-2009 (EC Aug.21'09,p5). Yet Chinese crude imports from Ecuador averaged just 16,300 barrels per day in 2010, down 55% on the previous year. Transportation costs are high, and Chinese refineries are not optimized for Ecuadorean grades.

Instead, the value of China's Ecuador presence has lain elsewhere, in providing a springboard for expansion in Latin America's oil industry and an avenue for PetroChina to develop an active global trading role, as the CNPC affiliate recreates itself as an international integrated company (EC Jan.14,p3). Virtually all of China's crude entitlement from Ecuador is sold on the open market, mainly to refineries in California, with PetroChina now the country's main lifter. PetroChina also swaps some supplies for crude more suited to China's refineries -- a twist demonstrating the increasing complexity and sophistication of China's energy security strategy.

Other overseas equity oil that doesn't make its way to China includes CNOOC's interests in Argentina and offshore Nigeria. [Read full]

(China agreed to loan Russian companies, Rosneft and Transneft $25 billlion to finance the East Siberia Pacific Ocean---ESPO---oil pipeline in exchange for 300,000 bbl/d of oil shipments---please see my post here. China is the world's second-largest consumer of oil behind the United States, and for the first time the second-largest net importer of oil in 2009---please see my post, including remarks, here.  -- D.R.)

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