Energy & Resources, Talking Point

China’s scramble for oil

A great discovery is celebrated. But the search for oil is now an overseas one

China’s scramble for oil

They liked their state heroes more rugged in the old days. Certainly a bit more robust than the two bank branch managers that Beijing has been lauding recently as ‘model workers’ (for “helping clients manage their finances and save money”, it turns out).

Almost exactly 50 years ago, China struck black gold under the Manchurian grasslands of Daqing in the far north east of the country.

Propagandists needed a legendary figure as a focal point for national celebration.

So ‘Iron Man’ Wang Jinxi, a shepherd-turned-oilman from rural Gansu, was burned into the national consciousness as a workaholic patriot. In the most famous coverage, Wang was pictured waste-deep in a gushing well, battling to keep a single drop from being wasted.

There have been whispers since that this was not quite the reality. Geologists think that as much as 90% of Daqing’s early output may have been squandered through outdated drilling techniques.

The Iron Man’s popularity hasn’t suffered as a result and a film commemorating his life has been pulling in the crowds this year.

His revival is a timely one. Half a century on and there is talk of a new generation of oil exploration, again regarded as vital to China’s future.

But this time the search is on overseas.

This makes the latest oil race political too?

Yes, as to some observers it looks like a scramble to control foreign oil assets.

With the discoveries in Daqing (and later in Bohai Bay and the South China Sea) China had no need to import oil at all until 1993. Even today it is the fifth largest global producer, ahead of countries like Venezuela, Brazil, Kuwait and the UAE in barrel per day terms.

But this output covers a little less than half of current demand for more than 8 million barrels a day. The rest has to be shipped in, and imports will rise with overall demand for oil, which is expected to increase by as much as 150% by 2020. More cars, more power, more plastic – just more GDP in general – will mean that more oil is needed too.

So Chinese oil firms have been on the lookout for oil internationally. Dealogic estimates that $17 billion has been spent on overseas acquisitions in the last year, as well as another $50 billion in debt-for-oil loans, on investments in Iran, Kazakhstan, Iraq, Russia, Brazil and Canada.

The Chinese have been active in Africa too, especially in Sudan, Nigeria and Angola.

Last week there were reports of a huge potential new deal in Nigeria. CNOOC (one of China’s three energy majors) is said to be in talks to buy 6 billion barrels of production in a contract rumoured to be worth up to $50 billion. That would be one in six barrels of Nigeria’s proven reserves.

Which means a “locking up” of oil supply?

This is the view of the more fearful oil strategists. They say that rather than buy on the open market the Chinese plan is to secure control of block production ‘at the well-head’ and ship it all home. Other countries will find oil more difficult to come by as a result.

The problem with this argument, says Erica S Downs at the John L Thornton China Centre, is that three-quarters of global reserves are off-limits to foreign owners. This would make the plan a foolish one – the Chinese would be chasing something largely denied to them from the outset.

Still, that might seem to validate the rush to buy up assets where foreign ownership does turn out to be more achievable. Perhaps that’s why Africa is getting so much attention.

But Downs argues that even this is not enough to support the “locking up” stance, as it ignores oil’s status as the world’s most fungible commodity. If the Chinese majors were intent on tankering their foreign oil straight home, this would only displace some of the supply currently being imported at contract and spot prices.

As this oil would then be sold elsewhere, the game is not necessarily zero-sum after all.

It might even lead to lower prices?

Downs thinks so. In a 2006 study of overseas oil drilled by Chinese joint ventures, she discovered that at least two-thirds had been sold on the international markets – and not just pumped into the nearest Panamax bound for Pudong.

Anyway, this all counted for less than 1% of total global production that year – hardly a sign of a Sino stranglehold.

In fact, you can make a better case for the opposite – that Chinese investment is expanding the flow of oil. Chinese firms have also been more prepared to put money into riskier projects than their international counterparts. If these investments work out, this is further incremental supply.

So the criticism is overstated?

Many still worry about the Chinese approach, especially when it involves deals with regimes with poor human rights records.

There is also annoyance that Beijing makes cheap financing available to its oil firms, who are then accused of overpaying in their spending sprees. CNOOC seems to be leading the charge internationally, with PetroChina and CNPC hot on its tails. The smallest operator Sinochem brings up the rear.

But this is not quite the same as claiming that the deals are all being called from a patriotic playbook.

A genuinely mercantilist approach would see the national champions (why have more than one?) avoid competition for assets. This has not always been the case. Some deals even appear to have proceeded in the face of opposition from the bureaucrats.

Profit motivation remains as strong as patriotism too. For the Chinese oil firms there is a clear business rationale: ‘upstream’ investment (in overseas exploration and production) promises to be a lot more profitable than refining and distribution activities back home, where pump prices for diesel and gasoline are usually capped.

Still, isn’t China’s oil strategy more ‘political’ than others?

State ownership of large chunks of the oil majors certainly complicates things. But it is hardly uncommon elsewhere in the world. The difference, perhaps, is that outsiders fear the scale of future Chinese demand.

The rest of the industry can hardly be said to have thrown itself upon the mercies of the free market either. The OPEC cartel is a classic case of political interference.

And much of the current fretting over the struggle for oil supremacy was touched off in 2005, when the US Congress intervened to block a CNOOC bid for California-based Unocal. Legislators argued that the deal ran contrary to the national interest in economic and security terms.

The Unocal failure also points to the potential limitations of a “locking up” strategy – even if there really is a ‘China-first’ mission, it is not pre-ordained to succeed.

The backdrop to the latest Nigerian negotiations was disappointing news from Angola (state giant Sonangol had rejected further interest from CNOOC and PetroChina) and from Libya too (the vetoing of a CNPC bid for Verenex Energy).

The Iron Man may not have liked it. But China’s oilmen today now seem much readier to take ‘no’ for an answer.

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