Paying the price

The working relationship between oil producer CNOOC and Li Ka-shing, one of Asia’s wealthiest men, goes back a long way.

In late 1999 CNOOC was planning a New York listing but its IPO was cancelled due to weak investor interest. The state firm’s executives cold-called Li for help. He invested $200 million as a pre-IPO investor and sent a representative to sit on CNOOC’s board of directors. A year later CNOOC successfully floated its shares in Hong Kong and New York.

After the fundraising, CNOOC’s quest for offshore oil began in earnest. Its earliest exploration efforts focused on the South China Sea. Again, Li became heavily involved and his Canadian unit Husky Energy poured more than $5 billion into joint ventures with the Chinese oil major, according to Xinhua.

One of those deals hit the jackpot in June 2006, when Husky discovered a deep-water well in Liwan – located about 300km south of Hong Kong – with potential resources of up to six trillion cubic feet of natural gas.

This month Husky and CNOOC should be celebrating the tenth anniversary of that find – one of the largest offshore natural gas discoveries in China. Instead, questions have been asked about relations between the long-term partners.

The first cracks in the relationship appeared in April when, after announcing a disappointing set of first-quarter results, Husky warned that it was considering legal action against CNOOC.

At stake is the afore-mentioned Liwan project. Husky operates and owns 49% of the joint venture. CNOOC holds the remaining interest, buys the gas from Husky on contractual volumes and prices, and then resells it, primarily in the Pearl River Delta region.

The project is seen as Husky’s growth engine – delivering stable sale volumes at much higher gas prices than in North America. However, according to its latest results announcement, it only received payment for volumes of around 150 million cubic feet per day, or about 50% of contracted sales, in the first quarter. Worse still, CNOOC officials have asked Husky to reduce the fixed fee the state firm pays for the gas due to pricing changes in Guangdong’s natural gas market.

“Our view is that there’s no contractual basis to change the price unilaterally. We have a legally binding take-or-pay contract in place,” Husky’s chief executive Asim Ghosh said during a conference call.

There isn’t much sympathy for CNOOC in the press, but the state firm has been footing some of the bill for the Chinese government’s energy policy. While imported gas prices are unregulated, onshore ones are closely controlled by the National Development and Reform Commission (NDRC). According to news portal Jiemian, when the contract prices for Liwan were agreed international oil and gas prices were high. Since then they have fallen more than 60%. The NDRC made its first cut to “city gate” prices for domestic gas in November last year, followed by another reduction in April. That has made buying natural gas from Husky and reselling it in Guangdong into a lossmaking business for CNOOC.

The dispute will be keenly watched, in part because the Liwan project has been hailed in sections of the state media as a shining example of Li Ka-shing’s contribution to the country’s economic development. This point was explicitly made by Xinhua last September when the Hong Kong tycoon had come under attack for being unpatriotic and moving assets away from his country of birth (see WiC297).

Besides CNOOC’s dispute with Husky, Zhejiang Natural Gas, a Hangzhou-based gas distributor affiliated with CNOOC, is facing a potential lawsuit from Primeline Energy (another Canadian firm) under similar circumstances.

For the time being, CNOOC seems confident that Husky won’t take the matter to court. “When the operating conditions change, even long-standing friends would have different views,” its chairman Yang Hua told reporters in Hong Kong last month. “The best way forward is to sit down and negotiate.”

In March CNOOC reported a 66% plunge in net profit to Rmb20 billion ($3.1 billion) for 2015 as global crude prices sank to a 12-year low. Revenues for the first three months of this year dropped 31% despite a 5% growth in production. Its bigger state counterparts are also suffering.

PetroChina, the listed unit of CNPC, has suffered its first ever quarterly loss, in part because it has signed up to long-term contracts for massive volumes of imported liquefied natural gas (LNG) at high prices, and the upstream business of Sinopec is also lossmaking.

The reversal in fortune for the trio of energy giants has followed in the wake of a high profile crackdown on the oil sector by Wang Qishan’s graftbusters (see WiC207).

Perhaps this is setting the scene for a more fundamental shift in the market – and one that may offer private sector firms more opportunities. There were signs of change in Shandong earlier this year, for instance, when 16 private sector refineries came together in the provincial capital Jinan to announce the formation of the China Petroleum Purchase Federation of Independent Refineries.

Known as ‘teapot refineries’, these smaller oil firms were responding to a policy breakthrough last year when they were granted their first import licences for crude as a means for Beijing’s reformers to break the monopoly of the state majors in the sector.

Oil imports by Shandong province, where most of teapot refiners are based, surged 300% in the first quarter (year-on-year), driving up China’s overall crude imports by 13% (by volume) to 91.1 million tonnes in the same period.

That’s led to bustling activity along the Shandong coast, with private sector refineries rushing to buy crude (much of it from Russia).

“It might be a bit of an exaggeration to say there is an oil tanker traffic jam at Shandong’s ports, but it’s true that the ports are running on tight schedules and some ships have to divert to other ports like Dalian or Tianjin,” a refinery official told the South China Morning Post.

These private sector oil firms seem more upbeat than their state-owned rivals. IPOs could follow as the ‘teapots’ seek to fund their expansion into the territory of China’s traditional energy giants.

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