chinese energy expansion in the western hemipshere - for china's reform (bottelier)

8/3/2019 Chinese Energy Expansion in the Western Hemipshere - for China's Reform (Bottelier)

1/14

Introduction - The dragon breathes fuel

China is endowed with many things: a rich history, a strong tradition of governance, and a

vast population and large territorial footprint at the center of the worlds largest continent.

its economic growth over the past decade has proven that it can mobilize these resources

to grow its productive capacity and move on from a long period of underdevelopment. One

endowment it lacks, however, is hydrocarbon energy and specifically the amount requisite

to continue its resource-intense development trajectory. As its demand for resources has

grown, its need to look outward to secure them has grown as well. The Chinese national

oil companies (NOCs) have been key actors in this going out process, but as resource

needs grow and Chinas demand constrains world markets, it is uncertain how the NOCs

will work to secure the supply that Chinas growth is demanding.

China has not always found itself in this import-dependent situation. Less than thirty years

ago China was a net exporter of oil and other commodities as its underdeveloped local

market used its commodities to service Japanese growth. Now, China is the worlds

second largest consumer and importers of oil and annual demand growth is higher than all

the rest of the world combined. This demand from China has been an important contributor

.1

Stranko 1

1 International Energy Agency, 11

Chinas Contribution to Global Demand Growth


2/14

.2

to unstable and constantly increasing global oil prices.3 Now, demand is outpacing supply

and the modest drop in demand from developed economies has not offset Chinas

extraordinary consumption growth. In fact, Chinese demand growth has been the most

important driver of global demand growth for some time, a trend that will not soon abate.

Chinas NOCs audacious investors

The resource agenda of Chinas NOCs is closely connected to the governments broader

goal of energy security. In pursuit of this goal, the Chinese government has broadened its

strategy from pure equity and joint-venture investments to shoring up better trade

relationships, offering foreign aid and installing transportation and telecom infrastructure to

support their investment goals. This strategy is one that emanates from the government as

a whole and not just the NOCs, with the National Development and Reform Commission

requiring Chinese NOCs to invest in upstream energy suppliers overseas.4

Traditionally, Chinese companies have plied traditional supply routes in Russia, the Middle

East and Southeast Asia for oil supply, but they are increasingly looking further afield to

Africa, North and South America for diverse supply sources.5 This voracious demand for

Stranko 2

2 ChinaOilWeb data report, 2010

3 Blas (Financial Times), full text

4 United States USCC Report, 4

5 Chart and information from Moran, 10

Saudi Arabia

Angola

IranRussia

Sudan

Oman

Others

Middle East

AfricaAsia

Russia

South America

Chinas Largest Oil Suppliers2009

Chinas Largest Oil Suppliers byregion 2009


3/14

oil has led it to some of the worlds

m o s t h o s t i l e p r o d u c t i o n

environments, both technologically

and politically. From purchasing

exploration rights in Iran to

competing with domest ic oi l

companies for concessions in

Russia, Chinese companies appear

to have a risk appetite that exceeds

t h a t o f o t h e r N O C s a n d

supermajors like ExxonMobil and

Shell. Although a large part of this

risky business comes from the

sheer growth in demand that the

companies have ! experienced ina very short period of time, part of this

appetite may derive from the lack of Chinese NOC experience in hostile environments.

In the Western Hemisphere the approach has been more guarded and, despite headline

successes and failures, the risk profile has been more measured. The focus of this essay

is to explore three brief case studies in the Western Hemisphere of Chinese NOC

involvement in the energy sector and understand Chinese motivation for finding oil

supplies in unconventional places. Also, given the sometimes hostile regulatory

environment throughout the region, not just in Latin America but also in the United States

and Canada, the essay also explores the question of how China reacts to political risk and

sovereign challenges to its energy interests.

Stranko 3

Chinas Largest Natural Resource ProcurementCases -

Chart credit: Moran, page 10


4/14

Stranko 4

Chart credit: Center for American Progress (2010)


5/14


6/14

resource companies have failed in the past several years. The most notable was

Australian-based BHP Billitons attempted takeover of the Potash Corporation of

Saskatchewan, which was blocked ultimately over reasons of national interest. According

to Canadas respected Financial Post, the federal government twice delayed approval of

the PetroChina/Encana transaction and, in order to avoid another BHPBilliton debacle,

may have quietly set transaction conditions that neither PetroChina nor Encana could

accept.7

Still, the Chinese have successfully invested (and received government approval) in part of

ConocoPhillips oil sands interests, but did so at a premium of nearly 100% of the assessed

value.8 The government, with terms like this, would have a difficult time demonstrating the

deal did not bring economic benefit to Canada. But given failures elsewhere it appears

they may be demanding some premium from Chinese companies that want to operate in-

country. Whether this is to compensate for the political ramifications or the uncertainty of

how to deal with Chinese NOCs in one of Canadas most precious energy assets is

unclear. Regardless of the reason why substantial alignment could not be attained, the

Canadian government has been firm on its attitude towards national interest in large

foreign resource acquisitions, and Chinese NOC investments have not been given on par

treatment with those from elsewhere.

CASE STUDY 2Sinopec and Petrobras 2009 - Cooperation but no equity

In early 2009, the China Development Bank agreed to lend Petroleos Brasileiros

(Petrobras) US$10bn to assist in its efforts to exploit the Santos pre-saloffshore basin off

the coast of Southern Brazil. The deal set off speculation that the Chinese state oil

Stranko 6

7 Simon (Financial Times), full text

8 Hatcher (Houston Chronicle), full text


7/14

companies was planning to buy up a percentage of the production of Brazils newly-

discovered deep sea reserves, but in reality the deal just guaranteed 100,000 barrels per

day delivery of crude to Sinopec for 10 years at market prices.9

Given the estimated investment in developing the field will clock in close to US$200bn, a

loan guarantee equal to 5% like the one Sinopec is making certainly does not constitute

market-cornering practice. Also, unlike the attempted CNOOC acquisition of Unocal in the

U.S., the Petrobras deal did not involve any equity stake. Additionally, the promised crude

supply was not even planned to come from the new production, rather from existing

Brazilian fields. The loan-for-oil agreement, though, was not to be the end of the story and

Sinopec continued in negotiations with Petrobras to take a larger role in the exploration

and production of the fields. By mid-2011, Sinopec was already in advanced negotiations

to acquire two blocks of the Santos basin production. And ahead of the mid-year visit of

President Dilma Rousseff to China, Petrobras announced that Sinopec would join the

Brazilian company on-site to develop the offshore oil fields.

What this strategy reflects is a growing tendency for the Chinese oil companies to avoid

the high-profile equity investments or partial takeovers that they had attempted in the past

decade. Instead of taking major stakes, the Petrobras deal shows that they are using their

influence and capital to slowly build relationships in areas of political and economic interest

like Brazil. Also, given that these are deepwater exploration projects, Chinese oil

companies will be very interested in understanding Petrobras already-advanced

technology. With oil being discovered by supermajors and neighboring NOCs in the South

China Sea, the goodwill generated by the loan-for-oil agreement may result in a very

valuable engineering lesson for Sinopec.

Stranko 7

9 Ausick (24/7 Wall Street), full text


8/14

CASE STUDY 3CNOOC and Chesapeake - Finally, an equity success story

In early 2011, CNOOC and Chesapeake Energy (the U.S.s largest shale gas exploration

company) announced that CNOOC would take a 33% stake in Chesapeakes assets in two

U.S. shale plays. The deal, worth in total more than US$2 billion, provided an outlay of US

$570 million for 800,000 acres of drilling leases in Colorado and Wyoming and an

additional commitment to fund two-thirds of Chesapeakes share of the costs that would be

repaid over a period of three years. The deal has a clear benefit for Chesapeake: a major

investment in a time of weak American capital markets and a view into the world of

conducting ajoint partnership with a Chinese NOC. CNOOC, however, has even more to

gain from a fruitful alliance, and that is experience and expertise to exploit similar

resources at home.10 China has an estimated 36 billion cubic meters of shale gas reserves

(twelve times the countrys conventional deposits) but heretofore has not possessed the

technology to effectively exploit their resource. This investment gives CNOOC a front row

seat to the most advanced techniques in hydraulic fracturing, or fracking, and how to

manipulate wellheads in order to extract the maximum amount wells without contaminating

its environs.11

After the disastrous experience of CNOOCs bid for Unocal, it is remarkable that the

company has been able to make such a substantive bid in one of the U.S.s leading

energy companies. Clearly, what makes this deal different is a much worsened U.S.

domestic investment climate in 2011 than in 2006 and a Congress that had more pressing

issues to address. But the nature of the stakeshale gas versus oilmight also be an

important distinction to make.

Stranko 8

10 CNOOC, full text

11 Nicholson (New York Times DealBook), full text


9/14


10/14

Zha Daojiong, a professor of international political economy at Peking University in Beijing,

was less confident that they were just inexperienced investors. He believes that Chinese

outward investment in the energy sector is motivated by more practical reasons. His take

was that investments in countries with high political risk and a chance of expropriation

were just testing grounds for bigger things. The goal is not to make absolute profits or be

able to claim a foothold in an important market. Instead, Chinese NOCs that are struggling

from decades of technical inferiority are using these opportunities to learn from more

sophisticated exploration and drilling methods. Given the vast amount of excess liquidity

floating around the central governments budgets, it is easy to make investments and walk

away if they are not productive so long as some innovation or learning to Chinese

engineers comes from it.14

In the oil space, this may be expertise on the how to drill in offshore wells. In the gas

space, this may involve finding new ways to turn a drill head multiple times so as to extract

more gas from the same tight spaces. Either way, according to Professor Zha, Chinese

joint ventures are looking for more than just profits in their investments overseas. He also

believes minor and moderate losses will be written off as trial and error experiments in the

greater going out strategy. In certain cases, like in the case of CNOOCs investment in

Chesapeake, Chinese NOCs will extract as much expertise and innovation as possible in

order to modernize processes and exploration technique in more favorable surface

environments.

Stranko 10

14 Personal Interview, Zha Daojiong


11/14

Will Chinese NOCs have to become more like their peers or will peers become morelike them?

Given the number of headline investments abroad that have failed, one might conclude

that Chinese NOCs are committing vast amounts of political and economic capital to

projects before properly vetting them. Certainly in the cases like PetroChinas failed bid for

Encana assets are illustrative. On the surface, it may seem that resource investment

xenophobia is rearing its head in parts of the hemisphere. But another interpretation that

observers can make from these experiences is that, while Chinas resource investment

record in the developing world has been largely successful, it has struggled in countries

with more transparent governments and stronger institutionalization.

And in these countries, like in the aforementioned purchase of ConocoPhillips assets in

Canada, companies and governments have demanded China pay a healthy premium to

play. Perhaps this happens because resource nationalism in places like the U.S. and

Stranko 11

Estimated Chinese Share of Overseas Equity in Oil-Exporting Countries

Chart credit: International Energy Agency


12/14

Canada has regulatory teeth, whereas in less-developed political systems large

companies can have a greater influence on the approval process. Perhaps also advanced

countries and oil companies understand that Chinese companies are not just paying for

the underlying asset but also the expertise and intellectual capital they can gain from these

partnerships.

On the whole, the most successful joint ventures and resource-based investments of

Chinese NOCs in the oil sector have, with few exceptions, taken place in non-OECD

jurisdictions and with companies that are not fully market-driven. Where they have failed

has been in those with fully transparent vetting processes in more advanced economies.

And although there could be a selection bias with Chinese companies unwilling to get

involved in areas where they know they will face challenges, the message state

companies are sending is clear. Even if it is not credible, investee governments like

Canada and the U.S. believe Chinese NOCs do not operate best where local standards of

governance, monitoring and accountability in joint ventures are superior to Chinas own. In

Canada, PetroChina could not convince the Canadian government that a lucrative deal

was in the national interest. Even in Brazil, Petrobras has not yet agreed to any equity

participation in its burgeoning oil production. Likewise, investors in these same

jurisdictions are demanding premiums for Chinese participation, possibly pricing in the loss

of intellectual capital and future revenue possibilities in China from proprietary knowledge.

The gas sector is different, though, and the deal with Chesapeake demonstrates that

Chinas NOCs are bullish about the potential to develop shale gas resources at home and

are willing to put up large sums of money to develop that expertise. Governments

understand that the gas will most likely be sold locally, and companies understand that

given the nature of shale, their expertise will likely be demanded even when the Chinese

Stranko 12


13/14

NOCs return home to drill. It also suggests that the localized nature of the gas industry

(that gas production is not as easily commodified and exported as oil) may not rouse the

same resource nationalism as oil. Finally, it demonstrates the types of compromises and

concessions Chinese NOCs are willing to make to work towards domestic production and

greater energy security at home.

The new phase of this going out strategy of the Chinese NOCs could simply be one of

diversification. Or perhaps the focus on the Western hemisphere may come from a

recognition that their traditional sources of supply in the Middle East are much more

vulnerable to political turmoil than they once thought. At the same time, recent moves into

the Brazilian energy sector may show a new strategy in the hemisphere, namely one of

cautious and long-term relationship building. This may be, in part, due to a maturing

Chinese view of the world and understanding of where their investments will fall under

more or less scrutiny. It also may come from the realization that companies Petrobras

does not work under fully market-scrutinized terms, and that the operating structure has

important commonalities with Chinese NOCs.

This is also why Latin America, more so than North America, stands at an important

crossroads between the two types of investment China has been making abroad. With few

exceptions, Latin American countries have much stronger institutions and more stable

governments than other recipients of Chinese inward investment. At the same time, there

is enough leeway in Latin American political and economic systems (including the

presence of large, state-owned resource companies) to broker deals with Chinese

companies without much external participation or democratic legitimacy.

Stranko 13


14/14

But clearly Chinas energy foray into the Western Hemisphere could dissipate as quick as

it materialized. Energy imports from the region account for only 5% of its total oil imports,

and this supply gap could easily be absorbed by production in the Middle East and

Southeast Asia. Still, as prices rise and supply is constrained by political instability and a

lack of investment in upstream exploration, China is likely to continue exploring

unconventional sources of supply.

Chinas interest and continued investment in risky projects will continue as long as it needs

to secure upstream oil supply at prices acceptable to the market. But it appears that

Chinese NOC interest in Western Hemisphere oil and gas production, then, is less a play

to gain short-term access to vast new sources of production to displace traditional

providers. Rather it looks more like a testing ground for developing new technology to use

at home and a platform for boosting ties for an uncertain energy future. For oil and gas

companies, and the governments that regulate them, Chinese capital has been an

important source of investment at broadly favorable terms. Given these complementaries,

and the contrast to the political and economic environments in traditional suppliers closer

to home, Chinese NOCs may well find the hemispheres storied resource nationalism less

risky than the systemic turmoil elsewhere.

Stranko 14

chinese energy expansion in the western hemipshere - for china's reform (bottelier)

Documents