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China's increased focus on energy security is driving a
revitalization phase. This shift follows a long period of muted
investment caused by lower oil and gas prices, coupled with
unsuccessful efforts to replicate US success in unconventionals
resource production. A government push to increase production is
resulting in commitments from domestic national oil companies
(NOCs) to ramp up domestic production and increase foreign
participation. This is clearly welcome news for companies holding
existing acreage, who will assess recent policy changes and signals
to better position themselves in China. The implementation of the
NOC plans, along with a government drive for more diversified
participants in the exploration and production (E&P) sector,
could signal an improved trajectory for investment and
production.
China's Energy Security Concern
As the largest oil and gas importer in the world, China appears
ready to rejuvenate its E&P sector. Domestic oil production has
been declining since 2016, caused by a highly mature resource base.
The widespread use of enhanced oil recovery-related solutions for
major producing fields was very expensive, making domestic
resources less competitive. Although China has huge unconventional
gas resources, the ability to translate them into real production
volumes has been difficult, and it has not been possible to meet
the government's nconventional gas targets. Complex subsurface
conditions and above-ground risks contributed to the challenge.
China's dependency on imported oil reached a level of 70% in
2018. This increased dependency on imported oil and gas made energy
security a top priority for the Chinese government. The China-US
trade dispute has only accentuated China's energy security concern.
The US shale revolution has made US a net exporter, and it will
become the biggest contributor to crude production growth in the
coming years. This combination of factors is further driving China
to accelerate its energy security strategy and execution.
Yet energy security is not a new concern for China. Security
drove Chinese NOCs to expand their international portfolios
aggressively from 2009 to 2013, when the oil price was above $100
per barrel. During those years, China's economy was rapidly
expanding, driving increasing oil demand. With oil prices
forecasted to continue increasing - given the rising global demand
from developing countries like China and India - aggressive
international merger and acquisition activity (M&A) was
considered the most viable strategy for Chinese NOCs. However, the
oil price crash in 2014 put a brake on that approach. Assets
acquired at high cost became burdens to the NOCs, and further
expansion was no longer a viable route.
After some portfolio reassessment and consolidation, it was
expected that international M&A activity would rebound as
prices recovered. Instead, NOCs renewed their focus on domestic
assets as a source of production growth (see Figure 1).
NOCs in Action
Echoing the government's call for domestic oil and gas
production increases, the major NOCs committed to China's
Seven-Year Action Plans. The plans, which focus on domestic
upstream production from 2019 to 2025, are orchestrated by the
National Energy Administration.
China National Petroleum Corporation (CNPC) and China National
Offshore Oil Corporation (CNOOC) disclosed key targets of their
Seven-Year Action plans. CNPC focuses on production growth and
reserve addition in its four core regions: Xinjiang, Songliao,
Changqing, and the Southeast regions. CNOOC set the target of "two
twenty millions:" 20 million cubic meters of gas in the western
South China Sea and 20 million metric tons of oil in the eastern
South China Sea (see Figure 2).
The emphasis on exploration, especially in frontier areas,
reflects the challenges of production growth with maturing
producing portfolios. Both CNPC and CNOOC plan to increase
exploration spending. CNPC will spend 5 billion yuan (US$640
million) per year on frontier exploration, five times the current
spending level. By 2025, CNOOC aims to double exploration
activities and proven reserves compared with its 2017 level.
Unsurprisingly, shale and tight gas remain a key focus for the
NOCs. CNPC aims to produce 24 billion cubic meters (bcm) of shale
gas (from 4.2 bcm in 2018) and 35 bcm of tight gas in 2025. The
organization will spend 54 billion yuan (US$7.8 billion) on shale
gas in the Sichuan basin in the next seven years. CNPC also
revealed its four-step strategy for shale gas in Sichuan earlier
this year, aiming to produce 42 bcm in 2035.
The improved economics of shale gas - coupled with a more
investor-friendly regulatory environment and clear commitments from
the NOCs - provides a basis for achieving these targets. However,
challenges around oilfield service capacity, as well as the
anti-hydraulic fracturing sentiment in the earthquake-prone Sichuan
region, add complexity.
Policy Reforms to Attract Foreign Investors
Over the years, the Chinese government has been exploring
reforms and incentive programs to vitalize the industry. The
reforms focused on four areas:
Optimizing subsidy and tax-reduction programs for
unconventionals
Piloting new acreage awards and exit mechanisms to diversify
participants
Improving administration and simplifying approval
requirements
Improving wellhead price and pipeline access with citygate gas
price and pipeline reforms
Subsidies were the primary tools used to incentivize
unconventionals when activity started. Even in May 2019, a new
unconventional gas subsidy program includes tight gas for the first
time. It offers extra weighting for coal bed methane and production
growth in heating season.
Since 2017, policy focus gradually shifted from subsidies to
structural reform. A May 2017 government document, "Several
Opinions on Deepening Oil and Gas Reform," set the blueprint for
reform. It aimed to create a new E&P competitive landscape in
China, which is dominated by the NOCs, has diversified
participants, and includes new acreage-awarding and exit
mechanisms. Reform plans have been significantly accelerated since
the China-US trade dispute escalated in 2018.
Several new policies have been released to attract foreign
investors, including eliminating approval by the National
Development and Reform Commission for the Overall Development
Program and piloting different acreage-awarding methods. A more
recent step is to allow foreign investors to invest in upstream
projects independently, without partnering or forming a joint
venture with the NOCs.
Through these policy updates the government also has sent clear
signals to foreign investors, encouraging participation in China's
E&P. Yet attracting new foreign players poses continued
obstacles, such as the availability of attractive assets for
foreign companies.
More incentives and reforms can be expected to further open the
market, as China aims to secure its energy supply by producing more
domestic oil and gas. Overall, these recent steps are positive.
However, they also should be compared to the competition from other
countries that are making positive changes to attract their own new
investors.
Posted 06 November 2019 by Kunfeng Zhu, Associate Director and
Nick Sharma, Executive Director, Global Upstream Oil & Gas