Reform of China’s oil industry at a time of low prices
Economic reform is high on the national agenda, at least according to the Third Plenary Session of the 18th Central Committee of the Communist Party of China, held more than two years ago in November 2013. Specific proposals included, among many others, allowing state-owned enterprises (SOEs) to draw on different sources of funding, improving the government systems for managing SOEs, obliging the SOEs to improve their economic performance and to compete on equal footing with other types of enterprise, promoting the private sector, enacting market rules that are fair, open and transparent, and, finally, allowing the prices of resources to be determined by the market. Whilst the reform agenda targets both the petroleum and electrical power industries, this column focuses solely on the oil and gas.
As I have described in an earlier column, moves to encourage the involvement of mixed sources of capital date back to 2010 when the Ministry of Land and Resources reclassified shale gas as an “independent mineral resource” in order to allow a wide variety of companies to acquire exploitation rights in the licensing rounds held in 2011 and 2012. In 2013, Sinopec sold a 30% share of its oil retail business to a group of 25 foreign and domestic investors and PetroChina sold a portion of its pipeline business in the west of China. Since then the government has been pressing PetroChina to sell off more of its pipelines in order to reduce its stranglehold over the domestic pipeline network that had allowed it to obstruct the implementation of the rather weak provisions for third-party access issued by the government in 2014.
In November 2015, the ever-declining oil prices and need for cash finally drove the PetroChina to sell a 50% share of its Trans-Asia Gas Pipeline Company to state-owned China Reform Holdings, raising about US$2.4 billion. This subsidiary manages the pipeline system that carries gas from Central Asia to western China. A further sale of three domestic trunk lines that could raise as much as US$47 billion is also said to be about to take place.
The most meaningful reforms have been taking place further downstream. Since 2012, the government has been progressively raising the quantity of crude oil that may be imported by companies other than the large national oil companies (NOCs). The main new importers are the small-scale refining companies, the so-called “tea-pot refiners”, which now operate more than 10% of the nation’s refinery capacity. They were permitted to import a total of 37.6 million tonnes of crude oil in 2015, more than 10% of the national total and, from this year, will be able to export their products. Private and local government enterprises are also heavily involved in city gas supply.
As oil prices continued to fall in December 2015 and January 2016, the government decided to remove the link between international and domestic prices for oil products when crude oil prices are below US$ 40 per barrel. The two justifications for this step are to avoid a surge in demand for oil products which would worsen pollution and to protect the NOCs from excessively low prices. In contrast, the government continued to lower city-gate gas prices during 2015 in order to boost natural gas consumption and reduce air pollution. Meanwhile, the price paid to gas producers remains constant in order to stimulate production. This pricing disconnect results in financial losses for pipeline companies and LNG importers.
So far, so gradual. What next? Should we expect an overhaul of SOEs, including the NOCs, similar to that of 1998 when the state sector was radically restructured and commercialised, with some companies being listed and millions of workers being laid off? The consensus among those whom I have met is that this is unlikely, for the risks facing the government are too great. Societal unrest is probably more difficult to contain than 20 years ago, not least due to the proliferation of social media and the ever-increasing gap in wealth and income.
The conflicting pressures on the government are well illustrated by the obvious tension between a series of announcements in December 2015 and January 2016. Media reports indicated that the government considers it essential to close or overhaul so-called “zombie” and “rust-belt” SOEs that are incurring massive financial losses or even have no sales at all. The rebalancing of the economy means that most such enterprises are within the heavy industry sector, notably steel, cement and coal. But at the same time, the government is demanding that SOEs employ the 300,000 soldiers who are about to lose their military jobs.
These and other conflicting priorities facing the government create a challenging context for the Presidents of Chinese NOCs. On the one hand, the senior management of the NOCs continues to be subject to the anti-corruption campaign. Regardless of the need for these measures, it necessarily creates paralysis in the corporate leadership. On the other hand, the companies are facing pressure from the government to improve their financial management and pay higher dividends to the state, at a time when oil prices are at and likely to remain at their lowest level in real terms since the NOCs were listed in the years 2000 and 2001. Finally, the government is committed to improving the safety and environmental performances of all companies, including the NOCs.
So what are the NOCs to do? They, and other energy SOES are cutting salaries, bonuses and other “fringe benefits”, but are reluctant to lay off large numbers of staff. As mentioned above, they can raise cash in the short-term by selling off assets and shares in subsidiaries. However, the operating costs of many domestic oil fields are significantly higher than the internationally-linked price that the NOCs receive. With its large refining capacity, Sinopec’s position allows it to benefit from the low crude oil price and the decision of the government to set a floor for product prices. More serious is the vast portfolio of overseas assets held by the NOCs, some of which probably have negative value today, notably in North American unconventional oil and gas plays. Who, if anybody, would want to buy these assets, and which Chinese CEO would dare to be labelled as the person who sold state assets at a major financial loss?
In the short-term, the government will probably be reluctant to either provide financial support to the NOCs or to impose any radical reform on them. In the absence of clear and robust signals from the government, the leaderships of the NOCs are likely to continue taking what measures they can to raise cash, yet without undertaking any substantial corporate restructuring. On the one hand, they will be hoping for higher prices sooner rather than later, on the other hand, the prevailing political environment is such that nobody wants to take major risks. With “politics in command”, as it is today, brave economic steps are off the agenda.