Chinese oil giants may buy oil collectively—if they can find a way to cooperate
China’s four state-owned oil giants are reportedly discussing the formation of a group to buy foreign crude oil in unison. The problem with this purchasing group isn’t the logic underpinning it, but the divergent interests of the companies themselves and the sharp-edged history between them.
Scott McKnight - June 30, 2020
China’s four state-owned oil giants are reportedly discussing the formation of a group to buy foreign crude oil in unison. On the surface, the plan makes sense. Since China is the world’s largest oil-importing countries—and each of these individual companies is a high-volume buyer of oil on its own—the purchasing group would greatly increase each company’s buying power, diversify risks in times of crisis, and push down prices as oil exporters jockeyed to offload its production in China’s enormous market. The buying group would also likely enhance China’s ‘energy security’, a term that has again become something of an obsession for the Chinese party-state as it becomes locked in trade wars with the United States and the European Union as well as a territorial conflict with India, among other disputes.
“The coronavirus-induced oil market collapse has hit Chinese NOCs especially hard. Not only are these companies major oil refiners, they are also significant oil producers.”
The four firms that make up the possible consortium—CNPC (中石油), Sinopec (中石化), CNOOC (中海油) and Sinochem (中化集团)—collectively import over 5 million barrels per day (bpd), the equivalent of about one-fifth of the roughly 24m bpd that the Organization of Petroleum Exporting Countries (OPEC) produced in May. In the past decade, China’s crude oil imports have nearly tripled, from less than 15m tonnes in 2009 to nearly 45m tonnes in late 2019 before the onset of the coronavirus pandemic.
The problem with this purchasing group isn’t the logic underpinning it, but the divergent interests of the companies themselves, to say nothing of the sharp-edged history between them. Although each is a national oil company (NOC) and therefore state-owned, China’s oil giants have proven stubbornly profit-oriented and resistant to reforms and oversight. Since the industry-transforming reforms of 1997-98 ended the monopoly of each of these companies in one segment of the oil business (for example, CNPC monopolized onshore upstream operations, Sinopec monopolized refining operations), the reforms effectively converted each of these companies into competitors. Their respective listings on foreign stock exchanges at the turn of the century only guaranteed that these companies would pursue profits, including voraciously searching for oil and gas assets abroad as part of the ‘go out’ strategy, while still balancing the objectives of the Chinese party-state.
What’s driving cooperation?
Apart from the obvious market logic of cooperation, three factors seem to be motivating the formation of the group. First, the coronavirus-induced oil market collapse has hit Chinese NOCs especially hard. Not only are these companies major oil refiners (Sinopec is the largest oil refiner in the world with a refining capacity of 5.8m bpd), they are also significant oil producers. Together they account for practically all of the 4.2m bpd that China produced in 2019, good for fifth among countries by production.
Source: www.globaldata.com
Old and mature
The problem is that, while this falls way short of China’s domestic demand, much of this production comes from mature or ‘legacy’ oilfields, none more famous (or older) than Daqing. The northeastern field was discovered in 1959-60 and catapulted China into the upper echelon of oil-producing countries. These older fields are infamously expensive to operate, suffering from either difficult geology or declining pressure levels, two factors among others that makes these fields unprofitable in the current low-price environment.
The Chinese government, committed to achieving some degree of China’s oil self-sufficiency and reflecting the powerful influence that these NOCs exert on Chinese governments at all levels, has guaranteed a price of $40 per barrel. So, while much of the rest of the world is shuddering wells, drastically scaling back production and some even declaring bankruptcy—especially shale and ‘tar sands’ producers in North America—these price floors partially help to protect the bottom lines of China’s NOCs. (It also makes refining in China obscenely profitable amid these low prices, which explains why China’s oil imports surged despite the coronavirus lockdowns). But even these price protections haven’t spared these NOCs. PetroChina, the listed ‘child’ of CNPC, made the biggest cuts to capital expenditure, slashing nearly 32% this year. Similarly, CNOOC, the specialized offshore oil and gas producer, has floundered under high levels of debt and with expensive assets abroad. On June 29, the company announced a significant find in the shallow waters of the Pearl River Mouth basin.
Becoming more flexible, not just more diverse
The second factor driving this push for buying coordination is China’s search for greater flexibility in the volumes and sources of its oil purchases. China’s emergence as the world’s largest oil importer since early 2018, the natural result of nearly four decades of rapid economic growth in the world’s most populous country, has greatly impacted world oil markets. It has also made major oil exporters, seeing stagnant oil demand in Europe and the ‘shale revolution’ in the United States, turn to Asia and China in particular to offload large volumes of oil.
For the last twenty years and in pursuit of ‘energy security’, China has successfully diversified its sources of oil, cautious of becoming overdependent on any single source. The Middle East as a whole still accounts for about half of China’s oil imports, though this is spread over nine countries. Fifteen countries collectively provide over 90% of China’s oil importers; Saudi Arabia, the largest supplier, provides almost 17% of the total. China’s search for reliable sources of energy has also motivated its push to deepen energy ties with Russia, as this solidifies a transport route of oil and natural gas that avoids strategically vulnerable sea lanes. The same logic applies to China’s deepening energy ties with energy-rich central Asian republics Kazakhstan and Turkmenistan.
This pursuit of greater reliability and prices in the oil China imports also led to the central government granting independent or ‘teapot’ refineries (let’s not confuse ‘teapot’ with small; they certainly are not). Many of these ‘teapots’ are located in the coastal province of Shandong and thus have ready access to ports and pipeline infrastructure, a key reason why Russian and Brazilian oil imports have risen sharply over the past decade.
Both China’s enormous demand for oil done by many purchasers—the NOCs as well as the teapots—have naturally altered the countries from which China imports this oil as well. While the two largest countries are both the de facto leaders of the OPEC+ group—Saudi Arabia and Russia sold China 9.16m tonnes and 7.71m tonnes respectively in 2019—these purchases take different forms and, as talks of forming this purchasing group show, could be done differently so as to benefit China and to increase the profit margins of China’s NOCs.
On the one hand, Saudi Arabia, United Arab Emirates (UAE) and Iraq sell their oil through long-term contracts, which have fixed terms and are usually negotiated on a monthly basis. While this is contracting form is stable, it can also be inflexible, as the oil market collapse of the last several months showed.
On the other hand, the trading arms of China’s NOCs, including Unipec (Sinopec) and Chinaoil (CNPC), also purchase oil from the spot market. This contracting form grants the companies greater flexibility in delivery and prices. With the Chinese city of Wuhan as the epicentre of the novel coronavirus, which sparked nationwide lockdowns and shrunk China’s oil demand by one-fourth (about 4m bpd), China struggled to manage the previously agreed upon import volumes from those long-term contracts. India, another massive oil importer, declared force majeure and effectively refused to accept oil shipments.
Rely on ourselves and trust no one
The Chinese party-state has never been fully comfortable with being a net oil importer, a fact it has had to live with in greater volumes since 1993. This leads us to the third factor driving this push for coordination between China’s oil giants: the central government itself. Xi Jinping has insisted on China becoming self-sufficient in a long list of ‘strategic’ sectors. Since the summer of 2018, this has reignited the Maoist urge to be self-sufficient in energy production, which led China’s NOCs to ramp up capital spending in domestic fields with only a marginal increase in production. Conflicts with the US and EU over trade, the status of Hong Kong and the fate of Muslim minorities in China’s far west; actual physical fighting between Chinese and Indian troops over disputed territories thousands of feet in the Himalayans; and Canada over the detention of Huawei executive Meng Wanzhou (something I’ve commented on here and here), among others—all of these disputes have only bolstered the party-state’s view that China must defend its interests and be reliant on no one in doing so.
Conclusion: Be wary
The creation of an oil-importing monopsony would benefit China’s NOCs and the party-state more broadly. It would increase the bargaining power of the companies and likely lower prices on imports. It may not result in a changed contracting approach with the massive oil exporters like Saudi Arabia that prefer to deal in long-term contracts, but it may result in better prices for Chinese purchasers. In the broader context in which the Chinese party-state finds itself in disputes with multiple countries at the same time, it may also help to ensure a steady and reliable flow of oil, though this is questionable. What is more doubtful is the ability of China’s NOCs, each powerful in their own right and deeply self-interested, to put aside past differences and unite around the common goal of better prices and more reliable oil. The fact that there has been no official comment on the details of the plan as of yet should indicate that the central government, however supportive of a purchasing group, is also realistic on the possibility of it coming to fruition.
