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The Challenges Facing China's Oil Behemoth Abroad

"PetroDragon" expert Xu Xiaojie talks about the overseas opportunities and hurdles—including those in Sudan—facing China National Petroleum

State-owned China National Petroleum Corp. (CNPC) is the parent company of PetroChina (PTR), the Hong Kong and Shanghai-listed oil and gas behemoth. As CNPC's listed arm, PetroChina last November became the world's most valuable company, with a market capitalization that topped $1 trillion, the first and only company in the world to do so.

More recently, however, PetroChina has fallen back to earth, its stock plunging more than 40%. The company is facing new challenges, including slowing production in its mainland oil fields, new taxes from Beijing that are biting into profits, and growing notoriety for its role as the top investor in Sudan, a country targeted by international activists for human rights abuses (BusinessWeek, 2/28/08).

CNPC counterpart China National Offshore Oil, parent company of CNOOC (CEO), China's largest offshore player, is back in the news, too. Its $16 billion plan to jointly develop Iranian gas fields is drawing concern in Washington as lawmakers there push for sanctions against Iran's nuclear program.

After working for 25 years at China's largest oil and gas outfit, Xu Xiaojie now serves as director of the Institute of Overseas Investment at CNPC's Research Academy of Economics & Technology. He also is a participating fellow at the James A. Baker Institute for Public Policy Energy Forum at Rice University in Houston and the author of PetroDragon's Rise: What It Means for China and the World (European Press, 2002). The 48-year-old Xu recently sat down at the Westin Hotel in Beijing for a two-hour-plus interview with BusinessWeek China bureau chief Dexter Roberts to discuss the company's overseas development, the new challenges facing CNPC and PetroChina, and why his company will continue to do business with Sudan. Edited excerpts follow:

Your investment in Sudan is highly controversial. How do you answer those who are criticizing your company and China for being there?

For CNPC we are very carefully handling the political issues in Sudan, including the Darfur issue. Our goal is to do something good for the country and for the people there. And we have done much for their economy and helped them change from an oil importer to a big exporter. And we know that if we shut down our projects in Sudan this is not good for anyone—including the people of Sudan, the African region, and not good for China as well.

We will keep doing our business as an oil company. But of course, we will also cooperate with the government there and with the international community as well. But we do have some principles. We don't want to force them to change. We will forward messages from the international community to them. And we can work with international agencies to encourage them to improve their behavior. We actually have made great efforts there. But finally this is a political issue, and CNPC doesn't like to act as a political agent. CNPC is an oil company.

What have been some of the challenges you have faced while developing abroad?

In countries including Venezuela, Ecuador, Russia, and Kazakhstan, they are starting to rethink their opening to foreign direct investment as oil prices get higher. Many foreign companies have made most of their investment in upstream operations but put little in downstream projects. This isn't such a good situation when a country wants to develop its whole industry.

Some countries are starting to create compulsory terms for investment. So if you want to get permission to invest in upstream, then you also have to commit to some investment in downstream projects. These are new changes. Nigeria is one country that is doing it this way. Algeria and Libya also now much more emphasize national interests and are rethinking the privatization of these industries. This means that countries will levy high prices on foreign companies and raise the percentage of ownership held by their own national companies.

And now we have concerns in Sudan, too. They are looking at changing some investment terms, including raising taxes and having more stringent policies when cooperating with foreign companies. And this country is a special challenge because they are facing a referendum on independence between the north and south in the next few years. The question is whether the south maintains itself as a part of the north. Our projects in Sudan cross both regions where there is the potential for a war. So this is a major, major potential impact on our company. Now we are just studying the situation.

To what degree should observers see CNPC and PetroChina as agents of the Chinese government?

I fully oppose this viewpoint. In fact, before 1997 all projects that CNPC developed overseas were not approved by the government at all. At that time, the central government's argument was that China is a developing country, so any extra capital should be used at home. So CNPC's top management took a big risk. If they had lost money overseas then management would have lost their job. Fortunately all the projects, big and small, have been successful. China has benefited and that has shown the government that we have done the right thing going overseas. This helped the leadership decide on the appropriateness of the going-abroad strategy. The government realizes there is a growing need for resources from abroad and not just oil and gas but all kinds of resources. Also, we have realized the wisdom of not only introducing foreign investment into China, but that we also have to step out of China to work with others globally.

And is Beijing supporting financially your expansion overseas?

The government uses taxation and foreign-exchange policies to help companies going abroad, of course, but nothing else. Banks give us loans, but they are commercial. They like to work with us for purely commercial reasons. Going abroad is a national policy and not only for oil companies. But the government can't order companies what to do because now we have a market economy. Instead, the government simply encourages companies to go abroad to take advantage of low-cost products and operations. But outside China, our companies compete seriously with their peers without any government support.

Do you think that Chinese oil and gas companies can cooperate more abroad with international companies in exploration and development?

It is only in the beginning stages so there is still big room to expand. We have had very good relationships with companies like Canada's Talisman (TLM) and Malaysia's Petronas in the Sudan. Now Talisman has left. We also have had good relations with India's Oil & Natural Gas Corp. (ONGC) operating together in Sudan and Syria. Even though India and China sometimes compete for the same resources, our companies still have been able to cooperate closely. And we also have close relations with the Norwegian oil company Statoil (STO) and with France's Total (TOT) both inside and outside of China.

We would like to expand our international cooperation with Western oil majors. We have cooperated very well in China, but we would also like to cooperate more with them overseas. We realize we face common problems in developing countries like Venezuela. Sometimes we should consider standing together when we negotiate with host countries. If CNPC only negotiates alone with a host country, this gives the world the incorrect image. It looks like CNPC is working closely with Venezuela, for example, with the Chinese government's political support. But by working together with other international companies we can overcome that image.

I realize that cooperation is tough. But we might be able to start by cooperating more in the Gulf region—in Iraq for example. CNPC actually has had a big project in Iraq. And we don't like to lose our piece of that big pie. So why don't we work together with international Western majors in Iraq? Another place I think might be in an African country like Nigeria. I know that some of the Western majors like Shell (RD) have encountered some hardships and problems in Nigeria. Well, CNOOC has a big project in Nigeria. So I believe there is big room for those two to work together there.

What will CNPC and PetroChina's business performance look like going forward?

Domestically, many of our fields are mature, especially in the east part of the country, so production there is decreasing. In the west part of the country it is not easy to increase production without having high costs. There is high geological risk which requires a higher investment [than] the same size investment in Africa, for example. But this dilemma is the same one facing international oil companies around the world, and especially for American oil companies, of course.

As a result, overseas production will become a bigger and bigger proportion of our business. Of course we are facing tough issues downstream in China. We are also facing new levies on our company, including windfall taxes. And we have those high costs of development at home. But CNPC can still make huge money from high oil prices as our upstream business keeps growing strongly at home and abroad. I think our future will be bright.

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