China's Big Play for Middle East Oil
China's Middle East energy footprint has been expanding. In February, it made a deal for a stake in Abu Dhabi’s onshore oil. In March, Saudi Arabia’s King Salman bin Abdulaziz travelled to China to strengthen trade ties, and now a Chinese consortium is lining up for a stake in the Aramco IPO.
Geopolitical trends favor deeper engagement, but Chinese companies need to show they can deliver.
The Chinese need new upstream opportunities. Domestic production from the country's highly mature fields has slumped: down 6.9 percent last year and 8 percent year-on-year so far in 2017. But, encouraged by the government to guarantee energy security, companies' capital budgets are set to soar again this year. Sinopec will spend as much as BP, and even at the low end of estimates, PetroChina, the listed unit of China National Petroleum Corp., or CNPC, will be the highest-spending listed oil company in the world.
Meanwhile, with concerns over shale oil competition and a possible peak of demand in developed countries, the Gulf Cooperation Council states want to secure their position in the Chinese market, now the world’s largest importer. They seek to hedge their geopolitical bets as the U.S. seems less reliable as a guarantor. And at a time of tight funds, Chinese direct investment is increasingly welcome.
As it has attempted with Russia with its OPEC cooperation, Saudi Arabia in particular has sought to lure China away from its patronage of Iran. Until recently, large-scale oil investment by Chinese companies in the Middle East was limited almost entirely to Iraq and Iran. Through CNPC and China National Offshore Oil Company, known as CNOOC, the country is the dominant player in the southern Iraqi fields, while Sinopec is prominent in the Kurdistan region, though its assets have underperformed.
Sinopec and CNPC continued activities in Iran, though at a low level, through the period of heavy international sanctions. The Iranians regard Chinese companies with skepticism over delays, alleged lack of quality and overcharging, but realize they cannot do without them. China is likely to provide leading players when foreign investment gains pace after Iran’s new petroleum contract and the results of its presidential election later this month. In November, CNPC partnered with Total to sign a preliminary agreement on Phase 11 of the supergiant South Pars gas field in November.
By contrast, direct investment by China in the GCC’s oil industry was limited until recently. Formal joint ventures with Saudi Arabia orbit around the downstream: refineries at Yanbu and Rabigh in the kingdom, Fujian and a planned one at Yunnan in China, and petrochemicals in both countries. This is consistent with Saudi Arabia’s strategy of assuring global market access. But it did not give the Chinese what they have sought: access to oil production.
Now, the Saudis have somewhat changed tack. China Investment Corp., its sovereign wealth fund and its largest oil company, CNPC, may both become anchor investors in the Aramco IPO, giving them an indirect stake in the Saudi upstream. The Saudis’ optimistic valuation may lean heavily on Beijing’s support.
The renewal of the concession of the Abu Dhabi Company for Onshore Petroleum Operations, or ADCO, offered more direct participation. Following the award of stakes to Total, Korea’s GS, Japan’s Inpex and BP, CNPC picked up 8 percent and its compatriot China Energy, known as CEFC, got 4 percent in February. CNPC was already a player in Abu Dhabi’s oil fields via its 2014 joint venture Al Yasat.
CNPC’s interest in Abu Dhabi’s large, long-life reserves is understandable. But the role of CEFC, a private company under the leadership of 39 year-old oil trader Ye Jianming, is more surprising. It has risen swiftly to prominence, with close links to the Chinese government, military and Beijing’s “One Belt, One Road” grand strategy. CEFC has built on its oil trading, storage and transportation business, which include the first private storage to be leased for China’s strategic petroleum reserve.
The company, which has minimal upstream assets to date, claims the deal has brought it 10 million metric tons per year of crude oil from Abu Dhabi, about 200 000 barrels per day. This is in line with the total 12 percent stake of CEFC and CNPC, given that ADCO is expanding output to 1.6 million bpd.
CNPC’s technical skills do not appear to be ideally suited to Abu Dhabi’s fields, and CEFC has close to no upstream experience. Their participation brings an assured market while strengthening China’s political and security commitment to the UAE. And, like the potential consortium for the Aramco IPO, they illustrate Beijing’s ability to mobilize engineering and financial expertise in support of China Inc.
But have Chinese investments in the Gulf upstream reached a natural limit for now? Other than Iran or acquiring something directly from a Western major, there are not too many other juicy targets left. Already bitten by political risk in other flagship ventures in Syria and South Sudan, CNPC, CNOOC and Sinopec are heavily exposed to Iraq’s risky and low-return environment. Kuwait and Saudi Arabia are unlikely to open their upstream for direct participation, while contracts for Qatar’s major oilfields have been renewed with others. The only significant upcoming opportunity is the 2018 expiry of the Abu Dhabi Marine Areas concession.
And Chinese companies need to demonstrate that they are able to do the job. The CNPC subsidiary that built Abu Dhabi’s key strategic oil pipeline to the Indian Ocean port of Fujairah was heavily criticized over construction faults. As with BP in Iraq’s Rumaila field and Total in South Pars, Chinese firms may lean on international partners for technical and management skills in tricky, novel environments.
The deepening Gulf-China oil cooperation reflects natural and inevitable political and economic trends. Its recent acceleration comes from the coincidence of timing of opportunities with the market downturn. But though such energy ventures meet the needs of both sides, China needs to learn fast to make the most of its momentum.
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