China’s oil companies secure access to Middle East oil and gas reserves

The first few months of 2009 were notable for the large loans made by China’s government to Russia, Brazil and Venezuela in return for promises of oil supply. In contrast, China’s national oil companies appeared to be rather passive, despite the low oil price and the consequent attractive value of many assets. This has now changed.

The month of June 2009 saw China’s national oil companies appear to secure access to substantial oil and gas reserves in Iran and Iraq. At the beginning of the month it was announced in Iran that CNPC had replaced the French company, Total, as the main foreign participant in the development of Phase 11 of the South Pars gas field. Some 8% of the world’s reserves of natural gas lie in this field. Three weeks later the Canadian company, Addax, revealed that its board had agreed a take-over of the company by China’s Sinopec and that the deal would include some 42 million barrels of oil in the Kurdish region of Iraq. Finally, at the end of the month the only deal to be concluded in Iraq’s licensing round was by a consortium of BP and CNPC for the 7.3 billion barrel South Rumaila field.

The Middle East (excluding North Africa) holds about 60% of the world’s proven conventional oil reserves and about 40% of the world’s proven natural gas reserves. China is set to be one of the world’s largest importers of oil and gas. It is therefore no surprise that diplomatic, economic and energy relations between China and the countries of the Middle East have been systematically deepened over the last ten years.

Energy relations between China and Middle Eastern states take a number of forms:
•    Growing imports of oil, mainly crude oil, from the Middle East to China;
•    Investments by Chinese companies in oil and gas assets in the Middle East, mainly upstream;
•    Investments by Middle Eastern companies in oil assets in China, mainly downstream;
•    The provision of oil-field and construction services by Chinese companies in the Middle East.

In 1990s, Oman and Yemen dominated oil exports to China from the Middle East, as the crude oil from these countries had a low-sulphur content, or in oil-field jargon, was sweet. In contrast, most crude oil from the Middle East is rich in sulphur and is sour. China’s traditional refining capacity was constructed to process China’s domestic crude oil which is sweet. As a result, China has been slowly upgrading its refineries and constructing new refineries able to process sour crude oils from the Middle East. By the end of 2008, China’s refining capacity able to process sour crude oil amounted to some 20% of the country’s total capacity.

The proportion of oil from Saudi Arabia and Iran grew dramatically from late 1990s, but China’s ability to import the sour crude oils from Saudi, Iran and other Middle East exporters continues to be constrained by a shortage of suitable refining capacity. As a result the proportion of China’s oil imports from Middle East remain in the range 45-55% of total oil imports and China has put great effort into raising imports of sweet crude oil from Africa and Eurasia. A further reason for constraining the level of imports from the Middle East has been the desire to limit, as far as possible, the country’s dependence on the Middle East through diversifying sources of supply.

The years since 2000 have seen Chinese NOCs take a number of steps to gain access to investment opportunities in the Middle East, mainly in exploration and production, but also in the construction of refineries. The target investments are of two types. The first type comprises a small number of large or very large oil and gas fields in the countries with the major oil and gas reserves, such as Iran and, to a lesser extent Iraq, Saudi Arabia, Kuwait and the UAE. Before June 2009, only the Yadavaran oil field in Iran and the Al-Ahdab field in Iraq could be considered to be secure and substantial deals.

The second type of investment involves a number of smaller or higher risk projects which may yield commercial profits to the Chinese NOCs, but are not of a size as to be of strategic importance neither to the large NOCs nor to China’s government. Such investments are scattered across the Middle East.

The deals announced in June 2009, if implemented, dramatically enhance the future production of China’s oil companies, especially of CNPC, in the Middle East. Not only are the reserves significant, but the deals also place the Chinese in a strong position in Iran and Iraq, two countries which together hold 20% of the world’s oil reserves and 18% of the world’s gas reserves.

China and East Asia are potentially of as great importance to the Middle East oil and gas producers as the Middle East is to China and East Asia. Today some 68% of Middle Eastern oil exports flow to the Asia-Pacific region. Though only 8% reaches China, this proportion is set to rise. Further, 75% of Middle Eastern LNG goes to East Asia, mainly Japan and South Korea. None of China’s LNG imports come from the Middle East, but this is likely to change in the near future when LNG imports arrive from Iran and Qatar.  

As a consequence, certain national oil companies in the Middle East have been seeking opportunities to invest in China. The first of these was Saudi Aramco which entered negotiations with Sinopec as early as 1993 to construct new refining capacity at Qingdao, in Shandong Province. This project only came onstream in 2008. Saudi Aramco’s second refinery project with Sinopec, in Fujian Province, was commissioned in 2009. Another Saudi company, SABIC, plans to build a cracking plant in Tianjian, whilst the Kuwait Petroleum Corporation and the Qatar Petroleum Company also plan to build refinery and petrochemical plants. In addition, these companies plan to be involved in the construction of oil storage facilities as well as participating in the retail of oil products.

Though an inevitable logic underlies the growing engagement between governments and oil companies of the Middle East and of China, the relationship is not without its tensions, even in the purely commercial sphere. Saudi Arabia’s investments into China’s refining sector were delayed by more than ten years by the unattractive nature of the pricing system for oil products in China. More recently, in July 2009, China launched a trade dispute with Saudi Arabia over alleged dumping by Saudi of methanol.

China’s oil companies are far from focusing all their attention on the Middle East. June 2009 also saw agreements signed between China and Myanmar for the construction of oil and gas pipelines from the coast of Myanmar to south-west China. These pipelines will carry oil and gas not just from fields in Myanmar but also from the Middle East, thus reducing the costs and risks of transporting oil and gas by ship through the Malacca Straits and the South China Sea. This import route will supplement existing and soon-to-be-completed pipelines from Central Asia and Russia, and together they will significantly reduce China’s dependence on ships for oil and gas imports.

Further afield, CNPC is seeking to take over Ineos, British refining and petrochemical company, and both CNPC and CNOOC are in discussions with Spain’s Repsol over asset purchases and joint ventures worth billions of dollars.

Philip Andrews-Speed is Director of the Centre for Energy and Mineral Law and Policy at the University of Dundee, Scotland.

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