[NGW Magazine] China extends its overseas reach

This article is featured in NGW Magazine Volume 2, Issue 21

China has expanded its overseas gas production efforts in line with its foreign and economic policy and is using physical or financial power to secure its passage home.

With its global bargaining power rising, China is launching initiatives such as the ‘One Belt One Road’ while continuing to pursue its old strategies such as claiming the South China Sea, part of the Maritime Silk Route.

According to the BP Statistical Review 2017, gas demand grew 7.7% to 210.3bn m³ in 2016 while gas production rose just 1.4% to 124.6bn m³, and other fossil fue output declined. China’s gas supplies will exceed 360bn m³ by 2020, according to China’s National Development and Reform Commission (NDRC).

NDRC also projected that proven reserves of conventional gas will go up by 3 trillion m³ and shale gas reserves will grow by 1 trillion m³ by 2020. NDRC said: “The country will encourage the more qualified enterprises to get involved in natural gas imports based on market-oriented principles.” Incentives are already increasing inward foreign investment, especially from international oil and gas majors who are collaborating with state-owned enterprises.

China handles its overseas oil and gas production via its three main state-owned representatives: Petrochina/CNPC, China National Overseas Oil Corp (CNPC) and Sinopec. 'Capitalism with Chinese characteristics' means these companies can develop and produce hydrocarbons while still competing for the same pool of political, financial and physical capital and resources, with an “internal” free-market dynamic.

Increasing co-operation with Russia

In recent years, co-operation between China and Russia in the upstream sector has risen, with the duo participating in significant projects in each other’s upstream sector. This encompasses several segments of the industry and Rosneft appears to be more adroit at dealing with China than Gazprom, which is yet to agree a price with China. Gazprom is only one of many gas suppliers courting China, something it is not used to after decades of dealing with pipeline-dependent Europe.

Rosneft and Beijing Gas Group signed a shareholder and operating agreement for the Chinese company’s 20% stake in Verkhnechonskneftegaz. According to Rosneft, this transaction will enable both companies to develop the Verkhnechonsk field including gas production and access to China's natural gas distribution network. With an initial evaluation of $3.2/barrel of oil equivalent reserves, the  field has 173mn metric tons of oil and gas condensate and 115bn m³ gas, using Russia’s generous C1-C2 definition for classifying reserves, which ignores the economics.

The liquids production level is now 8.5mn metric tons (mt)/yr. All the oil from the field is transported for export via a section of the East Siberia-Pacific Ocean pipeline from the Kozmino Port. By 2020, the throughput of the ESPO-1 and ESPO-2 pipelines will increase to 80mn mt/yr and 50mn  mt/yr respectively. It is expected to ensure China’s gas supply. 

Map from http://en.transneft.ru/about/projects/current/1204/

 For the last two years, China Oilfield Services (COS) has been contracted to drill in Russia’s offshore. The deepwater semi-submersible rigs Nanhai-8 and Nanhai-9 were contracted in 2016 for the important exploration wells Magadan-1 and Ulberikanskaya-1 in the Sea of Okhotsk. Nanhai-8 is drilling another well offshore Russia.

These wells were key to exploring frontier areas offshore Russia but they also allowed COS to expand its drilling and technical services to include experience in the Arctic region. This also contributes to China’s own domestic gas exploration and development efforts, especially in deeper waters.

More recently, Russian gas exporter Gazprom, CNPC and state KazMunaiGaz signed a MoU at the seventh St Petersburg International Gas Forum. They agreed on long-term strategic co-operation in the natural gas vehicle market, including building refuelling infrastructure along the Europe-China international transport corridor.

This agreement is expected to initiate an assessment of the potential number of liquefied natural gas-powered trucks and the amount of natural gas that could be used for refuelling them along the Russian, Kazakh and Chinese sections of the route by 2030. This sets the tone for connecting regional gas transportation systems linking offshore supply to landlocked countries in central Asia, such as Kazakhstan.

China receives an annual supply of 0.4bn m³/yr by pipeline from Kazakhstan out of a total 34.1bn m³/yr from Kazakhstan, Turkmenistan and Uzbekistan. China receives 4.3bn m³ from Uzbekistan such as the Russian-operated projects Kandym-Khauzak-Shady and the Gissar cluster. China also receives 29.4bn m³ from Turkmenistan, which has received generous loans to finance gas production.

The agreement with Gazprom and KazMunaiGaz will not only improve China’s international image and regional gas supply security: it can also be one of several options it has to ease temporary gas oversupply in certain areas, while building on existing gas supply routes.

China elsewhere

China imported 34.3bn m³ of liquefied natural gas in 2016, some of which came from major projects in which Chinese companies are shareholders.

From a region which has historically paid it tribute, southeast Asia, China received just 3.7bn m³ from Indonesia and 3.4bn m³ from Malaysia, and these were the highest contributors of all the southeast Asian countries last year. Southeast Asia falls within China’s global influence and is a part of the One Belt One Road so the potential for growth in energy trade and supply is evident.

A key project is in Indonesia, where Husky Energy and Cnooc have been jointly operating the Madura Strait production-sharing contract for almost a decade. More recently the BD gas field started up in the second half of 2016 at peak production of about 25,500 barrels of oil equivalent (boe)/day.

China also owns about 13.90% of the Indonesian Tangguh LNG project, operated by the UK major BP; and a 5.3% stake in the Australian North West Shelf LNG project. The LNG sourced from the North West Shelf LNG and the Tangguh LNG projects anchor long-term gas supply contracts to end-users via the Dapeng and Putian LNG terminals in China.

Australia is China’s main source of LNG – a total of 15.7bn m³ came from there in 2016, while its second largest, Qatar, provided 6.5bn m³/yr  China and Australia have strong trade links in other energy components as well, which further ensures China’s gas supply remains reliable. Key are Gorgon, Asia Pacific LNG and QC LNG, although China's appetite for LNG has been greater than its willingness to pay in recent years, as the oversupply of LNG mounts. This year however it is already importing much more LNG than last year.

In Africa, Cnooc has reserves of 138.0mn boe and produces 80,297 boe/day, which represents 3.6% and 6.2% of total reserves and daily production respectively. The company owns a 45% stake in the OML 130 block in Nigeria, a deepwater project involving four oilfields: Akpo, Egina, Egina South and Preowei. The Akpo oilfield produces 62,000b/d and the Egina development is ongoing.

Nexen Petroleum, a Cnooc company, also owns 20% of the Usan oilfield in offshore Nigeria, another landmark oil and gas production base in west Africa. Elsewhere in the world, China’s state owned oil company Cnooc also owns stakes in the EagleFord and Niobrara shale oil and gas projects in the US, as well as the Buzzard oilfield and Golden Eagle oilfields in the North Sea.

Recent news reports have mentioned some China buyers had initial talks with Alaska LNG regarding the LNG imports into the Chinese market. According to Alaska Gasline Development Corporation, senior China NOCs buyers have visited North Slope facilities and considered it a potential “supplier for reliable, low-cost, clean energy.” But that project has been stalled for years, as cheaper gas is available elsewhere in North America.

Another move which is critical to China’s overseas gas production or a result of China holding equity gas overseas, is the usage of yuan-based resource contracts to encourage trading activities and sufficient liquidity. As suppliers warm to the idea of accepting renminbi as mode of payment, there will be effects on pricings. Being a major, if not the biggest consumer, China is already a price-maker and now has plans to become a benchmark in oil price and therefore gas pricing.

China has the ability to price oil and gas in yuan using a gold-backed futures contract in Shanghai, which it hopes will offer alternatives to traditional pricing benchmarks such as WTI and Brent, and eventually Henry Hub.

While all the signs indicate an overall positive picture, there are also other risks. Many of these infrastructure projects have long lead times, increasing the lending and credit risks and the absolute investment returns.

Also, international factors add to the complexity of physical infrastructure that has to straddle borders, as well as the complications from contractual agreements which if incomplete, leave an open door to currency fluctuations and foreign policy changes, especially with regards to historic sovereignty..

South China Sea

The South China Sea route is key to its investments in southeast Asia, Oceania and North Africa and security needs to be guaranteed to ensure the continuous flow of trade including energy supplies through the Indian Ocean and the South Pacific Ocean. China last year imported 68% of its crude, the highest ever proportion.

The South China Sea territorial legitimization process has come a long way since the American Crestone Energy Corporation-Conoco concession conflict in 1994-1996. Even though several countries including China, Vietnam, the Philippines, Brunei Malaysia claim territory in the Paracel and Spratlys Islands, last year a landmark decision was made by the International Court in Hague, awarding sovereignty to the Philippines, Chinese representatives being absent when the decision was announced.

While there was a great deal of soft and hard power posturing, it appears China and the Philippines are ready to work on Service Contract 57, north of the Malampaya gas field, a decision which was endorsed by the Philippines' Department of Energy in September.

But the likelihood of this particular project proceeding seems low and the delay shows the tensions that can suddenly be brought into play in sensitive areas such as this.

It also shows China’s increased efforts at opening up to foreign collaboration in offshore gas development projects while not recognising absolute sovereignty rights claimed by others. While China continues to build islands in the South China Sea, the ownership of its spoils will remain contested for the foreseeable future.