Long the dominant drivers of the world’s economy, the “advanced” economies of North America and Europe saw that dominance weaken as the Twentieth Century drew to a close, although they still accounted for almost one-half of the world’s economic growth over the decade of the 1990s.

But Asia was on the rise. Accounting for about one-third of the world’s economic growth in the 1990s, the Asian economies (both the advanced and developing economies) saw their share of the world’s economic growth increase to almost 40% during the 2000-05 period and to almost 50% during the 2005-10 period, surpassing the share of the North American and European economies.

More dramatically, however, according to the forecasts of the International Monetary Fund (IMF), over the next five years, Asian economies will account for about 50% of the world’s growth, while the former leaders, North America and Europe, remain at about 25%.

Asian growth will be led by China and India. The IMF expects China alone will account for almost 30% of the world's growth over the next five years.

The Rising Dragon

China is the world’s most populous country and the second largest consumer of oil. Consumption (including Hong Kong and Taiwan) has grown from slightly more than 2.0 million barrels per day (MMb/d) in 1980 to more than 10 MMb/d in 2010, while natural gas consumption grew from about 575 billion cubic feet (Bcf) to almost 4.5 trillion cubic feet (Tcf).

More critically, according to forecasts from the International Energy Agency, over the next 25 years, Chinese oil consumption is expected to almost double to more than 19 MMb/d, while natural gas consumption increases by a factor of five, reaching more than 22.4 Tcf.

The challenge for China is to develop or secure the supply necessary to meet this tremendous demand growth. China has substantial energy resources -- proved reserves of almost 15 Bbbl of oil and almost 100 Tcf of natural gas -- but these would not be sufficient to fuel the expected level of demand growth.

Even with its vast, technically recoverable unconventional gas resources in the form of shale and coal-seam gas (CSG), China is facing growing energy import dependence.

Oil, Gas Industry Structure

China’s oil and gas sector remains dominated by the three national oil companies (NOCs) -- China National Petroleum Corp. (CNPC or PetroChina), China Petroleum & Chemical Corp. (Sinopec), and the smaller China National Offshore Oil Corp. (CNOOC).

Each of these NOCs has listed business units on international exchanges, but these remain firmly under the control of state holding companies. Recent government restructuring of the NOCs has increased the commercial incentives of senior management although these continue to conform to the government’s energy policy objectives both in China and abroad.

The opportunities for foreign companies to develop onshore acreage are rare, although the government’s attempts to boost domestic oil and gas production have allowed selected foreign companies to carve out a niche in offshore basins and as partners to the NOCs in developing technically challenging onshore fields.

The need for Chinese NOCs to develop new technical skills to enhance oil and gas recovery and boost their competitive position has been the main driver behind recent increases in the number of production-sharing contracts signed with foreign partners.

China’s midstream and downstream sectors are undergoing rapid expansion as they aggressively compete to win market share. China’s two larger state oil companies and subsidiaries operate the majority of domestic oil refining capacity and the main oil and gas trunk lines.

Some foreign investors have been invited into the refining sector by the NOCs in return for providing long-term crude oil supplies or project management skills for new planned facilities, and foreign companies also benefit from selling LNG to China’s growing numbers of regasification terminals.

Policy Objectives

China’s prodigious economic growth has led to a rapid rise in energy demand of all types over the last 10 years, driven by China’s booming heavy industry sector; its large commercial export sector; and its rapidly expanding, energy-consuming middle class.

China’s oil and gas policy is heavily influenced by its growing dependence on imports, which accounted for more than 60% of total oil demand in 2010, with the majority of imports coming from the Middle East.

China’s oil and gas demand will increase dramatically to 2035, accounting for about 65% of the world’s oil demand growth and about 30% of its natural gas demand growth. (Images courtesy of Ernst & Young)

China started importing crude oil in 1993, and imports have grown significantly since then. Concerns over growing import dependence have prompted the government to intensify domestic exploration, boost crude oil and oil product storage capacity, and secure long-term crude oil supply deals from overseas producers.

The government also is beginning to adjust pricing structures for oil products to make them more responsive to international markets following record growth in international crude oil prices in mid-2008.

Additionally, China is making substantial investment to develop the natural gas sector in line with the government’s efforts to diversify the country’s primary energy mix away from coal, both for energy security reasons and to curb carbon dioxide emissions per unit of gross domestic product.

As a result, China’s policy response to consumption growth and to the rising import dependence has focused primarily on ensuring stable and secure supplies of oil and gas for the domestic market.

One significant move has been to maximize the domestic resource base. China’s NOCs have been encouraged to carry out hydrocarbon exploration in new areas such as in the far-western Xinjiang Province and in the South China Sea.

Increased exploration for unconventional gas and shale gas, along with coalbed methane or CSG, also is under way with some foreign participation. The government has set a target of making natural gas account for 10% of the energy mix by 2020, up from the current 3%.

Promoting gas consumption will allow China to diversify its energy mix away from inefficient and high-carbon-dioxide-emitting coal.

The recent rise in onshore gas wellhead prices for domestic purposes in China was partially designed to encourage upstream companies to invest in extracting more costly gas reserves, including offshore, tight, sour, and unconventional gas, to help meet this long-term supply target.

The government also has encouraged overseas merger and acquisition (M&A) activities with the aim of increasing access to equity oil or to production off-take rights from overseas fields. Chinese companies have been aggressively acquiring oil and gas assets and/or companies in all of the major producing regions. Additionally, Chinese state banks have pledged large loans to oil producer states as part of package deals that also include long-term crude oil supply agreements.

A number of these types of deals, known as variable production payment deals, have been signed with Russia, Kazakhstan, Angola, Venezuela, and Brazil, reflecting the government’s strategic aim to diversify dependence away from the Middle East. China’s NOCs also have been stepping up efforts to procure gas from overseas markets.

A number of transactions, including volumetric production payment deals, have been signed with Russia, Kazakhstan, Angola, Venezuela, and Brazil, reflecting the Chinese government’s strategic aim to diversify dependence away from the Middle East.

Another tactic has been to increase long-term gas supply contracting. China has signed long-term LNG contracts with Qatar, Australia, Indonesia, and Malaysia. Strategic pipeline projects from Myanmar and Central Asia, underpinned by long-term agreements, have been completed or are under construction to improve domestic supply availability.

The government also has accelerated investment in oil storage capacity. China began building a strategic petroleum reserve in 2003 with a first-phase target of 102 MMbbl. The project was completed in 2008, and the government has launched the second phase of the program, which involves construction of a further eight storage bases with an estimated capacity of 168 MMbbl.

Following severe natural gas shortages in the winter of 2009-10, China’s NOCs have been boosting investment in gas storage, with the eventual aim of bringing storage capacity to between 8% and 10% of total consumption.

Expanding regional trading is another government objective. To create more flexible markets that can better respond to domestic demand fluctuations, as well as to boost profits, Chinese NOCs have been looking to increase their regional oil trading activities.

In particular, PetroChina has bulked up its trading teams in Singapore and in 2009 acquired a stake in Singapore Petroleum Co. to underpin its trading activities in the region.

In addition to supply security, the government has recognized the importance of preventing wasteful energy consumption that could undermine its own supply interests and is taking efforts to make pricing systems more reflective of international markets, while setting new efficiency standards for the sector.

At the same time, China’s government has been mindful of the need to keep fuel and gas affordable for the domestic population and the industrial sector so as not to significantly decrease purchasing power or increase operational costs for businesses.

Reform is therefore gradual as the government treads a delicate path between realizing its strategic interests in the sector and not upsetting domestic consumers or economic growth.

This has been reflected in the establishment of a new fuel pricing mechanism that links domestic gasoline and diesel prices with international market rates but still keeps price adjustments firmly in the hands of the government.

The increase in wellhead natural gas prices, together with the apparent reluctance of the government to increase city gas prices as part of natural gas pricing reforms in 2010, is further evidence of the gradualist nature of reforms.

While working toward its strategic goals, China has been opportunistic in timing reform implementation. The new fuel price mechanism was rolled out only after international crude oil prices had fallen so the linkage of domestic gasoline and diesel prices and international crude oil prices would not have a dramatic adverse impact on consumers.

Likewise, the acceleration of overseas M&A activity by NOCs, which has almost certainly received government sanction, was timed to take advantage of the fall in asset valuations and raw material costs.

The timing of future reforms will depend on market conditions as well and may also reflect the outcome of policy struggles among various agencies in the sector.

China’s Immediate Future

Looking ahead, the government has big plans to promote shale oil and gas in the country and to strengthen domestic production streams. Further reforms to natural gas pricing are expected to be rolled out gradually.

These could potentially include the removal of cross-subsidies among different consumer groups; linkage of natural gas prices with alternative fuel types; and a change of the pricing point from the wellhead to the city gate in line with previous government targets that were not implemented as a result of the May 31, 2010, rise in natural gas prices.

The Chinese government had long hinted that it would reform domestic natural gas prices, both to encourage upstream E&P operations and to allow more expensive imported gas to compete with local supplies in the market.

In May 2010 the government took what is likely to be the first step in domestic gas price reform by hiking onshore gas prices at the upstream delivery point by 230 yuan per thousand cubic meters, an approximate 25% increase on previous pricing levels. The price hike also terminated the previous two-tier pricing system for some upstream fields.

Notably, with unconventional gas development in China, oilfield services (OFS) companies should see a substantial increase in demand for their services. The current Chinese OFS industry will likely need outside help.

Service requirements are sharply higher for unconventional oil and gas developments, with specialized equipment, supplies, and technical expertise needed (e.g., higher horsepower rigs drilling long horizontal wells, using multistage hydraulic fracturing).

An unconventional gas boom in China will come with challenges -- potential tightness in equipment and skilled labor with a ramp-up in activity, as well as supply chain challenges.

Large, diversified OFS companies that are currently heavily involved with the North American unconventional boom will be particularly well positioned for an unconventional gas boom in China because these already have global supply chains in place.

But there likely also will be room for the ambitious, smaller, specialized OFS companies looking to grow internationally.

In the Chinese oil downstream, some investment opportunities for new refining and chemical capacity will be available to large IOCs with critical project management skills. Those deals also are likely to be tied to long-term crude supply arrangements. New creative partnership models like the recent joint venture between BG Group and the Bank of China may also emerge.

All segments of the industry will be impacted by China’s increasing need to obtain energy resources. And while the opportunities may be great, so will the challenges -- and it will be the companies that can navigate the obstacles that will reap the greatest reward.

Editor’s note: This is the on-line, expanded version of the article “China Invests In Global Oil, Gas Market To Fuel Domestic Growth” that appeared in the January 2012 issue of Hart’s E&P magazine.