Unlocking China s Energy Potential

Transcription

1 Unlocking China s Energy Potential September 26

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3 Unlocking China s Energy Potential OVER THE PAST DECADE, INTERnational energy companies have participated in China s economic growth. Many of them developed entry strategies focused on benefiting from exploding industrial and consumer demand, only to have the Chinese government counter with restrictive regulations. As a result, most international energy companies have experienced disappointing financial returns, and early investors have absorbed significant losses. Investments that reflect a better understanding of China s energypolicy challenges may lead to more profitable projects both for China and for its potential investors. China s rapid industrial development has created an insatiable appetite for all types of energy. To continue this growth, China must increase its imports of crude oil, refined products, petrochemicals, coal, and natural gas; it must also make major capacity additions in refineries, chemical plants, and power generation. At the same time, the Chinese government must balance competing demands: it must secure energy supply from diverse sources, attract foreign investment and technology, improve energy affordability and efficiency, and protect the environment. Many energy companies have evaluated opportunities in China on the basis of the economics of a single project, hoping to negotiate favorable terms with the government. But this approach has often led to disappointing results. Our research suggests that a comprehensive energy partnership one that helps the government meet its economic, energy, and environmental challenges is likely to yield better results and may improve companies competitive positions. The Opportunity: Low-Cost Production and a Growing Market Since 198 China has achieved the fastest economic growth the modern world has ever witnessed: a 1 percent compound annual growth rate for real GDP and a more than sevenfold increase in disposable income. This unprecedented growth has been fueled by exports of labor-intensive finished goods that are produced from domestic and imported raw materials such as petrochemical feedstocks. The growth has been concentrated in the eastern provinces of China, where there is abundant lowcost skilled labor as well as easy access to export facilities. Rapid industrial growth, increasing disposable income, and the advantages of low-cost-country sourcing have attracted interest from around the world. Hoping to gain a competitive advantage from low-cost labor, many companies in a variety of industries have invested in China, whereas other companies have banked on the growth of domestic consumer-retail industries as the Chinese increase their standard of living. In fact, most international companies have evaluated strategies to capitalize on the China opportunity as a source of labor, as a market, or both. The Challenge: Energy Self-Sufficiency The Chinese government is facing economic, environmental, and energy concerns that have caused it to impose internal price controls and strict regulations on foreign investments. When it comes to economic issues, the government is carefully subsidizing energy prices to ensure sustained economic growth. Disposable income in China s industrial east is $3,6 per year compared with only $4 per year in the agrarian west. This disparity has the potential to create social unrest in the country and encourages the government to pursue policies that control domestic prices of energy and staples in order to ensure continued economic growth and job creation. Even though social disruption and riots skyrocketed in China over the past ten years, the government still relies on economic prosperity as the glue that holds the social fabric together. The government is also struggling to solve the serious environmental problems associated with growth. The increasing use of automobiles with the resultant pollution is a case in point. Deteriorating air and water quality will be exacerbated by new refineries, chemical plants, and coalfired power-generation facilities. In fact, 16 of the 2 most polluted cities worldwide are in China. The biggest issue China faces, however, is energy self-sufficiency. The government is concerned about the security and diversity of the energy supply. Regulatory controls, restrictions on the growth of imports, and bids to acquire access to foreign supply have met with limited success. Tight regulatory controls on foreign energy investments have three dimensions: Ownership restrictions on investments in exploration and production (E&P), refinery, and wholesale ventures require that foreign companies undertake joint ventures with national oil companies (NOCs) Quotas limit or control imports of crude oil and refined products, apply only to nongovernmental importers, and are announced annually by the National Development and Reform Commission (NDRC) Unlocking China s Energy Potential 3

4 Regulation of both wholesale and retail prices of refined products permits domestic industries to grow even when prices for crude oil are high All of these regulatory policies are designed to protect domestic industries and ensure continued economic growth and job creation. For example, when the price of international crude oil climbs, China s government regulates prices to protect the domestic industry. As a result, only conventional E&P, exportoriented petrochemicals, and gas distribution are truly attractive investments for international oil companies. Refining, oil product retailing, and some petrochemical products are not attractive investments when energy prices are high. Such price regulation greatly reduces the attractiveness of substantial energy investments in China relative to international benchmarks. Even as China seeks to regulate foreign investment, its economic growth is being threatened by an energy shortage, and the country has begun to rely on imports to cover the supply gap. (See Exhibit 1.) China began importing crude oil in the mid-199s, and imports have grown at 15 percent per year since 21. Although additions to crude-oil reserves are reported to have averaged about 1 billion barrels during this period, domestic production has remained steady at about 3.4 million barrels per day. This shortfall is compounded by the fact that almost all of China s refining capacity has been designed to run heavy, very sweet crude oil, and its production volume in the region is rapidly declining. As a result, China has been forced to import large and increasing quantities of sweet West African crude oil at a substantial price premium. In 24 imports met around 4 percent of demand; by 215 imports will be required to satisfy more than 5 percent of demand. Natural gas imports in the form of liquefied natural gas (LNG) are also growing. Whereas gas accounted for about 4 billion cubic feet of total energy consumption in 24, gas demand is expected to triple by 215. It is likely that A comprehensive approach that helps China solve its energy-policy issues may generate superior returns. imports will meet approximately 25 percent of this projected demand. Electric power is also in short supply. In 24 the power supply gap was 13 terawatt hours (TWh); at current growth rates, this supply gap is expected to widen to about 8 TWh by 215. To reduce dependence on imports and ensure reliable supply, Chinese NOCs have tried, with limited success, to acquire international reserves and to create joint ventures with resource holders. Acquisition efforts have fallen short of expectations, however, and China is overpaying for overseas reserves. Some recent efforts to acquire E&P rights have been unsuccessful. They include the following: The Attempted Acquisition of Unocal. In 25 Chinese National Offshore Oil Corporation (CNOOC) made an $18.5 billion bid for Unocal but was forced to withdraw under political pressure from the United States, which feared that such a deal was a threat to U.S. national security. The Loss of Talisman s Oil Stake in Sudan. In 23 China National Petroleum Corporation (CNPC) waived its shareholder preemption right. India s Oil and Natural Gas Corporation (ONGC) acquired Talisman Energy s 25 percent stake in Greater Nile Petroleum Oil Company for $72 million. The Loss of a Stake in the Kashagan Oil Field. In 23 CNOOC and China Petroleum and Chemical Corporation (Sinopec) attempted to buy an 8.3 percent stake in the Kashagan oil field from BG, but BG partners preempted the deal and exercised their rights to buy the stake. Recent deals in which China overpaid for reserves include the following: The PetroKazakhstan Acquisition. In 25 CNPC won the PK deal with a bid of $4.18 billion ($55 per share). That price was about 2 percent higher than the PK market value of $3.4 billion. The Shell Angola Stake. In 24 CNPC won Shell s 5 percent stake in Block 18 Angola over ONGC s bid of $62 million coupled with a $2 billion aid offer. The Sudan Acquisition. In 23 CNPC acquired Block 3 in Sudan with a price 17 percent higher than ONGC s offer. The Potential Solution: Comprehensive Energy Partnerships Business as usual will not solve China s energy issues. The government will have to look to foreign investment, technology, and capabilities to help keep lights on and energy available to fuel economic growth. Moreover, potential investors that pursue the traditional approach, negotiating a single energy project, will likely fail. A more comprehensive approach that helps the Chinese government solve energy policy issues may generate superior returns and provide companies with advantaged access to all parts of the energy value chain. Some examples from the cement, airline, and refining industries can serve as guides to this type of approach. 4

5 EXHIBIT 1 China s Economic Growth Is Threatened by a Serious Energy Shortage Kilobarrels Cubic feet (billions) Imports as a percentage of demand Imports Domestic production Consumption 8, 6, 4, 2, TWh 8, 6, 4, 2, Power generation China s crude-oil supply China s natural-gas supply Power generation versus consumption SOURCES: National Development and Reform Commission; Economist Intelligence Unit; BCG analysis. 1 Estimate Imports (%) Cement-Manufacturing Joint Venture. Located in Sichuan, the joint venture, which was initiated in 2 with a large European cement manufacturer, constitutes the largest foreign direct investment in western China. The venture was designed to develop China s vast but forgotten western provinces, address China s cementsupply shortage and uncompetitive domestic manufacturing, boost manufacturing efficiency, and improve environmental protection in the industry. The result was an exclusive contract between the international cement manufacturer and the Yunnan government that consolidated the cement industry in Yunnan province. Refining and Petrochemical Joint Venture. An international oil company partnered with Sinopec and Saudi Aramco in this venture. The project included a long-term crude-oil supply contract from Aramco that helped China address its policy goal of a secure energy supply. The venture was also designed to transfer technology and expertise so that China could increase efficiency through improved refinery operations. To offset losses that would be incurred if it had to sell at the prices set by Chinese regulators, the international oil company got the right to sell at import parity that is, at world market prices. Initially, the import parity agreement was for the lifetime of the project, but with oil prices above $7 per barrel, the terms were shortened to three years. Even so, over the life of the project, overall returns to the international oil company are projected to be significantly above the cost of capital. Single-Aisle Planes of an Airplane Manufacturer. An international plane manufacturer set up the first large-scale foreign airplane-manufacturing plant in China and committed to buying more than $2 million worth of spare parts per year in China. The venture will alleviate the shortage of adequate transportation Unlocking China s Energy Potential 5

6 in China; support passenger and cargo growth of 1 percent and 3 percent per year, respectively; and boost the local economy through large-scale foreign direct investment and job creation. With its win of an order for 15 planes, the airplane manufacturer has secured more than $1 billion in sales. The Conclusion: Both Sides Benefit from Partnerships Major oil companies and large international utilities are well equipped to help China, given their deep capabilities across the energy value chain and their ability to invest in extensive capital projects. The overriding issue for China is to maintain a reliable supply of domestic crude oil and refined products. Thus, all sizable energy deals that are approved will likely include assistance to improve domestic E&P, major development of unconventional resources such as shale oil and tar sands, and LNG and refinery expansions. Investments such as these will help solve China s energy-policy issues and may be attractive to oil companies if the government grants special economic terms that create win-win situations for all parties involved. China has large reserves of unconventional resources that could be developed domestically with technology and foreign investment from major oil companies. Several E&P projects and the associated refinery capacity needed to convert shale oil and tar sands into clean refined products would reduce crude and product imports, while bolstering supply security. Unconventional reserves are 16 times greater than traditional reserves. If these unconventional reserves of tar sands and shale oil are developed, they could yield as much as 1,8 kilobarrels of crude oil by 215. (See Exhibit 2.) EXHIBIT 2 Shale Oil and Tar Sands Could Be Major Sources of China s Future Domestic Supply Unproven Barrels (billions) Kilobarrels Proven , Conventional and unconventional reserves (24) Oil reserves Shale oil Tar sands Estimated production of crude oil (215) 8 Tar sands , Shale oil SOURCES: Development and Research Center of China Geological Survey; ChemNet; BCG analysis. 1 This estimate is based on Canada s crude-oil production volume from tar sands, reached after the first ten years of production. 6

7 EXHIBIT 3 Well Productivity in China Appears to Increase More than 6 Percent When International Oil Companies Join E&P Projects Full ownership Joint production with foreign companies Kilobarrels 4, 3,5 3, 2,5 Domestic crude-oil production in China (24) , Barrels per well, Domestic crude-oil production in China (24) 62% 2, 1,5 1, ,55 3, PetroChina Sinopec CNOOC Others Total 2 PetroChina CNOOC (independent) CNOOC (in joint production) SOURCES: Company reports; BCG analysis. Improvements in traditional E&P could also help reduce imports. In 24 only 6 percent of China s crude production involved international oil companies. But recent technologysharing contracts with international companies have resulted in marked improvements in production per well compared with production by NOCs alone. In fact, well productivity could be improved by as much as 62 percent, which could be worth up to 2 million barrels to China. (See Exhibit 3.) In return for solving China s energy-policy issues, international energy companies could negotiate terms that rival returns in other areas of the world and get privileged access to other parts of the value chain through which China s growth will lead to profitable businesses. To succeed, however, these companies must develop a comprehensive energy part- nership. Although this approach is somewhat unconventional, we believe it is the best route to unlocking energy opportunities in China. Brad VanTassel Jim Hemerling Vincent Chin Oliver Steen Brad VanTassel is a vice president and director in the Houston office of The Boston Consulting Group. Jim Hemerling is a senior vice president and director in the firm s Shanghai office. Vincent Chin is a vice president and director in BCG s Singapore office. Oliver Steen is a practice area manager in the firm s Hamburg office. You may contact the authors by at: vantassel.brad@bcg.com hemerling.jim@bcg.com chin.vincent@bcg.com steen.oliver@bcg.com To receive future publications in electronic form about this topic or others, please visit our subscription Web site at Since its founding in 1963, The Boston Consulting Group has focused on helping clients achieve competitive advantage. Our firm believes that best practices or benchmarks are rarely enough to create lasting value and that positive change requires new insight into economics and markets and the organizational capabilities to chart and deliver on winning strategies. We consider every assignment to be a unique set of opportunities and constraints for which no standard solution will be adequate. BCG has 61 offices in 36 countries and serves companies in all industries and markets. For further information, please visit our Web site at The Boston Consulting Group, Inc. 26. All rights reserved. Unlocking China s Energy Potential 7

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