Reform buzzword in China’s oil and gas industry in 2016

Pounded by sinking crude prices, China’s energy sector will likely see opening of upstream exploration and production segment to non-state companies

PUBLISHED : Thursday, 31 December, 2015, 11:58am
UPDATED : Thursday, 31 December, 2015, 11:58am

China’s oil and gas sector will likely see unprecedented reform which would result in large-scale opening of upstream exploration and production to participation by non-state companies and a spin-off of midstream pipeline assets into one ore more independent entities.

The expected moves are part of wider reform aimed at improving efficiency of the nation’s energy industry dominated by giant lumbering state firms amid the most difficult operating conditions since the previous downturn in 2009 as oil prices tumbled sharply to 11-year lows.

This will be partly achieved through greater participation of the private sector that has been largely shut out of the strategic sector due to a lack of technical capabilities and access to exploration rights that are firmly in the hands of state firms.

“Two major developments are expected to take place in 2016, namely the opening up of the upstream sector to participation by domestic non-state firms, and the spin-off of pipeline assets,” said a source close to listed state-backed industry titan PetroChina.

The company will be the most affected by the changes, since it controls around 60 per cent of the nation’s oil and gas output and proven reserves, and over 70 per cent of the nation’s crude oil and gas pipelines.

Analysts generally do not expect oil prices to see a significant rebound until mid to late 2016 amid a glut which has severely dented the oil giants’ cash flows and profits.

The upstream opening will be made possible by forcing the state giants to surrender some of their registered exploration rights acreages where they have failed to meet their investment and exploration work commitments, the source said.

The Ministry of Land and Resources will then auction the rights to potential domestic investors, including private companies.

To survive the downturn, the domestic state giants are expected to cut capital expenditure on new projects and infrastructure building, and slash salaries and staff bonus for the second year in a row.

“All levels of staff, from top to bottom, have already seen their compensation and benefits cut as such payments are linked to [PetroChina’s] financial performance,” the source said.

Beijing is expected to release soon a long-awaited policy document on the reform of the oil and gas industry, which will likewise include a restructuring of pipeline assets.

“The restructuring may require all pipeline owners, both state and privately-owned firms, to inject their pipelines into a co-owned new entity that will be run independently, but it is not clear whether all pipelines - crude oil, refined fuel and natural gas - will be bundled into one or separate entities, all at once or over multiple stages,” the source said.

The purpose of restructuring is to prevent anti-competitive and discriminatory behaviour, and to allow open and fair pipeline access to them by all energy producers, traders and distributors, hence making the entire supply chain more efficient and investment-friendly.

To prepare for the reorganisation, PetroChina recently announced a consolidation of three domestic gas pipeline units into one.

It also announced to sell half of three gas pipelines linking China and Central Asia to a central government-owned firm, and sell a city-gas distribution firm to its Hong Kong-listed gas logistics subsidiary Kunlun Energy. Both are expected to see it book disposal gains that will help cushion profit declines due to falling oil prices.

Analysts expect the overhaul to bring benefits to the industry in the long term.

“Through control of oil and gas [logistics] infrastructure, PetroChina as the largest producer also controls pipeline access which is a barrier to independent exploration and production,” said American brokerage Sanford Bernstein senior analyst Neil Beveridge in a note.

“The separation of pipeline assets [away from] PetroChina ... will allow it to focus on exploration and production, although it will [face] greater competition in the long run.”

While reform will increase competition, ratings agency Fitch said in a note the big three state-backed firms’ dominance will not likely be eroded significantly in the medium term, given their scale and importance of the country’s energy sector.

They also expect PetroChina, China Petroleum & Chemical (Sinopec) and CNOOC to continue to cut capital expenditure in 2016 after a 23 per cent year-on-year cut in the year’s first nine months, albeit by a milder degree to prevent a sharp drop in domestic oil and gas production.