Woe to oil: why China’s 2017 output will extend record decline

China’s oilfields are likely to pump less crude in 2017, extending last year’s record output decline, as the industry feels the time-lag effect of capital expenditure cuts , while the government arm twists producers to switch their business focus from volume to profits.

Production is likely to fall gradually to 3.5 million barrels a day by 2020, from 4.2 million barrels per day in 2015, according to a forecast by Angus Rodger, director of Asia-Pacific upstream research at Wood Mackenzie.

“China’s domestic oil production accounted for 5 per cent of global supply in 2016, but that share looks set to shrink considerably over the next few years,” Rodger said in an interview with the South China Morning Post from Singapore. “Capital investment cuts by the major Chinese national oil companies, shifting government policies to focus on profitability rather than output volume and oilfield maturity are the key factors behind this decline.”

Two of China’s oldest and largest oilfields, PetroChina’s Daqing (大慶) field in Heilongjiang province, and Sinopec’s Shengli (勝利) in Shandong, have already reduced their 2016 production by 4.8 per cent and 11.8 per cent respectively, as low global oil prices forced them to shut unprofitable wells, according to a Shanghai Securities News report.

The three state-owned Chinese oil majors PetroChina, China Petroleum & Chemical (Sinopec) and CNOOC, which together account for around 92 per cent of the nation’s oil output, slashed their domestic exploration and production spending by 20 to 45 per cent in 2015, and by a further 10 to 16 per cent last year as oil priced halved, Rodger said.

He expects “marginal increases” for this year’s budget as oil price rebounded from a low of around US$28 a barrel a year ago to around US$56 in recent days, amid continued caution and disciplined spending by the majors.

The combined effect of China’s production cuts will worsen the nation’s dependence on imported supply, analysts said.

China’s oil demand grew 3.5 per cent last year to 11.9 million barrels a day. With domestic output shrinking, the nation has had to look to even more imports to meet demand.

Already, imports met 66 per cent of China’s oil consumption last year, higher than the 62 per cent recorded in 2015.

Imports will also be bolstered by China’s plan to increase its oil reserves to 900 million barrels by 2020, equivalent of 90 days of demand, said Sanford Bernstein’s senior analyst Neil Beveridge.

With the yuan’s 8 per cent slump against the US dollar in the past year, increasing imports will erode the profit margins of Chinese oil refiners, since crude oil prices are denominated in dollars. Sinopec, the world’s second-largest oil refiner, will have to pass its importing cost to customers as higher yuan-denominated pump prices for gasoline and diesel to preserve its margin, analysts said.

To address supply security concerns, Beveridge estimated the nation to have added an “unprecedented” amount - over 100 million barrels - to the reserve last year, raising it to more than 313 million barrels currently.

The first clear sign of a reduction may come as early as Thursday, when CNOOC, the largest Chinese offshore oil producer, may unveil a 2017 oil and gas target that is 3 per cent lower than the actual output in 2016, according to Beveridge.

CNOOC’s 2017 capital expenditure may rebound after a three-year decline to 65 billion yuan, from last year’s range of between 50 billion yuan and 55 billion yuan, he said. Capital expenditure was as much as 107.4 billion yuan in 2014, dropping to 66.5 billion yuan in 2015, according to its annual reports.

Still, higher project spending does not immediate translate to immediate increases in production, analysts said.

“Increases in capital expenditure [on new projects this year] only impact production starting 2022 given the five-year project lead time,” Nomura’s Asia oil and gas research head Gordon Kwan said. “The prior years of expenditure declines from 2013 will trigger more oil production declines in China, especially in mature fields like Daqing and Shengli discovered in the 1960s,” he said.