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China’s Risky Move To Boost Domestic Oil Production

Vanand Meliksetian

China's unprecedented economic development since Deng Xiaoping's "Open Door Policy", has transformed the Asian country into the second largest economy of the world. The booming economy has had the undesired side-effect of increasing Beijing's dependence on foreign oil imports. 

Twenty-five years ago, China produced approximately 4 million barrels per day (mb/d), which was enough to satisfy the Asian country's domestic demand for petroleum products. In April, on average, 10.64 mb/d were imported, which is a new record. In 2018, the ratio of foreign oil dependency reached 70 percent and this number is expected to grow.

It is a reason for concern, as oil is a crucial product for maintaining stability and security. Beijing is aware of its relative weakness because most of the imported oil reaches mainland China through shipping lanes, which are controlled by the U.S. Navy. The relative weakness of the Chinese navy increases the risks and exemplifies the security threat in case of a blockade. Therefore, Beijing has been pushing domestic energy companies to increase production from local oil fields.

Rising investments

In the next five years China's ‘big three', PetroChina, Cnooc, and Sinopec, aim to increase spending by 517 billion yuan or $77 billion, which is a growth of 18 percent compared to last year. In contrast to Western firms, the Chinese state-owned energy giants are investing in oil fields that are mature and require high-costs to raise production. These assets need an increase in investment between 13 and 27 percent to reach their goals.

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Pouring money into oil fields with low productivity has become a concern for private investors who are skeptical about the future ability of Chinese energy companies to pay a dividend. Although the firms are state-owned, they are also listed on both Chinese and U.S. stock exchanges. As the potential rates of return of the concerning oil fields are relatively low for international standards, the value of the shares has dropped significantly.

The Communist Party states its goals

The reliance on foreign oil producers has become especially worrying for Beijing due to the escalating trade war with the U.S. and President Xi has now directly called on Chinese energy companies to increase domestic production. According to a researcher at the China National Petroleum Corp., the parent company of PetroChina, the additional spending will only increase production to 200 million tons by 2022, which is not a significant gain.

According to analyst Neil Beveridge from Sanford C. Bernstein & Co. "there is no question that those companies are under much pressure to grow production quickly. There will be a concern that in our low commodity price environment, this could erode returns and shareholders will want to see discipline."

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The Chinese energy firms are taking a significant risk by increasing production at oil fields with low productivity compared to top-tier assets. However, it also underlines Beijing's attention to decrease dependence on foreign producers. In this context, oil is not only a vital source of energy but also a strategic asset.

Shale and natural gas

Chinese energy giants have also been trying to replicate the American shale boom. However, they are facing significant challenges as the shale formations in China differ from the ones in the U.S. because the oil and gas deposits are located much deeper in the Earth's crust and are less concentrated which makes extraction more difficult and expensive. Add to this that Western companies are reluctant to share their technological know-how due to intellectual property rights issues.

Besides oil, China is also growing increasingly dependent on foreign natural gas. Beijing's push to combat air pollution through the so-called coal-to-gas policy has significantly increased the consumption of gas. In 2017 natural gas made up around 7 percent of China's total energy mix. The government intends to increase that number to around 15 percent in 2030. It could make China the world's largest importer of LNG with approximately a quarter of the entire global production of 500 million tons.

Beijing doesn't look keen to become overdependent on foreign producers for crucial resources to power the economy and security apparatus. Especially the current standoff with the U.S. and heightened tensions are a reason for concern. Therefore, the government is pushing its energy giants to increase domestic production despite the high costs and low productivity.

By Vanand Meliksetian for Oilprice.com

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