China's pragmatic competition policy
Beijing has been reticent to open up production of its key domestic industries to market mechanisms and, consequently, outside firms. But if needs be it will – as it is doing with shale.
ConocoPhillips on September 11 became the latest Western oil major to announce plans to expand operations in China to include the country's still-infant shale gas sector.
The company's announcement was both vague and well-timed. China is in the midst of its second tender for shale gas blocks. But unlike the first, invitation-only tender, in which just six state-owned enterprises were allowed to bid, the current round has already drawn more than 75 applications from a variety of companies, both state-owned and private, as well as local governments. Many bidders, such as the privately owned Zhongtian Urban Development Group or the Chongqing municipal government, have little to no experience in the energy sector.
More important for ConocoPhillips and its competitors, though, is that the current tender – which closes October 25 – is the first to allow foreign energy firms to jointly bid as minority partners with Chinese companies. As Beijing moves to rapidly develop the country's shale gas sector, it will have to balance the need for greater participation from foreign and non-state players with its own imperative to maintain central control over its slowing economy.
The decision to open the bidding process to non-state actors – and, theoretically, to partnerships between foreign companies and domestic private enterprises – reflects Beijing's desire to accelerate development of China's shale gas sector. The government intends to do so by chipping away at the near-monopoly of a handful of state-owned enterprises on domestic oil and natural gas exploration.
Efforts to increase competition
The tender is part of a series of policy shifts aimed at introducing market elements into the country's budding shale gas sector. Other recent changes include the reclassification of shale-derived oil and natural gas as an "unconventional mineral" in September 2011 – a move that technically excludes it from oil and natural gas exploration rights (virtually all of which are controlled by a few major state-owned energy companies). Also notable is an experiment, launched in December 2011, to synchronise domestic and international natural gas prices. So far, this policy is limited to Guangdong and Guangxi provinces, but Beijing said it intends to nationalise the policy by 2014 – around the time that China will begin producing shale gas.
Incremental policy reforms that allow for moderately greater participation from non-state actors do not, however, add up to a market. The current open tender is not intended to fundamentally undermine the grip of central state-owned energy firms on China's oil and natural gas resources. Rather, it is designed to kick-start exploration in less-developed fields – those not already controlled by the state-owned sector – by opening them to outside investment from companies willing to take on added risk in order to establish a stronger foothold in the Chinese shale gas sector.
In this sense, Beijing's decision to hold an open tender is reminiscent of efforts throughout the late 1980s and 1990s to dilute state players' control over key industries such as oil and natural gas, coal and steel. In the late 1990s, Beijing broke state-owned China National Petroleum Corp's absolute monopoly over China's oil and natural gas production by creating the China Petroleum and Chemical Corp. (also known as Sinopec) and the China National Offshore Oil Corp. as state-run competitors. While each of these companies, known collectively as the Big Three, originally specialised in non-overlapping functions – Sinopec in refining, China National Offshore Oil Corp. in offshore exploration and China National Petroleum Corp. in domestic production – Beijing has encouraged them to become internationally competitive, fully integrated energy majors. Like the current tender, these moves were not meant to create a full-fledged market; rather, Beijing saw the introduction of competitive elements as a means to boost productivity while refining its own central control over the country's energy assets.
Shale basin energy exploration offers the central government an opportunity to introduce further market reforms into the country's energy sector by widening the role of non-state, and especially foreign, actors. On the one hand, Beijing may be trying to prevent the Big Three from prematurely extending their monopoly over conventional oil and natural gas production – collectively, they control 80 per cent of China's fields and 90 per cent of production – into the shale gas sector. At the same time, by relaxing restrictions on foreign participation in the second tender, Beijing is acknowledging that rapid development of shale energy plays will require far more diffuse application and understanding of – as well as innovations in – the technology involved. China's major deposits differ geologically from those in the United States, meaning that in many parts of China new tools and techniques will have to be developed. Doing so in the timeline Beijing has set (6.5 billion cubic meters per year by 2015, according to the 12th Five-Year Plan) will require more competition between more players in more parts of the country.
The Big Three are already actively exploring for shale plays in China and abroad, and they will continue to be the drivers of domestic production. But like any major energy firm, private or state-owned, their interest and investments will centre on the most potentially lucrative deposits, such as those in the Sichuan Basin or Guizhou. Their size and corporate structure leave them with little incentive to develop small and riskier fields. This may explain Beijing's decision to include only blocks in Hunan, Jiangsu and Anhui provinces – far from the country's major shale deposits – in the second tender. Notably, these blocks all fall outside the 80 per cent of Chinese oil and natural gas fields controlled by the Big Three.
Foreign companies have long been involved in China's oil and natural gas sector. At the state's initiative, in recent years that involvement has grown to include shale plays. Royal Dutch/Shell is already actively exploring for shale plays in conjunction with PetroChina and China National Offshore Oil Corp. in China's south-western Sichuan province, which is believed to hold some of the world's largest deposits. Likewise, Chevron Corp, BP and ExxonMobil have all recently partnered with Chinese state-owned energy firms to survey in Sichuan, Guizhou and surrounding provinces.
All of these partnerships took place outside the open tender process, under the direct supervision of Beijing. They are designed to compel Western oil majors to share technology with their Chinese counterparts in exchange for a foothold, however small, in the country's nascent shale gas sector.
In theory, the current open tender breaks from this policy by offering foreign companies an opportunity to play a more prominent role as partners with less-experienced Chinese firms. But in practice, it will be difficult for Beijing to prevent the grip that the Big Three exert on domestic oil and natural gas production from extending into shale gas. Beijing's reclassification of shale gas as an unconventional mineral last year may help undermine the Big Three's monopoly over exploration rights, but building a more competitive environment will require the diffusion of new drilling technologies to many more domestic players and, in turn, far greater access to capital.
Doing so may be the difference between meeting or falling far behind Beijing's ambitious goal of sourcing 10 per cent of China's energy from natural gas by 2020. There is little doubt that China will one day be a major producer of natural gas from shale. The question is how much and how soon it will produce. Foreign energy companies, eyeing China and East Asia as key future markets, will want a stake in those markets even if heavily circumscribed by Beijing. In the meantime, Beijing will struggle between the need to rapidly develop new sources of energy as its conventional oil and natural gas reserves dry up and the need to maintain control over a slowing economy.
Stratfor.com. Reprinted with permission of STRATFOR.