China finds opportunities in oil price drop

This week, Cnooc announced plans to reduce capital spending as the government and large state-owned enterprises respond to the collapse in oil prices. China’s third-largest oil producer said it would cut development spending by 67 per cent and, albeit less dramatically, reduce exploration and production capital expenditure.

At the same time, the Beijing government and refiners such as Zhuhai Zhenrong have increased their purchases of crude oil to record levels. Sinopec, another big state-owned energy enterprise, opened up a tank farm for crude oil on the resort island of Hainan in November.

These apparently contradictory signals reflect changes in the sources of growth in a slowing Chinese economy and show how the government and corporate China are exploiting the collapse to reduce their longer-term vulnerability to price swings in the volatile energy market.

It is easy to understand why Cnooc is cutting back spending. The economy is growing slightly below the level the cadres have commanded and slowed to 7.1 per cent in the final quarter of 2014. Reinforcing that trend is the fact that the energy intensity of Chinese production has gone down. Chinese crude oil demand per unit of gross domestic product has been dropping by 4.3 per cent a year since 2005, according to data from JPMorgan Private Bank.

Moreover, as the sources of growth shift slowly from manufacturing to services and from exports to domestic demand, that drop will probably accelerate, making further oil capex cuts likely — and shareholders happier.

But China is also looking ahead and taking advantage of the speedy and unexpected reversal in the oil price.

The increase in demand for crude on the mainland comes because China is exploiting lower oil prices to dramatically boost its storage capacity for both commercial and strategic reasons. By doing so, it will address one of its perennial weaknesses, its reliance on imported energy, and make itself more competitive.

The move comes at a moment when pessimism about Chinese prospects generally is on the rise. That downbeat attitude reflects chronic excess capacity, an overbuilt property market and concerns about a corporate sector that has borrowed too much, whether in renminbi or appreciating US dollars.

The way China is taking advantage of the declining oil price also suggests that some of the pessimism is unwarranted. The dramatic expansion in commercial and strategic holdings of crude while the price is half of what it was just months ago is only part of the story. The government is also increasing taxes rather than pass on the full benefit of bargain fuel prices to consumers.

Those taxes will go partly to dealing with China’s monumental environmental issues, according to Miswin Mahesh, Barclays’ commodities analyst in London. That spending should be good for China and its neighbours, if the past is any guide.

Up to now, Chinese growth has been good news for the rest of the world. In 1990, China’s contribution to global GDP growth was 5 per cent. Since 2010, the figure has swelled to more than 40 per cent. Its role as a crutch for world growth has become especially important as the growth rate of other emerging markets has fallen. (Last year emerging markets as a whole grew only 4 per cent — the worst figure since 2009 — and this year may even drop slightly below that.)

China’s demand for crude is already lifting the fortunes of shippers and others. Among the biggest beneficiaries of the increase in Chinese appetite for crude is Iran, says Amrita Sen, chief oil analyst with Energy Aspects in Houston and London. Indeed, Chinese demand for oil from Iran accounts for more than India, Japan, and South Korea combined. (All these countries have received specific exemptions from US-imposed sanctions on Iran, and they may also import more than the level the waivers allow.)

Earlier on, before China received permission from the US to procure Iranian oil, the country paid for its Iranian imports in renminbi. But today, Ms Sen says, the Chinese are using dollars. That benefits both sides. Tehran finds dollars more useful than renminbi as there are still controls on what Iran can do with its Chinese currency.

At the same time, China has clearly decided it is better to obtain real assets such as oil with its dollars than to purchase paper securities. Right now, both US Treasuries and the US dollar look attractive, while oil does not. But China always takes the long view — and in the long term neither Treasury securities nor the greenback seem as attractive as they do today — at least as seen from Beijing.

Source: http://www.ft.com/intl/cms/s/0/b083f7b4-ab8d-11e4-b05a-00144feab7de.html#axzz3Qnw9Fh8K

Latin moves in China’s rush for oil

In a few weeks’ time, two oil rigs off the coast of Brazil will move smoothly into production, pumping thousands of barrels of oil a day out of the Peregrino oilfield in the Campos basin. They would be unremarkable if it were not for the story that lies behind the field and its investors. Owned by Statoil of Norway, another investor in the project is Sinochem, a Chinese state-owned energy and trading group, which won a bid for 40 per cent of the field in one of the most hotly contested bidding rounds in the industry last year.

Sinochem paid $3.1bn for that stake, sealing the deal last June. It is not unusual for Chinese oil companies to make big acquisitions these days – last year they spent more than $30bn on overseas mergers and acquisitions, accounting for roughly one-fifth of global deal activity in the sector.

But the Peregrino story is unique because the process pitted three of China’s largest oil companies against each other in heated rounds of bidding – a scenario that is a harbinger of Chinese oil majors expanding their hunt for assets overseas.

It was not long ago that all of the country’s outward-bound investments were carefully choreographed by Beijing. Big state-owned enterprises would lobby for months to convince their regulators to approve investments overseas. That system had one major advantage: it prevented Chinese oil companies from bidding against each other for overseas assets, since the regulator would not usually grant approval for two companies to bid for the same thing.

However, that changed in 2007-08 when regulators in Beijing started taking a slightly more hands-off approach. The result is that Chinese companies have started competing for assets overseas with each other, not only with their western peers.

One of the clearest examples of this was the bid contest for the 40 per cent stake in the Peregrino oilfield. The block was contested by no less than three Chinese state-owned oil companies: Sinochem, which grew out of China’s state oil trading arm; Sinopec, which historically has run most of China’s refineries; and Cnooc, which specialises in offshore oil production.

“[In] the Peregrino auction ... Sinopec and Sinochem were extremely competitive, aggressive. Cnooc was there but wasn’t quite as aggressive,” says one person involved in the deal.

The hot bidding meant the companies’ strategic approach to the deal became a key factor in determining who won. According to two people who worked on the deal, Sinopec offered the best financial terms, but insisted on standard conditionality and due diligence. Sinochem, meanwhile, made an unconditional bid, according to one insider – an unusual gamble for the industry but certainly an attractive proposition for the seller.

Statoil also seems to have been drawn by the prospect of working with Sinochem in the future. “I am pleased that we also have agreed to sign an MoU [memorandum of understanding] to jointly investigate further opportunities in Brazil and elsewhere,” said Helge Lund, chief executive of Statoil, when the deal was announced.

Sinochem is relatively new to China’s overseas oil rush. The company’s $3.1bn spend on the Peregrino stake was nearly twice as much as the total amount it had previously spent on overseas oil projects. Although it is a large conglomerate, with roughly $15bn in assets at the end of 2009, it has traditionally been focused on importing oil and trading oil and chemicals, including fertilisers.

Sinochem made its first overseas energy acquisition just eight years ago, in 2003. But it did not take long for the company to make a mark in the global oil M&A field. Most recently, it explored the possibility of launching a counterbid for Anglo-Australian mining group BHP Billiton’s $39bn hostile bid for PotashCorp, the potash mining company based in Saskatchewan, Canada. Sinochem eventually decided not to pursue the deal – partly because of opposition from Chinese regulators concerned about overpaying for the assets.

In many ways Sinochem is typical of the Chinese companies making waves in global M&A. They have been extremely fast to move into the sector they are interested in, and those who have worked with them describe Sinochem’s M&A team as savvy and sophisticated.

One particular coup was Sinochem’s decision to walk away from a potential acquisition of Nufarm, an Australian agricultural company, in 2009. Today, Nufarm shares are trading at a less than half of what Sinochem was offering at the time, before the deal fell through.

That is not to say that there has not been a learning curve. As with any companies doing overseas M&A for the first time, Chinese resources companies have been learning the ropes. Sometimes that has been painful, as with Cnooc’s failed bid for Unocal, the US oil group, in 2005, which was derailed by loud political opposition out of the US. But China’s state-owned companies have largely been remarkably fast learners.

Investment shift

China’s overseas investments in oil and gas have become an important driver of the industry. Last year, Chinese energy companies spent more than $30bn on overseas energy deals, about one-fifth of global deal activity. To give a sense of the pace of the change, consider that in 2008, Chinese energy deals accounted for just 4 per cent of the global dealbook.

While this shift towards overseas investment has been initiated at the highest levels of government as part of the “go out” strategy under which state-owned enterprises are encouraged to venture overseas, it is also driven by commercial considerations.

“In general, the Chinese can take a more long-term view. They are probably on balance less payback-focused [than other oil firms] and more focused on improving the number of barrels produced,” one oil and gas banker observes. “This makes them very competitive bidders.”

Some industry experts say that Chinese oil companies have a history of overpaying for assets, although a recent report from the International Energy Agency refutes this claim.

The country’s large oil companies have a mandate to boost production, and their ownership structures usually make shareholder value a secondary consideration (one exception is Cnooc, which is structured differently from Sinopec or CNPC, China’s largest oil and gas producer). This structure allows companies to take longer-term bets on oil than their western peers, because they do not have the pressure to turn around their investments as quickly.

Many state-owned oil companies cut their teeth on assets that were not hotly contested by global oil competitors, sometimes in investments in Africa or the Middle East in countries deemed too risky or unpalatable for most energy firms. This is rapidly changing, though – as the Peregrino oilfield saga shows.

Source: http://www.ft.com/intl/cms/s/2/05230786-5ec8-11e0-8e7d-00144feab49a.html#axzz1ZTnHKNnT