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China: a new model in overseas oil strategy
By Fareed Mohamedi, PFC Global Risk
China has seized the global recession as an opportunity to secure long-term deals that will make inroads into previously closed markets and enhance its energy security. The costly and often unsuccessful strategy of capturing equity barrels through direct investment is being complemented by a new model: loan-for-oil deals with governments in search of financial assistance. China has begun to lock in future supplies while establishing a large foothold in key producing states like Brazil, Kazakhstan and Russia deepening its trade partnerships and opening new opportunities for its National Oil Companies (NOCs) and domestic service companies.
New model emerges
Several years ago, policymakers in the United States and Europe began to view China's overseas energy investments with alarm. China was investing heavily in Africa and making forays into Kazakhstan and even Latin America, with Chinese NOCs receiving strong diplomatic and financial backing by the government. Skeptical observers viewed China's investments in energy and mining as a resource grab that would lock up supplies and crowd out investment from western countries.
Those fears, not surprisingly, proved to be unfounded. China faced familiar obstacles in its overseas oil investment, including difficult contract terms, rising service sector costs and operational risks for personnel all of which contributed to project delays. Its energy investment in Africa is a case in point. Although the three Chinese NOCs acquired acreage in a wide range of African countries, many of those projects remain in the exploration stage and results have often been disappointing. Technological shortcomings largely prevented the Chinese NOCs from competing in the deepwater, and China's late entry into the game resulted in less promising onshore opportunities. A large share of the NOCs' assets were held in politically risky states like Sudan (still a very large component of CNPC's overseas production) or countries with much smaller resource potential and limited exploration history like Mali and Niger.
The Chinese NOCs' mandate to go abroad has not subsided. International operations are still viewed as a vital means for CNPC, Sinopec and CNOOC to build operational skills and gain access to advanced technology. Overseas operations also provide opportunities for Chinese seismic and drilling companies, in keeping with China's goal of building a world-class service sector.
Although direct investment by Chinese NOCs will continue with each maintaining a distinct investment strategy the bilateral deals signed by China in the past few months mark an opportunistic effort to take advantage of current economic conditions. In the short term China has shifted its focus to a loans-for-oil strategy that will capitalize on opportunities to diversify its supplies and increase its energy security.
Loans-for-Oil
The Chinese government has finalized bilateral deals with Russia, Brazil, Venezuela and Kazakhstan that will collectively provide $50 billion in Chinese loans in exchange for future oil supplies. Under the terms of the bilateral deals, China would receive at least 1.2 mmb/d in future supplies within the next ten years. The loan-for-oil deals have three distinct advantages for the Chinese: they allow China to lock up future supplies, extend its presence in countries that have been difficult for the Chinese NOCs to penetrate, and create opportunities for Chinese service sector companies.
The most tangible benefit is that China has secured sizable export commitments. In a February agreement, the Chinese Development Bank (CDB) signed two 20-year loan agreements with Rosneft and Transneft (the Russian state transport monopoly) that will provide $25 billion in financing in exchange for 300 mb/d of oil shipments via the East Siberia-Pacific Ocean (ESPO) pipeline. In a deal finalized in May, the CDB agreed to a $10 billion loan to Petrobras in return for Sinopec's access to 200 mb/d of oil beginning in 2010. A $4 billion deal with Venezuela will finance projects that will increase Venezuelan exports to China from roughly 350 mb/d to 1 mmb/d by 2015. Finally, a bilateral deal with the Kazakh government gives China a 50 percent stake in Mangistaumunaigaz (MMG) which holds roughly 370 mmb in reserves while ensuring sufficient financing for the 3,000 km Kazakhstan-China pipeline. Several of these bilateral deals stipulate that China will be repaid in cash rather than in barrels, with its borrowers simply repaying principal and interest.
Aside from the supply commitments, the loan-for-oil agreements will expand China's footprint in a handful of key producing states. In Russia, for example, the Chinese deal represented a significant step forward after several years of contentious renegotiations of a 2005 export deal between the two countries. The newest deal between China and Russia took months to negotiate, as both sides drove a hard bargain. The final agreement met Russia's core objectives it alleviated Rosneft and Transneft's short-term financing difficulties and freed up cash for Rosneft to consider acquisition opportunities. It also met China's primary goals of ensuring stable crude supplies, guaranteeing enough cash to finance phase one of the ESPO pipeline, and earning loan guarantees from Russia's state-owned bank Vnesheconombank. In the end, the Russia-China deal strengthened a relationship that both sides view as a strategic priority in the coming years.
Similarly, the Chinese deal with Kazakhstan in which CNPC and the China Export-Import Bank will lend $5 billion each to Kazmunaigaz (KMG) and the Development Bank of Kazakhstan, respectively marked a turning point in a trade relationship that has proven difficult in recent years. When CNPC acquired PetroKazakhstan in 2005 at that point the largest overseas acquisition by a Chinese NOC the Kazakh government introduced new legislation that granted pre-emptive rights to KMG in future deals. CNPC was criticized for paying too much for the PetroKazakhstan acquisition, but its 67 percent stake in that company has now been accompanied by a 50 percent stake in MMG giving CNPC a much larger foothold in the upstream in Kazakhstan. The Chinese government views the effort to secure additional crude supplies from Russia and Kazakhstan through the lens of energy security; additional pipeline imports serve as a hedge against possible supply disruptions elsewhere, for example in shipping lanes in the Straits of Hormuz or Straits of Malacca.
Finally, the loans-for-oil agreements will open new opportunities for Chinese service companies. CNPC's service sector subsidiaries in manufacturing and engineering could win pipeline construction contracts for the ESPO phase one and its spur line to China. China's loan to the Development Bank of Kazakhstan will be partly used to construct a "West Europe-West China" highway that would likely employ Chinese construction laborers. Other potential opportunities for Chinese companies in Kazakhstan as a result of the bilateral loans include the construction of a gas pipeline and potential joint work in uranium mining all projects that would meet job creation objectives of both governments in underdeveloped areas. And China's loan agreement with Petrobras stipulates that the Chinese could supply the Brazilian NOC with "equipment and services in the areas of LNG facilities, offshore drilling rigs and service ships."
Brazil is a particularly enticing market for Chinese service companies, given the enormous demand for engineering, construction and drilling contractors as Petrobras tackles its $174.4 billion five-year investment plan. Although the Brazilian government (and Petrobras) may prefer to turn to domestic companies, the capacity of the Brazilian service sector is limited, and those firms may not be able to match the cost competitiveness of Chinese companies.
Willing partners
China has shrewdly seized an opportunity to make long-term loans in a down cycle, at a time when project finance is hard to come by and traditional bank lending has become difficult to secure. In all of these deals, the Chinese government has found that its partners are more willing to make compromises whether on interest rates, loan guarantees, or upstream access in order to attract capital.
While foreign governments may have begrudgingly accepted some of the Chinese terms, the new investment model still holds some distinct advantages for them. In most cases the Chinese NOCs are not directly investing in the upstream or have acquired only smaller assets so host governments are not forced to defend themselves against charges that China has seized control of their oil resources. The interest rates charged by the Chinese for these loans are in most cases fairly low under 6.5 percent in the case of the CDB's loan to Petrobras. Those terms are easier for China's borrowers to accept, and while the interest rates may be low they still exceed China's return on investment in US Treasury bills. And China will essentially pay market prices for its oil imports, in contrast with a past loan to Russia that was renegotiated when Russian companies complained that the Chinese were receiving barrels at a substantial discount.
Perhaps most importantly, many governments are finding it easier to negotiate directly with the Chinese than to make deals with numerous international oil companies; the Chinese government can leverage its finances and the capabilities of its NOCs and service companies in a single deal. As Petrobras CEO Sergio Gabrielli stated last month, "there isn't someone in the US government that we can sit down with and have the kinds of discussions we're having with the Chinese."
(China.org.cn September 11, 2009)
By Fareed Mohamedi, PFC Global Risk
China has seized the global recession as an opportunity to secure long-term deals that will make inroads into previously closed markets and enhance its energy security. The costly and often unsuccessful strategy of capturing equity barrels through direct investment is being complemented by a new model: loan-for-oil deals with governments in search of financial assistance. China has begun to lock in future supplies while establishing a large foothold in key producing states like Brazil, Kazakhstan and Russia deepening its trade partnerships and opening new opportunities for its National Oil Companies (NOCs) and domestic service companies.
New model emerges
Several years ago, policymakers in the United States and Europe began to view China's overseas energy investments with alarm. China was investing heavily in Africa and making forays into Kazakhstan and even Latin America, with Chinese NOCs receiving strong diplomatic and financial backing by the government. Skeptical observers viewed China's investments in energy and mining as a resource grab that would lock up supplies and crowd out investment from western countries.
Those fears, not surprisingly, proved to be unfounded. China faced familiar obstacles in its overseas oil investment, including difficult contract terms, rising service sector costs and operational risks for personnel all of which contributed to project delays. Its energy investment in Africa is a case in point. Although the three Chinese NOCs acquired acreage in a wide range of African countries, many of those projects remain in the exploration stage and results have often been disappointing. Technological shortcomings largely prevented the Chinese NOCs from competing in the deepwater, and China's late entry into the game resulted in less promising onshore opportunities. A large share of the NOCs' assets were held in politically risky states like Sudan (still a very large component of CNPC's overseas production) or countries with much smaller resource potential and limited exploration history like Mali and Niger.
The Chinese NOCs' mandate to go abroad has not subsided. International operations are still viewed as a vital means for CNPC, Sinopec and CNOOC to build operational skills and gain access to advanced technology. Overseas operations also provide opportunities for Chinese seismic and drilling companies, in keeping with China's goal of building a world-class service sector.
Although direct investment by Chinese NOCs will continue with each maintaining a distinct investment strategy the bilateral deals signed by China in the past few months mark an opportunistic effort to take advantage of current economic conditions. In the short term China has shifted its focus to a loans-for-oil strategy that will capitalize on opportunities to diversify its supplies and increase its energy security.
Loans-for-Oil
The Chinese government has finalized bilateral deals with Russia, Brazil, Venezuela and Kazakhstan that will collectively provide $50 billion in Chinese loans in exchange for future oil supplies. Under the terms of the bilateral deals, China would receive at least 1.2 mmb/d in future supplies within the next ten years. The loan-for-oil deals have three distinct advantages for the Chinese: they allow China to lock up future supplies, extend its presence in countries that have been difficult for the Chinese NOCs to penetrate, and create opportunities for Chinese service sector companies.
The most tangible benefit is that China has secured sizable export commitments. In a February agreement, the Chinese Development Bank (CDB) signed two 20-year loan agreements with Rosneft and Transneft (the Russian state transport monopoly) that will provide $25 billion in financing in exchange for 300 mb/d of oil shipments via the East Siberia-Pacific Ocean (ESPO) pipeline. In a deal finalized in May, the CDB agreed to a $10 billion loan to Petrobras in return for Sinopec's access to 200 mb/d of oil beginning in 2010. A $4 billion deal with Venezuela will finance projects that will increase Venezuelan exports to China from roughly 350 mb/d to 1 mmb/d by 2015. Finally, a bilateral deal with the Kazakh government gives China a 50 percent stake in Mangistaumunaigaz (MMG) which holds roughly 370 mmb in reserves while ensuring sufficient financing for the 3,000 km Kazakhstan-China pipeline. Several of these bilateral deals stipulate that China will be repaid in cash rather than in barrels, with its borrowers simply repaying principal and interest.
Aside from the supply commitments, the loan-for-oil agreements will expand China's footprint in a handful of key producing states. In Russia, for example, the Chinese deal represented a significant step forward after several years of contentious renegotiations of a 2005 export deal between the two countries. The newest deal between China and Russia took months to negotiate, as both sides drove a hard bargain. The final agreement met Russia's core objectives it alleviated Rosneft and Transneft's short-term financing difficulties and freed up cash for Rosneft to consider acquisition opportunities. It also met China's primary goals of ensuring stable crude supplies, guaranteeing enough cash to finance phase one of the ESPO pipeline, and earning loan guarantees from Russia's state-owned bank Vnesheconombank. In the end, the Russia-China deal strengthened a relationship that both sides view as a strategic priority in the coming years.
Similarly, the Chinese deal with Kazakhstan in which CNPC and the China Export-Import Bank will lend $5 billion each to Kazmunaigaz (KMG) and the Development Bank of Kazakhstan, respectively marked a turning point in a trade relationship that has proven difficult in recent years. When CNPC acquired PetroKazakhstan in 2005 at that point the largest overseas acquisition by a Chinese NOC the Kazakh government introduced new legislation that granted pre-emptive rights to KMG in future deals. CNPC was criticized for paying too much for the PetroKazakhstan acquisition, but its 67 percent stake in that company has now been accompanied by a 50 percent stake in MMG giving CNPC a much larger foothold in the upstream in Kazakhstan. The Chinese government views the effort to secure additional crude supplies from Russia and Kazakhstan through the lens of energy security; additional pipeline imports serve as a hedge against possible supply disruptions elsewhere, for example in shipping lanes in the Straits of Hormuz or Straits of Malacca.
Finally, the loans-for-oil agreements will open new opportunities for Chinese service companies. CNPC's service sector subsidiaries in manufacturing and engineering could win pipeline construction contracts for the ESPO phase one and its spur line to China. China's loan to the Development Bank of Kazakhstan will be partly used to construct a "West Europe-West China" highway that would likely employ Chinese construction laborers. Other potential opportunities for Chinese companies in Kazakhstan as a result of the bilateral loans include the construction of a gas pipeline and potential joint work in uranium mining all projects that would meet job creation objectives of both governments in underdeveloped areas. And China's loan agreement with Petrobras stipulates that the Chinese could supply the Brazilian NOC with "equipment and services in the areas of LNG facilities, offshore drilling rigs and service ships."
Brazil is a particularly enticing market for Chinese service companies, given the enormous demand for engineering, construction and drilling contractors as Petrobras tackles its $174.4 billion five-year investment plan. Although the Brazilian government (and Petrobras) may prefer to turn to domestic companies, the capacity of the Brazilian service sector is limited, and those firms may not be able to match the cost competitiveness of Chinese companies.
Willing partners
China has shrewdly seized an opportunity to make long-term loans in a down cycle, at a time when project finance is hard to come by and traditional bank lending has become difficult to secure. In all of these deals, the Chinese government has found that its partners are more willing to make compromises whether on interest rates, loan guarantees, or upstream access in order to attract capital.
While foreign governments may have begrudgingly accepted some of the Chinese terms, the new investment model still holds some distinct advantages for them. In most cases the Chinese NOCs are not directly investing in the upstream or have acquired only smaller assets so host governments are not forced to defend themselves against charges that China has seized control of their oil resources. The interest rates charged by the Chinese for these loans are in most cases fairly low under 6.5 percent in the case of the CDB's loan to Petrobras. Those terms are easier for China's borrowers to accept, and while the interest rates may be low they still exceed China's return on investment in US Treasury bills. And China will essentially pay market prices for its oil imports, in contrast with a past loan to Russia that was renegotiated when Russian companies complained that the Chinese were receiving barrels at a substantial discount.
Perhaps most importantly, many governments are finding it easier to negotiate directly with the Chinese than to make deals with numerous international oil companies; the Chinese government can leverage its finances and the capabilities of its NOCs and service companies in a single deal. As Petrobras CEO Sergio Gabrielli stated last month, "there isn't someone in the US government that we can sit down with and have the kinds of discussions we're having with the Chinese."
(China.org.cn September 11, 2009)
