Chapter 3: Overview of Chinese Energy Policy
3.2 History of Chinese Energy Policy
3.2.1 Self-Sufficiency Period (1949-1993)
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country’s energy and transportation sectors.”114 One example of this can be seen in CNOOC Ltd.’s ultimately unsuccessful bid to purchase Unocal for $18.5 billion.115 Unable to fund this bid itself, it lined up a $7 billion loan from its parent company as well as a $6 billion loan from the Industrial and Commercial Bank of China.116 CNOOC’s bid for Unocal failed in part due to American perceptions that CNOOC was in effect receiving subsidies from the Chinese government that Chevron would not be able to match.117 CNPC’s attempt to purchase Russia’s Slavneft in 2002 faced similar opposition from Russian lawmakers.118
3.2 History of Chinese Energy Policy
3.2.1 Self-Sufficiency Period (1949-1993)
The newly formed People’s Republic of China was predominantly rural and relied mainly on coal for energy production: coal accounted for 96% of energy production and 94%
of energy consumption in 1950s China.119 Mao Zedong’s decision in the early 1950s to industrialize China carved out a small place for oil in China’s energy mix. The importance of oil as a strategic resource became clear when China’s participation in the Korean War led to the Coordinating Committee for Multilateral Export Controls (COCOM) declaring an oil embargo on China, and forced China to rely on its communist allies for oil exports.120 In response, Mao created the Ministry of Petroleum (MPI) to manage and coordinate the
“production, transportation, and marketing of oil,” which marked the beginning of China’s
114 Downs, "Who's Afraid of China's Oil Companies," 93-94.
115 "China Oil Firm in Unocal Bid War," BBC, http://news.bbc.co.uk/2/hi/business/4121830.stm.
116 "Who's Afraid of China's Oil Companies," 91.
117 Although the bid failed, it was revealed afterwards that had CNOOC been prepared to offer a slightly higher bid, Unocal shareholders might have agreed to CNOOC’s offer. Elizabeth Douglass, "Unocal Says It Favored Cnooc Bid," The Los Angeles Times, http://articles.latimes.com/2005/jul/26/business/fi-unocal26.
118 Kong, China's International Petroleum Policy, 106.
119 Meidan, The Structure of China's Oil Industry, 3.
120 Ibid., 4.
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push for energy security through self-sufficiency.121 Like the rest of the Chinese economy at the time, the energy sector fell under a “command-and-control governance system,” which refers to the central government controlling “all decisions over the entire production chain,”
as well as setting supply and demand targets for local petroleum administrative bureaus (PABs) to meet.122 This model was developed and refined at the first of China’s oilfields, the Daqing oilfield. The Daqing PAB controlled not only the core oil business, but also other ancillary services such as infrastructure and social services for workers.123 Of the 260,000 employees of the Daqing PAB, “only 40 per cent worked in the core oil business[es]” of extraction, transportation, refining, marketing, and R&D.124 The discovery of other oil fields soon followed, and by 1963, China had become self-sufficient and a net exporter of oil.125
With Deng Xiaoping’s ascent to power in 1978, China began the slow transition from a command to a market economy. Energy consumption naturally grew with the economy, but energy production failed to keep pace. 1980 saw the first drop in petroleum production growth rate, which spurred the central government to reform the petroleum industry.126 The central government began by switching to the contract responsibility model, where it would set an annual petroleum production target for the Ministry of Petroleum Industry (MPI);
excess oil could be exported or sold to the domestic market, with revenues could be put towards purchasing foreign technology or exploration and production (E&P) investment at home.127 The central government also established a two-tiered pricing system for oil sales: oil production up to the annual quota would be sold at a price point set by the government, but excess oil could be exported at international market prices, giving NOCs an additional
121 Ibid.
122 Kong, China's International Petroleum Policy, 8-9.
123 Meidan, The Structure of China's Oil Industry, 4.
124 Ibid.
125 Kong, China's International Petroleum Policy, 8-9.
126 Ibid., 9.
127 Ibid., 10-11.
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incentive to increase production.128 These reforms were able to temporarily reverse the drop in petroleum production, but the mid-1980s were a difficult period for the petroleum industry overall because of the maturation of existing oil fields, increased labor costs, and pricing distortions between “upstream output and downstream products” which “allowed refineries to profit at the expense of oilfields.”129 Government-directed improvements in energy
efficiency were able to reduce energy consumption, but double-digit inflation meant that further reforms would not be implemented until 1990.130
Beginning in 1990 the State Planning Commission (SPC) began to raise prices for the in-plan petroleum output while increasing the volume of petroleum that could be sold at that price.131 In 1994 the State Council abolished the contract responsibility model and allowed Chinese oil companies to retain their profits.132 By 1998, reforms had progressed such that oil prices were somewhat aligned with world prices. The State Development and Planning Commission (SDPC) classified Chinese domestic crude oil into four categories and priced them against four international benchmarks, with each price being determined by the benchmark price plus an additional premium to account for transportation cost and price differentials.133 Starting in 2001, the SDPC linked domestic oil prices to “weighted average oil product prices of the Singapore, Rotterdam, and New York oil markets”; a system that remains in use today.134
The decentralization of petroleum production occurred concurrently with the decentralization of petroleum pricing. Back in the 1950s, when China had a command
128 Meidan, The Structure of China's Oil Industry, 9.
129 Ibid.
130 Some in the Chinese government believed that inflation would lead to social instability, and these fears appeared to come true with the Tiananmen student protests in 1989. Kong, China's International Petroleum Policy, 11.
131 Ibid., 12.
132 Ibid.
133 The SPDC is the successor to the SPC. Ibid.
134 Ibid.
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economy, the energy industry was modeled after the Soviet system and consisted of a single ministry (the Ministry of Fuel Industry) with a handful of bureaus underneath it.135 The SPC sat between various economic ministries and the State Council, and directed national
economic development.136 By 1955, the Ministry of Fuel Industry had been disbanded and replaced with the MPI, the Ministry of Coal Industry (MCI), and the Ministry of Electric Power (MEP).137
The next thirty years would be marked by the periodic disbandment and consolidation of ministries, until the creation of the first NOC in 1982. CNOOC was established under the MPI in order to manage offshore E&P as well as coordinate with foreign oil companies.138 It was given “general bureau” rank, making it beneath a “full ministry” but above a regular bureau.139 The State Council then created Sinopec in 1983 by grouping “refining and petrochemical assets from the MPI, together with chemical enterprises from the Ministry of Chemical Industry and synthetic fiber manufacturing from the Ministry of Textile
Industry.”140 In 1988, the remaining administrative portions of MPI itself were restructured to become CNPC, making it responsible for “formulating national quality standards for the oil industry and devising policy for environmental protection,” as well as “the right to oversee international cooperation in developing China’s onshore oil and natural gas.”141 Both Sinopec and CNPC retained the political rank of their predecessors as ministries.
The creation of the NOCs did not represent a full move towards decentralization, and the NOCs themselves stumbled through their early years. They continued to be managed by the State Council while also performing the administrative functions of their predecessors.
135 Meidan, The Structure of China's Oil Industry, 10.
136 Ibid.
137 Ibid., 11.
138 Kong, China's International Petroleum Policy, 13.
139 Meidan, The Structure of China's Oil Industry, 11.
140 Kong, China's International Petroleum Policy, 13.
141 Ibid.
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Kong states that they were “not only market participants but also market regulators.”142 Nor were the NOCs vertically integrated in the style of Western corporations. Instead, each focused on a single area of petroleum production: CNPC on onshore upstream production, CNOOC on offshore upstream production, Sinopec on downstream refining, and Sinochem on oil trading.143 This lack of vertical integration meant that the NOCs were unevenly affected by price volatilities in the oil market and less competitive than their Western counterparts. Quotas and prices were still set by the central government, and the administrative shuffling within the energy industry had not yet resolved organizational redundancy.
3.2.2 “Going-out” (1993-2013)
The first NOC to develop an overseas strategy was CNPC. Prior to full
decentralization, CNPC was having the most difficulty dealing with the concurrent crises of declining petroleum prices, maturing oil wells, and depleted petroleum reserves.144 In 1991 CNPC was still responsible for crafting onshore sector policies, and proposed a three-pronged strategy that would maintain China’s petroleum supply and make CNPC’s operations
profitable. The first prong of the strategy was the development of immature oilfields in Western China while increasing natural gas development. The second prong was the
diversification and specialization of its subsidiaries, with savings and profits reinvested into additional E&P operations. The third prong was the promotion of the development of domestic resources with the help of foreign capital and technology while turning to the international market in order to keep up with growing domestic demand. Overseas expansion was appealing for a number of reasons. For one, seismic surveys suggested that China had
142 Ibid., 14.
143 Ibid.
144 Ibid., 33.
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relatively poor reserves when compared to the Middle East, South America, the former Soviet Union, and even the United States.145 Not only would it be easier to find new oilfields, lower production costs abroad meant that even with international shipping costs, “exploring and producing oil abroad was still competitive in comparison to domestic production.”146
One of the most important factors contributing to overseas expansion was China becoming a net petroleum importer in 1993. In response, the CNPC president Wang Tao suggested that CNPC should actively be “going-out” to aggressively engage in overseas E&P in order to make up for the growing shortfall in domestic production.147 This unleashed a wave of small but successful overseas projects that paved the way for other Chinese firms to expand overseas. The central government did not block these early projects, but was
unwilling to provide tax incentives or streamline the lengthy approval procedures.148 As the volume of Chinese petroleum imports increased, the central government finally took notice, and then-President Jiang Zemin gave his official blessing to CNPC’s “going-out” strategy.149 With its inclusion in the Tenth Five-Year Plan (2001-2006), the “going-out” strategy had gone from a CNPC initiative to “an overarching national strategy for China’s petroleum sector.”150
China’s NOCs began looking abroad by searching for opportunities to invest in E&P.
The first successful overseas investment was made by CNPC, which purchased 22 million cubic meters of an Albertan oil sands project in 1993.151 Unfortunately for the NOCs, international oil companies (IOCs) had a head start in overseas investment, and “dominated the international petroleum market in terms of capital, technology, and management
145 Ibid., 39.
146 Ibid., 40.
147 Ibid., 41.
148 Meidan, The Structure of China's Oil Industry, 20.
149 Kong, China's International Petroleum Policy, 45.
150 Ibid., 47.
151 Meidan, The Structure of China's Oil Industry, 19.
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experience,” meaning that the NOCs were left with acquisitions that the IOCs considered undesirable.152 As the NOCs (and CNPC in particular) began to gain experience investing overseas and Chinese oil imports continued to climb, Beijing allowed the size and quantity of overseas investments to increase as well. In June 1997 alone, CNPC signed $5.6 billion worth of oil contracts in Kazakhstan, Venezuela, and Iraq, with investments in Kazakhstan reaching
$9 billion by the end of the year.153
After this initial period of expansion in 1997, there was a brief hiatus in acquisitions from 1998 until 2000. The Asian Financial Crisis of 1997 led to a decline in oil prices, which prompted a shift from overseas investment back to direct purchases.154 This was also when China moved to properly restructure the petroleum industry. CNPC and Sinopec were restructured into fully integrated oil companies with both upstream (exploration and production) and downstream (refining petroleum products) portfolios, a regional focus
(northern/southern China), “integrated production, distribution, refining, and sales networks,”
and trading rights.155 The central government’s decision to fully decentralize oil prices and link domestic oil prices with international market prices was followed by a push for NOCs to list their core assets on stock markets, which “significantly enhanced the economic power of CNPC, Sinopec, and CNOOC.”156 The various agencies directing the petroleum sector were restructured as well. The two goals of this restructuring were to reduce government
expenditure by reducing the number of agencies and to separate the corporations from the regulating bodies that made policy.157 The restructuring effort was successful in that it streamlined the energy sector, but by reducing the number of government ministries and the
152 Kong, China's International Petroleum Policy, 63.
153 Meidan, The Structure of China's Oil Industry, 25.
154 Kong, China's International Petroleum Policy, 63.
155 Ibid., 15.
156 Meidan, The Structure of China's Oil Industry, 19-20.
157 Ibid., 26.
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number of officials in those ministries, regulatory bodies such as the State Economic and Trade Commission (SETC) and the State Development and Planning Commission (SDPC) became more dependent on the technical expertise contained within the NOCs when attempting to formulate policy.158
The NOCs were able to use this newfound political and economic weight to pursue overseas investments with renewed vigor. Bolstered by increased support from the central government, in 2004 the central government encouraged the policy banks to offer “direct capital contributions” and “subsidies associated with the official aid programmes [sic]” to companies that engaged in “preferential projects.”159 The State Council finally began offering export tax rebates, financial assistance, and foreign exchange assistance, among other
incentives.160 Chinese support was not merely economic, but political as well. The Ministry of Commerce and the Ministry of Foreign Affairs created catalogues to help Chinese
companies decide what industries to invest in, while embassies conducted feasibility studies in their host countries.161 This was topped off by high-level bilateral visits, involving senior officials up to then-President Hu Jintao.162
This multi-pronged approach led to an explosion in overseas investment. Prior to 2000, Chinese NOCs invested in fewer than 10 total overseas projects, but invested in at least 20 each year after 2000.163 By March 2009, the total number of overseas investments had climbed to 208 projects across 47 countries, the majority of which were in Africa, Asia, and the Middle East, reaching a total of over $60 billion worth of investments by September
158 Ibid.
159 Ibid., 41.
160 Ibid., 42.
161 Ibid.
162 Ibid.
163 Kong, China's International Petroleum Policy, 64.
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2009.164 The global financial crisis of 2008-2009 slowed the pace of foreign investments because the sharp decline in oil prices made direct purchases of oil more attractive than long-term investments. Even so, in 2009 China continued to sign bilateral agreements, such as a
$25 billion loan to two Russian energy companies for twenty years of access to oil165 and a
$10 billion loan to Brazil for 100 million barrels of crude oil a day.166
In pursuing overseas investments, China’s NOCs frequently seek what is called
“equity oil.” The term refers to oil acquired overseas and shipped directly back to China rather than being sold on the open market. The amount of oil produced and shipped back as equity oil is determined by the NOC; the equity oil option is provided to the concession owner as a guarantee on investment, but the owner can also choose to sell it on the open market as well. Senior officials in both the oil industry and the central government have publicly expressed a preference for equity oil over other types of oil supply. A 2004 report headed by the Development and Research Center of the State Council advocated that
“securing equity oil should be the major operation mode” of overseas expansion.167 Downs argues this preference stems from a fear that China could one day lose access to the world oil market, and would only be able to acquire oil by ordering NOCs to ship foreign oil back to China.168 Chinese oil analysts have revealed that “the target of Chinese oil companies’
internationalization is to ensure that overseas equity oil and gas production will account for between one-third and one-half of China’s total oil and gas imports.”169 In fact, China’s
164 Ibid., 64-67.
165 Robin Paxton and Vladimir Soldatkin, “China lends Russia $25 billion to get 20 years of oil,” Reuters.com, February 17, 2009, http://uk.reuters.com/article/2009/02/17/uk-russia-china-oil-sb-idUKTRE51G3S620090217 in Zhang Jian, "China's Energy Security: Prospects, Challenges, and Opportunities," (Washington D.C.: The Brookings Institution, 2011), 19.
166 Associated Press, “Brazil to supply crude to China - in return for $US10b loan,” Sydney Morning Herald, February 20, 2009, http://www.smh.com.au/business/world-business/brazil-to-supply-crude-to-china--in-return-for-us10b-loan-20090220-8cuv.html in ibid.
167 Kong, China's International Petroleum Policy, 93.
168 Downs, "Who's Afraid of China's Oil Companies," 82.
169 Kong, China's International Petroleum Policy, 92-93.
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NOCs have fallen short of this goal: equity oil made up only 26.10% of China’s total oil imports in 2007.170