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China's Pipeline Plan May Raise Energy Risk

An analysis by Michael Lelyveld 2020-01-06 -- China's plan to create a national oil and gas pipeline company may raise the country's reliance on energy imports, achieving just the opposite of what the government intends.

On Dec. 9, the government announced the long-awaited formation of a new state-controlled pipeline company, combining the infrastructure of the three national oil companies (NOCs) – China National Petroleum Corp. (CNPC), China Petroleum & Chemical Corp. (Sinopec) and China National Offshore Oil Corp. (CNOOC).

The new company, variously known as China Oil & Gas Piping Network Corp. or the National Oil and Gas Pipeline Group Co. or simply PipeChina, will be majority-owned by the NOCs through their shareholdings. But it will be controlled as a centrally-administered state-owned enterprise (SOE) under the State-owned Assets Supervision and Administration Commission (SASAC), according to various reports.

The outlines of the plan suggest that PipeChina will be a massive state holding with a sprawling network of pipelines and as many as nine import terminals for liquefied natural gas (LNG).

At the end of 2018, China had 96,000 kilometers (59,651 miles) of oil and gas pipelines, the Global Times reported.

Sixty-three percent were built by CNPC, 31 percent by Sinopec and 6 percent by CNOOC, the Communist Party of China (CPC) affiliated paper said.

The oil and gas network is expected to expand to 240,000 kilometers by 2025, the South China Morning Post reported.

SASAC is slated to hold a 40-percent stake in the company reportedly valued at U.S. $70 billion (490.5 billion yuan).

CNPC will have 30 percent, Sinopec will get 20 percent, and CNOOC will own 10 percent, Yicai Global news said.

Details of the plan, which has been considered in several forms with starts and stops since 2014, appeared to still be preliminary.

Making the announcement before the end of the year may have been the main goal after the government's National Development and Reform Commission (NDRC) promised the merger in its annual work report to lawmakers last March.

Previous reports had predicted it by mid-2019 and, prior to that, before the winter of 2018-2019.

Asset transfers from the three NOCs have yet to take place and negotiations appear to be at an early stage.

The Global Times quoted an unnamed official of CNPC's PetroChina subsidiary as worrying "whether the reform agenda and asset transfer can go forward smoothly, without encountering opposition" from the NOCs.

A straightforward goal

While the process may be slow and complicated, the goal is relatively straightforward.

Regulators have worried for years that the NOCs have used their control over pipelines to deny access to smaller and independent producers, discouraging domestic output of oil and gas.

Analysts have noted that market economies have promoted competition by separating production from distribution, as in the European Union's Third Energy Package of regulations.

In his own annual report last March, Premier Li Keqiang said the pipeline merger could become a national model for restructuring and reforming China's giant SOEs.

"In natural monopoly industries, network ownership and operation will be separated in light of the specific conditions of these industries to make the competitive aspects of their operations fully market based," Li said.

The pipeline issue has become pressing with China's dependence on foreign oil rising above 72 percent in the first 11 months of 2019 and reliance on gas imports expected to near 50 percent last year.

China's domestic oil production has remained stagnant for the past decade, posing a major energy security risk as demand continues to grow.

While oil output edged up only 1 percent from a year earlier in the 11-month figures, imports climbed 10.5 percent, the National Bureau of Statistics (NBS) said.

But in China's case, a pipeline merger may only serve to increase import dependence, said Michal Meidan, director of the China Energy Program at the Oxford Institute for Energy Studies.

The reason is that third-party access to pipelines is not China's only energy problem.

"I think there's still very little that's been clarified at this point. But overall, opening up the midstream will likely be more supportive for import growth than for domestic production," Meidan said in comments before last week's escalation of conflicts between the United States and Iran.

China's oil and gas production has been hampered for decades by difficult geology and a lack of major discoveries.

The drawbacks have raised costs and conflicts with the slow pace of price decontrol.

In the case of gas, China has largely pinned its hopes for domestic growth on shale gas production, which has fallen far short of targets so far.

"The geology is complicated and most of the majors expect future growth to come from unconventional reserves rather than conventional gas production, for which both the geology and costs are unclear," Meidan said.

Gas demand will grow

The growth of gas imports has cooled in the past year as the economy has weakened and authorities have slowed the pace of conversions from coal after stronger double-digit increases in 2017-2018.

Gas consumption in 2019 is expected to rise 10.7 percent to some 310 billion cubic meters (10.9 trillion cubic feet) from 280 billion cubic meters (bcm) in 2018.

In 11-month results, gas imports rose 7.4 percent from the year-earlier period, while domestic gas output gained 9.2 percent.

In its most recent forecast, the Paris-based International Energy Agency expects China's gas demand will more than double to 655 bcm in 2040, while domestic production will rise to only 306 bcm under stated policies.

"The launch of a new national pipeline firm ... may encourage an increase in LNG imports if third-party access does become more available and affordable," said an analysis last month by Argus Media, a provider of news and market data for the global energy and commodities markets.

Although the government has opened up exploration and production to foreign and private investors, non-state producers will want to see more liberalization of "city gate," or predistribution prices, Meidan said.

New producers will face pressure from local governments to make domestic gas output available for consumption close to home, while opening up access to pipelines in an expanded network may favor demand for more imports.

"Third-party access could increase import dependence as new entrants will want to import natural gas, especially if they can secure contracts based on current spot prices... as they will be more competitive than some of the majors' old term contracts," Meidan said.

"So, more actors could actually lead to a higher reliance on imported gas," she said.

A moneymaker?

Many questions about the PipeChina plan have yet to be answered. One of the big ones is whether it will make money.

Meidan notes that the processes of unbundling, spinoffs and liberalization have taken place in other markets where the infrastructure is mature. In China's case, much of the transport and storage expansion still needs to be done.

If the new PipeChina entity is to be self-financing, it may have to charge high rates to cover needed construction.

Relatively high rates may also be needed to attract the private capital that the government says it wants to participate in the company.

"That would then defeat the purpose of reducing prices for end-users through lower transport costs," Meidan said.

"Alternatively, the government may need to step in and subsidize it," she said.

Major differences between the announced plan and earlier versions also raise questions about whether PipeChina is in its final form or still a work in progress.

Under a version of the plan reported by Bloomberg News in 2018, the government's goal was to bring enough private capital into the project to lower the combined NOC shares to "about 50 percent."

The latest version appears to give the NOCs a clear majority with 60 percent of the shares. Even so, this may not reflect the dominance of CNPC's influence and control.

According to calculations based on figures from the China Securities Journal last year, CNPC owned 76.2 percent of the country's gas pipelines and 68.9 percent of the pipelines for oil.

In 2018, another Bloomberg report surprised analysts by disclosing that the NDRC plan would include both oil and gas pipelines in the merger. Earlier versions had only covered oil lines. Some experts voiced criticism of the plan, noting major differences in oil and gas operations.

In the long history of the restructuring, earlier industry resistance to the merger also brought all plans to a halt in 2016 when world oil prices slumped.

"One reason why a national pipeline company that provides access to all producers is no longer needed is because opposition among policymakers has increased to opening upstream exploration to more participants," Bloomberg quoted an unnamed inside source as saying at the time.

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