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A Long, Hot Summer for China National Petroleum Corporation

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Pacific Money

A Long, Hot Summer for China National Petroleum Corporation

A flurry of deals and political tensions complicate the outlook for China’s state-owned oil company.

Over the past three months, China’s flagship state-owned oil company, China National Petroleum Corporation (CNPC) has signed deals worth up to $300 billion for oil assets abroad. At the same time, however, the company has come under increasing political pressure domestically. The deals, which included agreements in Russia, Ecuador, Mozambique, Kazakhstan and Angola, have massively increased CNPC’s equity oil supply but have further involved Chinese national interests in potentially unstable countries. The tension imposed on CNPC operations by the contradiction between strictly business interests and Chinese politics has been further amplified by the recent removal of four experienced CNPC executives in what are likely politically motivated investigations. CNPC’s recent behavior highlights the Faustian bargain of Chinese state-owned enterprises (SOEs), which requires them to fulfill national interests and provide political fealty to senior party leaders rather than make purely business calculations of return on investment.

CNPC began its busy summer in late June by inking a $1.5 billion deal with Angola, buying out Houston-based Marathon Oil’s share of an offshore field. The same day, CNPC and Russia’s state-owned Rosneft signed a twenty-five year deal worth an estimated $270 billion. One week later, CNPC paid $5 billion for a share in Kazakhstan’s Kashagan field. The Kazakh deal was noteworthy because it was arranged through the Kazakhstan government, which bought back shares in the field from U.S. based ConocoPhillips, before re-selling them to CNPC. Lastly, on July 6, CNPC signed a major refining deal in Ecuador valued at more than $12 billion.

The centerpiece agreement of the summer was the CNPC-Rosneft deal, which was concluded as part of the 17th Annual St. Petersburg economic forum and was formally approved by Russian President Vladimir Putin and Chinese Vice Premier Zhang Gaoli. According to the terms of the deal, Rosneft will receive $60-70 billion in pre-payment, which represents a potentially huge drain on CNPC coffers even with easy financing from Chinese policy banks such as China Development Bank and Export-Import Bank of China. In return for this generous pre-payment, CNPC is scheduled to receive 30 million tons per year from Rosneft by 2018, with future pipeline construction raising the delivery rate to 46 million tons per year by 2025. In the context of China’s current import rate of roughly 135 million tons per year, this deal would supply a large percentage, albeit not a majority of China’s oil import needs during the twenty-five year term of the deal.

Politically, CNPC has solidified China’s emerging role as the dominant economic player in Central and North Asia. CNPC’s deal with Rosneft ensures that Russia will devote significant resources to upgrade and improve the crude oil pipeline to Daqing, rather than concentrate solely on the East Siberia-Pacific Ocean pipeline that terminates in Kozmino and exports to Japan, South Korea and the United States. Although the deal was overlooked in the U.S., CNPC’s deal with Kazakhstan received significant media attention in India. Indian national oil company Oil and Natural Gas Corp (ONGC) had been in talks to acquire the ConocoPhillips share of the Kashagan field before the Kazakh government exerted its preemptive rights and transferred the oil interest to CNPC. The Kashagan deal was perceived in India as a failure of India’s oil diplomacy and another example of Chinese companies unfairly using political clout in business deals.

CNPC’s government-brokered deals represent a potential danger to CNPC’s business interests by “doubling down” on countries with highly unstable political and economic systems. Surveys of public sector corruption by Transparency International in 2012 placed Russia at 133 out of 177 countries, with Kazakhstan at 132 and Ecuador at 118. These poor scores suggest that in spite of the large dollar amounts attached to the deals, CNPC will likely have a difficult working relationship in each country. Moreover, all three countries are reliant on oil revenues for government revenue and have a history of reneging on agreements or defaulting on loans, a dangerous combination for foreign investors. In Ecuador, President Raphael Correa refused to pay foreign debt from previous administrations after taking office in 2008, and referred to foreign bondholders as “real monsters.” China has become the largest source of financing in Ecuador since its government defaulted in 2008. In Russia, strict state control over the oil sector, a hallmark of the Putin-era and a reliance on oil revenue to buttress state spending opens the possibility for a “renegotiation” of the CNPC-Rosneft deal if political or economic conditions change in Moscow. On the surface, Kazakhstan appears more stable than either Russia or Ecuador but the issue of succession for the seventy-three year old Nursultan Nazarbayev remains unresolved. Collectively, the political risks of CNPC’s investment are substantial and represent a vulnerability to core CNPC business operations and Chinese national interests in a stable oil supply.

Further complicating CNPC’s calculations are a series of domestic issues including the suspension of construction at several new refineries due to a failure to curb emissions and the investigation of senior CNPC executives. The suspension of CNPC’s refinery expansion was the result of an increasingly stringent approach by China’s Ministry of Environmental Protection to clean up waste water runoff from refinery and chemical plant operations. The Ministry determined that CNPC had failed to comply with regulations mandating a 0.6 percent decrease in chemical oxygen demand in water runoff, which is an indicator of industrial pollution. Nitrogen oxide emissions were also cited as being above targets, which can lead to algae blooms in bodies of water, in large part due to CNPC using coal fired boilers that were not fitted with the proper filters. While the penalties imposed by the Chinese government will entail a cost in terms of time and money, as well as generating negative publicity among an increasingly environmentally conscious Chinese public, they will not fundamentally de-rail CNPC programs and long-term plans.

Much more significant is news that China’s State-owned Assets Supervision and Administration Commission of the State Council has opened an investigation into four senior CNPC officials for indiscipline. CNPC Vice General Manager Li Hualin, Vice President of the listed arm of CNPC, PetroChina, Ran Xinquan, chief geologist Wang Donfu, and deputy general manager Wang Yongchun are all subject to investigation for “serious violations of discipline.” All four have resigned for “personal reasons.” Prior to the investigation, Wang Yongchun had been in control of the key Daqing oil field, which had a net profit of $9 billion, roughly fifty percent of CNPC’s total profit in 2012.

Chinese political analysts noted that there were political connections between the CNPC investigations and a recent corruption investigation of Zhou Yongkang, who was the General Manager and Party Secretary of CNPC during the mid 1990s. Zhou Yongkang is perceived as a political opponent of Chinese Communist Party General Secretary Xi Jinping. Chinese Netizens largely ignored the news of the CNPC investigations and remained riveted on the Bo Xilai trial. The few bloggers and online commentators discussing the CNPC investigations generally felt that removing a few company officials was just an outcome of politics and would have little to no effect on CNPC’s privileged position in the Chinese market. Foreign reaction to CNPC investigations was quite sharp, and the market response to news of the investigations was immediate – PetroChina shares dropped by 4.4 percent, losing $1 billion in market value on the Hong Kong exchange in one day of trading.

CNPC’s recent behavior highlights an increasing disconnect between the political decisions, including personnel assignments, and the necessity for Chinese SOE’s to fulfill China’s long-term energy needs competing against business calculations of return on investment (ROI) and profitability. Global market analysts have been bearish on CNPC’s long-term profitability, with CNPC’s stock market listed subsidiary PetroChina falling out of the top ten global companies in terms of market capitalization. As Xi Jinping continues to consolidate his authority through personnel changes, the use of corruption charges against political enemies and increased “ideological work,” the chances of CNPC creating an efficient, world-class company seem increasingly remote.

Eric Setzekorn is a PhD candidate at George Washington University in the field of modern Chinese history.