Sweet & Sour
Chinese oil and gas is expected to be responsible for an array of
jumbo mandates in the coming years. Growing at a rate of 4%,
compared with 1% in Europe, Chinese oil and gas is hungry for
capital. Pressure from the WTO and the inefficiency of domestic
developers have opened what was a closed market to foreign sponsors
China became a net importer of oil in 1993. Throughout the late 1990s domestic demand increased and a growing transport industry ensures this trend will continue.
Natural gas, in contrast, is an underdeveloped market. Historically used for production of fertiliser, gas for energy was widely regarded as expensive and inefficient compared with the abundant resource of coal. Proven efficiencies and environmental concerns have, along with a growing trans-national gas market in Asia, changed Chinese attitudes. Recent targets state an increase in gas used for energy consumption from 2% to 6%, although this is viewed by many as very ambitious.
These goals were unobtainable to the Chinese oil and gas industry in its former guise. Over the last decade, state owned domestic incumbents China Petrochemical Corp (Sinopec), PetroChina, born from China National Petroleum Company (CNPC) and China National Offshore Oil Corp (CNOOC) have been restructuring. The broad aims of reducing inefficiencies and introducing competition have achieved a small degree of success. Crucially, foreign participation has been stepped up.
This is not the first invitation to international developers, with some participating in joint venture onshore exploration projects in the 1980s. These were very controlled however, with many foreign players complaining that they were restricted to largely unproductive areas. Entrance to downstream sectors was resisted totally.
The present climate signals a change in attitude. ?It is distribution that is attractive to investors,? says one Hong Kong based banker. ?The Chinese government may not particularly want their involvement in this sector but are forced to agree to it in return for assistance in other areas.?
?The Chinese need the cash flow and technological know-how of international developers,? agrees another player. ?With the emphasis on technology.? As this realisation plays out, multi-million dollar Sino-foreign ventures are emerging.
China's allure
Theoretically, first to come to fruition will be a group of petrochemical projects. The $4 billion Shell/China National Offshore Oil Corporation (CNOOC) project at Nanhai is currently taking lead arranger bids from banks. And hot on its tail are joint ventures between BASF and Sinopec and BP and Sinopec.
A minority stake in the country's first LNG receiving terminal at Guangdong has been awarded to BP and MOUs have been signed with shortlisted bidders for the proposed East-West pipeline. Gazprom and Shell have recently joined forces and are competing against groups led by BP and ExxonMobil. The winning bidder will form a joint venture with PetroChina to develop the $14.5 billion, 4167 km natural gas pipeline.
Selective is a word echoed by many in reference to investor appetite in China. Given the right conditions, it is an attractive prospect. Not only is it home to the fastest growing energy market in the world but its oil and gas projects hold significant strategic value as the sector develops right across Asia. Moreover, unlike the power sector, which opened to foreigners for a short time and then started to close, oil and gas is opening up for the long term. The scale and significance of the projects in question means that a commitment to joint ventures has to be greater.
The conditions are the crux, though. Lawrence Darby, corporate finance, Kaye Scholer, Fierman, Hayes & Handler LLP, describes the steps so far as significant but adds that, ?No one really knows the how serious the government's commitment to opening up the market to foreign investment and competition is.? Some say the sector's historical significance prevents wholly owned foreign enterprises, although Ashley Wilkins, head of project and sectorial finance for Asia at SG, suggests that the level of potential growth means that this cannot be ruled out.
Reforms and regulations
A program of structural and legislative reforms is underway, aiming to build on previous progress and promote checked liberalisation. But these take time. The transition from a command and control to a socialist market based approach is not a fluid one.
1998 saw the attempted remodelling of CNPC and Sinopec into two large, vertically integrated and competing companies. CNOOC, with its exclusive rights to developing offshore resources, has long been regarded as less cumbersome than its brothers. Central to the notion of reform was separating regulatory bodies and social welfare services from commercial entities. On the back of this, in 1999, CNPC spawned PetroChina to take over its most productive assets. Since then, IPOs have been issued on the Hong Kong and New York stock exchanges by Sinopec, PetroChina and CNOOC. A further key issue addressed in the late 1990s was that of pricing, with attempts made to link domestic with international prices.
These steps set reform within the petroleum industry in motion. But the road is a long one. Even limited competition between Sinopec and PetroChina is retarded, since the major impact of reforms was to divide the two companies geographically. The role of the government is still not clear, with no clear division between policy and regulatory bodies. Moreover the industry has no firm legal base. China has a history of being able to provide sufficient comfort for individual projects. But in order for international players to become an integral component in the industry, transparent and solid legislation must be put in place.
The World Bank has been involved in China's energy reforms in an advisory capacity since 1999 and claims consensus in China is to develop a framework conducive to private investment. But reforms take a long time to filter right through bureaucratic institutions. Conditions set out by the WTO and domestic needs suggest that foreign involvement will increase. But speed and extent are difficult to judge. Steeped in a history of domestic self-sufficiency and state control, the Chinese government will introduce competition only to limited degrees and on its own terms.
Future of gas
A driving force behind reform is the desire to develop a natural gas market. Easing dependence on coal and reducing oil imports are the reasons most often cited, but it is also seen as closely entwined with economic development for two other reasons. Its superior efficiency and environmental benefits as an energy resource make it better equipped to support predicted economic growth. Secondly, much of the known reserves lie in the underdeveloped western regions. It is hoped that exploration of the fields will confirm their development potential.
Unlike oil, the gas industry is starting from scratch. China has neither the necessary infrastructure nor the market and putting these in place is both time consuming and capital intensive. Lawrence Darby believes that there is sufficient political will at the highest level to progress development. Local levels however, with their abundance of cheap coal, will resist this. Moreover, a sector with little proven history does not inspire confidence in developers.
Transmission is perhaps the biggest obstacle. Building a network capable of transporting gas from its source in the west to industrial centres in the east is a daunting task. But plans for the East-West pipeline are moving forward. Running from the Tarim Basin in Xingjang to Shanghai, the pipeline has a projected total capacity of 12 billion cm/y. The basin is the China's richest natural gas resource, comprising some 8.4 trillion cubic meters.
PetroChina's initial request for foreign partners for this vast project met with little enthusiasm. Midstream assets are the sticking point, regarded by all as the technically and financially risky component. Foreign companies are unwilling to take it on without a stake in the more profitable sectors. Subsequent concessions on the part of PetroChina, in the form of a promise of a majority stake and participation in all stages of the pipeline project, has made the concession considerably more attractive. A shortlist has since been announced.
Construction of this pipeline would be a crucial kick-start for Chinese natural gas. However, Michael Kershaw, director at HSBC Hong Kong, points out that this is only one component. LNG terminals and pipelines from other countries are also crucial. BP scooped a 30% stake in the first LNG receiving terminal at Shenzen in Guangdong. The $600 million venture is majority owned by CNOOC, with the remainder held by local Guangdong companies (31%) and two Hong Kong energy firms. Bids are now going in for the $10 billion gas supply contract, considered the most lucrative component of the deal. LNG imports are also proposed for the cities of Qingdao, Shanghai, Fuzhou and Guangzhou. Estimates suggest imports of up to 3 million tonnes by 2010 and 10 ? 15 million tonnes by 2020.
Finding finances
Although staggering along with uncertain reforms and state owned entities resisting competition, large oil and gas projects are heading slowly towards the markets. Monies raised by the three domestics' IPOs are likely to contribute to financing their portion. PetroChina has said that it will seek funds for the pipeline through an A-share issue offered to the domestic market, although Sinopec's recent debut to domestic institutions was not received as well as had been hoped. The sheer size of many of the projects discussed, however, dictates that project financings will be necessary.
Limited recourse financing is not new to China, having played a role in infrastructure over the last decade. Primarily in the power sector, these projects have tapped both international and domestic funding pools. Although drawing lessons from these, pending oil and gas ventures are in a league of their own with regard to size, technical complexity and up-front capital. The risks lenders will be asked to take on are largely untested.
?The volatility of gas prices is cause for concern,? says John Bailey, analyst at Standard & Poor's. The question of supply and offtake is also contentious. Power plants are typically characterised by one PPA. Gas projects on the other hand are part of a chain. Each section relies on the smooth functioning of others. Midstream facilities are particularly undesirable from this point of view, feeling the risks characteristic of both upstream and downstream.
?The participation of domestic lenders is crucial in getting these projects financed,? says Patrick Barr, head of oil and gas at ANZ. There is considerable liquidity in the Renminbi markets but it has historically been tapped for very short-term financings. ?But in recent years they have been getting more used to lending into projects,? notes Lawrence Darby, ?which is a significant step for the oil and gas ventures.? The three main PRC Banks, with strong liquidity in both Rmb and $, will play a pivotal role.
?If the projects are structured correctly, international appetite will be considerable,? predicts Wilkins. ?SG is advising on the BP, Sinopec, Shanghai Petrochemical petrochemical project, which is opting for a limited recourse commercial route and is on course for a successful financial close.? Shell's Nanhai venture is quasi-corporate pre completion, after which the guarantees fall away, leaving a full project loan.
Private insurance and ECA support are readily available for China. But Darby notes that the latter would be closed in the future if the Chinese produce the equipment domestically. Financings with a degree of sponsor support may be able to stand up without ECAs though. Patrick Barr, head of oil and gas at ANZ, claims that PRI cover at Nanhai will be sufficient.
Currency risk is mitigated to a certain extent in the case of petrochemicals, which can be sold internationally to create dollar revenue if needs be. This spate of projects, of which at least two, if not all, are expected out in the markets by year-end will be carefully scrutinised. There is a widespread belief that international banks are willing to take on some Chinese market risk and the extent and structure will be judged by these deals.
Whether the structures will sit as easily on large gas projects is uncertain. There is very little infrastructure in place, the market is under-developed and excess gas in a pipeline cannot readily be sold overseas, as with petrochemical products. These increased risks have led some to speculate that large gas projects, particularly midstream assets, may have difficulty attracting international financing. At the very least, lenders will demand tighter comforts.
But the sector is undoubtedly moving, and will only continue to do so ? with foreign assistance. Outlook amongst the international lending community is guardedly enthusiastic, with many players expanding their interests in the area. ?China's needs in terms of oil and gas are huge,? says one. The rewards of investing, given the right conditions, could also be huge.
China became a net importer of oil in 1993. Throughout the late 1990s domestic demand increased and a growing transport industry ensures this trend will continue.
Natural gas, in contrast, is an underdeveloped market. Historically used for production of fertiliser, gas for energy was widely regarded as expensive and inefficient compared with the abundant resource of coal. Proven efficiencies and environmental concerns have, along with a growing trans-national gas market in Asia, changed Chinese attitudes. Recent targets state an increase in gas used for energy consumption from 2% to 6%, although this is viewed by many as very ambitious.
These goals were unobtainable to the Chinese oil and gas industry in its former guise. Over the last decade, state owned domestic incumbents China Petrochemical Corp (Sinopec), PetroChina, born from China National Petroleum Company (CNPC) and China National Offshore Oil Corp (CNOOC) have been restructuring. The broad aims of reducing inefficiencies and introducing competition have achieved a small degree of success. Crucially, foreign participation has been stepped up.
This is not the first invitation to international developers, with some participating in joint venture onshore exploration projects in the 1980s. These were very controlled however, with many foreign players complaining that they were restricted to largely unproductive areas. Entrance to downstream sectors was resisted totally.
The present climate signals a change in attitude. ?It is distribution that is attractive to investors,? says one Hong Kong based banker. ?The Chinese government may not particularly want their involvement in this sector but are forced to agree to it in return for assistance in other areas.?
?The Chinese need the cash flow and technological know-how of international developers,? agrees another player. ?With the emphasis on technology.? As this realisation plays out, multi-million dollar Sino-foreign ventures are emerging.
China's allure
Theoretically, first to come to fruition will be a group of petrochemical projects. The $4 billion Shell/China National Offshore Oil Corporation (CNOOC) project at Nanhai is currently taking lead arranger bids from banks. And hot on its tail are joint ventures between BASF and Sinopec and BP and Sinopec.
A minority stake in the country's first LNG receiving terminal at Guangdong has been awarded to BP and MOUs have been signed with shortlisted bidders for the proposed East-West pipeline. Gazprom and Shell have recently joined forces and are competing against groups led by BP and ExxonMobil. The winning bidder will form a joint venture with PetroChina to develop the $14.5 billion, 4167 km natural gas pipeline.
Selective is a word echoed by many in reference to investor appetite in China. Given the right conditions, it is an attractive prospect. Not only is it home to the fastest growing energy market in the world but its oil and gas projects hold significant strategic value as the sector develops right across Asia. Moreover, unlike the power sector, which opened to foreigners for a short time and then started to close, oil and gas is opening up for the long term. The scale and significance of the projects in question means that a commitment to joint ventures has to be greater.
The conditions are the crux, though. Lawrence Darby, corporate finance, Kaye Scholer, Fierman, Hayes & Handler LLP, describes the steps so far as significant but adds that, ?No one really knows the how serious the government's commitment to opening up the market to foreign investment and competition is.? Some say the sector's historical significance prevents wholly owned foreign enterprises, although Ashley Wilkins, head of project and sectorial finance for Asia at SG, suggests that the level of potential growth means that this cannot be ruled out.
Reforms and regulations
A program of structural and legislative reforms is underway, aiming to build on previous progress and promote checked liberalisation. But these take time. The transition from a command and control to a socialist market based approach is not a fluid one.
1998 saw the attempted remodelling of CNPC and Sinopec into two large, vertically integrated and competing companies. CNOOC, with its exclusive rights to developing offshore resources, has long been regarded as less cumbersome than its brothers. Central to the notion of reform was separating regulatory bodies and social welfare services from commercial entities. On the back of this, in 1999, CNPC spawned PetroChina to take over its most productive assets. Since then, IPOs have been issued on the Hong Kong and New York stock exchanges by Sinopec, PetroChina and CNOOC. A further key issue addressed in the late 1990s was that of pricing, with attempts made to link domestic with international prices.
These steps set reform within the petroleum industry in motion. But the road is a long one. Even limited competition between Sinopec and PetroChina is retarded, since the major impact of reforms was to divide the two companies geographically. The role of the government is still not clear, with no clear division between policy and regulatory bodies. Moreover the industry has no firm legal base. China has a history of being able to provide sufficient comfort for individual projects. But in order for international players to become an integral component in the industry, transparent and solid legislation must be put in place.
The World Bank has been involved in China's energy reforms in an advisory capacity since 1999 and claims consensus in China is to develop a framework conducive to private investment. But reforms take a long time to filter right through bureaucratic institutions. Conditions set out by the WTO and domestic needs suggest that foreign involvement will increase. But speed and extent are difficult to judge. Steeped in a history of domestic self-sufficiency and state control, the Chinese government will introduce competition only to limited degrees and on its own terms.
Future of gas
A driving force behind reform is the desire to develop a natural gas market. Easing dependence on coal and reducing oil imports are the reasons most often cited, but it is also seen as closely entwined with economic development for two other reasons. Its superior efficiency and environmental benefits as an energy resource make it better equipped to support predicted economic growth. Secondly, much of the known reserves lie in the underdeveloped western regions. It is hoped that exploration of the fields will confirm their development potential.
Unlike oil, the gas industry is starting from scratch. China has neither the necessary infrastructure nor the market and putting these in place is both time consuming and capital intensive. Lawrence Darby believes that there is sufficient political will at the highest level to progress development. Local levels however, with their abundance of cheap coal, will resist this. Moreover, a sector with little proven history does not inspire confidence in developers.
Transmission is perhaps the biggest obstacle. Building a network capable of transporting gas from its source in the west to industrial centres in the east is a daunting task. But plans for the East-West pipeline are moving forward. Running from the Tarim Basin in Xingjang to Shanghai, the pipeline has a projected total capacity of 12 billion cm/y. The basin is the China's richest natural gas resource, comprising some 8.4 trillion cubic meters.
PetroChina's initial request for foreign partners for this vast project met with little enthusiasm. Midstream assets are the sticking point, regarded by all as the technically and financially risky component. Foreign companies are unwilling to take it on without a stake in the more profitable sectors. Subsequent concessions on the part of PetroChina, in the form of a promise of a majority stake and participation in all stages of the pipeline project, has made the concession considerably more attractive. A shortlist has since been announced.
Construction of this pipeline would be a crucial kick-start for Chinese natural gas. However, Michael Kershaw, director at HSBC Hong Kong, points out that this is only one component. LNG terminals and pipelines from other countries are also crucial. BP scooped a 30% stake in the first LNG receiving terminal at Shenzen in Guangdong. The $600 million venture is majority owned by CNOOC, with the remainder held by local Guangdong companies (31%) and two Hong Kong energy firms. Bids are now going in for the $10 billion gas supply contract, considered the most lucrative component of the deal. LNG imports are also proposed for the cities of Qingdao, Shanghai, Fuzhou and Guangzhou. Estimates suggest imports of up to 3 million tonnes by 2010 and 10 ? 15 million tonnes by 2020.
Finding finances
Although staggering along with uncertain reforms and state owned entities resisting competition, large oil and gas projects are heading slowly towards the markets. Monies raised by the three domestics' IPOs are likely to contribute to financing their portion. PetroChina has said that it will seek funds for the pipeline through an A-share issue offered to the domestic market, although Sinopec's recent debut to domestic institutions was not received as well as had been hoped. The sheer size of many of the projects discussed, however, dictates that project financings will be necessary.
Limited recourse financing is not new to China, having played a role in infrastructure over the last decade. Primarily in the power sector, these projects have tapped both international and domestic funding pools. Although drawing lessons from these, pending oil and gas ventures are in a league of their own with regard to size, technical complexity and up-front capital. The risks lenders will be asked to take on are largely untested.
?The volatility of gas prices is cause for concern,? says John Bailey, analyst at Standard & Poor's. The question of supply and offtake is also contentious. Power plants are typically characterised by one PPA. Gas projects on the other hand are part of a chain. Each section relies on the smooth functioning of others. Midstream facilities are particularly undesirable from this point of view, feeling the risks characteristic of both upstream and downstream.
?The participation of domestic lenders is crucial in getting these projects financed,? says Patrick Barr, head of oil and gas at ANZ. There is considerable liquidity in the Renminbi markets but it has historically been tapped for very short-term financings. ?But in recent years they have been getting more used to lending into projects,? notes Lawrence Darby, ?which is a significant step for the oil and gas ventures.? The three main PRC Banks, with strong liquidity in both Rmb and $, will play a pivotal role.
?If the projects are structured correctly, international appetite will be considerable,? predicts Wilkins. ?SG is advising on the BP, Sinopec, Shanghai Petrochemical petrochemical project, which is opting for a limited recourse commercial route and is on course for a successful financial close.? Shell's Nanhai venture is quasi-corporate pre completion, after which the guarantees fall away, leaving a full project loan.
Private insurance and ECA support are readily available for China. But Darby notes that the latter would be closed in the future if the Chinese produce the equipment domestically. Financings with a degree of sponsor support may be able to stand up without ECAs though. Patrick Barr, head of oil and gas at ANZ, claims that PRI cover at Nanhai will be sufficient.
Currency risk is mitigated to a certain extent in the case of petrochemicals, which can be sold internationally to create dollar revenue if needs be. This spate of projects, of which at least two, if not all, are expected out in the markets by year-end will be carefully scrutinised. There is a widespread belief that international banks are willing to take on some Chinese market risk and the extent and structure will be judged by these deals.
Whether the structures will sit as easily on large gas projects is uncertain. There is very little infrastructure in place, the market is under-developed and excess gas in a pipeline cannot readily be sold overseas, as with petrochemical products. These increased risks have led some to speculate that large gas projects, particularly midstream assets, may have difficulty attracting international financing. At the very least, lenders will demand tighter comforts.
But the sector is undoubtedly moving, and will only continue to do so ? with foreign assistance. Outlook amongst the international lending community is guardedly enthusiastic, with many players expanding their interests in the area. ?China's needs in terms of oil and gas are huge,? says one. The rewards of investing, given the right conditions, could also be huge.
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