Robust industrial growth and increasing domestic living standards have left China with a nearly insatiable thirst for energy. And oil is playing an integral part in meeting that demand.
Although coal remains the chief source of energy, oil fuels China’s transportation, plays a crucial role in industry, and is a significant input in agriculture. During the height of the Cultural Revolution in 1969, China ranked 25th in world oil demand. Today, China is the world’s second-largest consumer of oil and the largest net importer of petroleum and other liquid fuels.
China’s growing demand for oil comes at a time when the petroleum industry is experiencing perhaps the most significant paradigm shift since the OPEC embargo in 1973. High crude prices combined with technological advances are allowing supermajors, petro-states, and independent oil entrepreneurs to unlock a new class of previously unattainable unconventional oils. These oils are globally more abundant and widespread than their conventional predecessors.How China navigates this complex new oil terrain will have far-reaching consequences for domestic affairs, international trade, the environment, and global security. With Beijing’s new leadership seeking to ensure that China’s economic growth charts a more sustainable path, it is the right time to address the nation’s future oil opportunities and challenges.
China’s Oil Industry
Until the 1990s, China enjoyed energy self-sufficiency due to the discoveries of the large Daqing field in northern China in the 1950s and other conventional plays in central China. Now, China’s oil consumption exceeds domestic production by more than 2:1, fueling the nation’s search for petroleum at home and abroad. China became a net oil importer in 1993 (see figure 1), and in 2013, it was responsible for one-third of all oil growth. Over the longer term, the U.S. Energy Information Administration projects that China’s output of oil and petroleum products will reach 5.6 million barrels per day by 2040. Most of the growth over the long term is expected to be from unconventional sources, including gas-to-liquids, coal-to-liquids, kerogen, and biofuels, as conventional crude oil production remains relatively flat.
China’s domestic oil production is dominated by its “big three” national companies: China National Petroleum Corporation (CNPC), China Petroleum & Chemical Corporation (Sinopec), and China National Offshore Oil Corporation (CNOOC).1 As of 2013, CNPC was the fourth-largest oil company in the world when measured by liquids produced and Sinopec was the fourth largest in terms of petroleum product sales.
The big three are eager to partner with Western companies to acquire resource access, best practices, and the technological know-how necessary for unconventional oil production. To that end, the Chinese government permits domestic firms to enter into production-sharing contracts with foreign oil companies.The evolving relationship between governmental ministries and the big three will play a crucial role in China’s venture into unconventional oils. While Chinese oil firms are majority state-owned enterprises that are run by senior-ranking Chinese Communist Party officials, tensions have nevertheless arisen in recent years between company leadership and the government over pricing and strategy, with particular concerns in Beijing that state-owned enterprises such as the big three are abusing their privileged position for private gain.
Keen to maximize their own profitability, the big three pressured senior officials to modify government directives that were perceived to negatively impact their profits. For example, the oil and gas company PetroChina (a listed company mostly held by CNPC) tried to block foreign investment in the country’s West–East gas pipeline even though doing so contradicted the initial wishes of China’s central government. PetroChina was successful and currently owns and operates the pipeline.
The National Development and Reform Commission (NDRC)—the country’s top economic planner that controls oil pricing—may be losing influence. The regime has pledged to shift approval for projects launched by private investors away from the NDRC, giving market players a more significant role both domestically and internationally. Such a change in decisionmaking responsibilities could produce unexpected outcomes.
The weakness of China’s regulatory institutions coupled with the national oil companies’ strong political position has allowed Chinese oil companies and refiners to attenuate Beijing’s efforts to both improve the environmental situation in the country and formulate a more modern, comprehensive energy strategy. This is particularly true in the case of failed efforts to close and clean up dirty, outdated refineries in Shandong Province. It is also exemplified by national oil companies’ ability to stall efforts by the Ministry of Environmental Protection to improve petroleum and diesel quality as smog has intensified in Beijing. Going forward, as China begins to contemplate further reforms in state-owned enterprises, particular attention should be paid to the oil sector.
Mapping China’s Oil Resources
China’s indigenous oil reserves are diverse, ranging from heavier conventional pooled oils and tight oils trapped in shale rock to extra-heavy kerogen and bitumen oil resources. The country’s national energy companies believe tight oils present relatively lucrative opportunities among unconventional hydrocarbons.
As of 2013, China possessed an estimated 25.6 billion barrels of proved conventional oil reserves.2 China also has an estimated 32 billion barrels of shale oil resources—10 percent of the globe’s technically recoverable tight oil resources. Rounding out China’s unconventional heavy oil resource potential is an additional 19.8 billion tons (over 100 billion barrels) of onshore heavy oil in place—including approximately 3 billion tons of oil sands (bitumen) and 16 billion tons of oil shale (kerogen). It is unclear at present how much more heavy oil is offshore.
The bulk of China’s known shale oil is located in five basins—Jianghan, Greater Subei, Tarim, Junggar, and Songliao. Oil reserves also span the border into Mongolia in the East Gobi, Tamtsag, and Erlian Basins and skirt southeast of Beijing in the Bohai Bay Basin. Additional tight oil deposits are found in the Sichuan and Ordos Basins spanning the center of China, which is home to the country’s oldest oil fields. Heavy oils, both bitumen and kerogen resources, are also located throughout China (see map).
China’s shale oil resources tend to be waxy and buried in deposits that are rich in clay, making them poor candidates for hydraulic fracturing (fracking) techniques that are currently used to extract other tight oils by injecting fluids or gases into rock formations to break them open and release the resources. And unlike the tight oils found in the United States in Texas and North Dakota, tight oils in China tend to be heavier and have a lower percentage of lighter condensates. Heavy oil is more carbon laden than lighter oil, and current extraction practices involve pumping carbon dioxide in addition to steam, which can make the recovery process even more carbon intensive.
China’s shale oils are typically buried deep underground—over 5 kilometers—and in hard, thick geologic formations. That means they require large inputs of energy and water to extract and extraction processes yield substantial quantities of contaminated produced water. The Tarim Basin in Xinjiang Province is known to have ultra-deep heavy oils that are some of the deepest in China, buried over 6 kilometers.
Economics will play a major role in determining whether these resources can be recovered. Horizontal drilling and other complex technologies used to extract these tight and heavy oils are particularly expensive in China. Pipeline infrastructure needed to transport the resources once they are extracted is not highly developed in the country. Years of unrestricted spending on mergers and acquisitions have eaten away at profits.
As China’s national oil companies look to become more cost competitive by increasing efficiency, improving governance, and honing technical wherewithal, they could help raise China’s standing in terms of oil development at home and abroad.
Oil development must also contend with geographic and geologic challenges. Oil stores in the east lie in major urban regions, so their development can impinge on the public. In the west, oil resources are relatively inaccessible; vast distances and difficult terrain separate them from markets. And the numerous active seismic faults surrounding these shale oil resources make them even less conducive to development.
Despite these challenges, unconventional oil is being pursued in China. In 2010, for example, Hess, a U.S. energy company, and PetroChina conducted a joint study of tight oil in the Daqing oil field. Jilin Oilfield Company, a subsidiary of PetroChina, has undertaken massive fracturing operations in the Changling gas field, and breakthroughs made there could be applied to tight oil reservoirs to liberate more resources. And American energy giant ConocoPhillips has teamed up with Sinopec to conduct tight oil exploration in Sichuan Province.
Oil ventures will likely continue to be undertaken. However, these projects are expected to become more difficult and costly over time. Increasingly, they will have to prove their profitability if they are to survive China’s new economic reforms that stress anticorruption efforts and rethink asset accumulation.
China’s Oil Investments Abroad
China has been eager to invest in overseas oil projects as well, a drive stoked by strategic concerns about supply disruption, the desire to acquire new technology, and efforts to profit from changes in the upstream oil sector. And Chinese companies have set ambitious targets for increasing direct ownership of oil fields, called equity oil. Most equity oil gets resold on the world market and never reaches China. In 2012, overseas operations for PetroChina accounted for 37 percent of the company’s oil and gas production.
In the same year, the total value of mergers and acquisitions undertaken by China’s three biggest oil companies climbed to a reported $34 billion, doubling from a reported $17 billion in 2008. And 2013 saw the unconventional oil (and gas) investments that China’s national oil companies made abroad at least double and become distributed more widely—in Peru, New Zealand, New Caledonia, East Africa, and the Russian Arctic. When bank loans are included, China has invested an estimated $400 billion in foreign oil development over the past five years (see figure 2).
Despite indications that China’s big three may have reservations about the profitability of North American unconventional oil production, they have been eager to invest in emerging plays on the continent. China is attracted to North America’s transforming energy market and to the potential that market holds for China to acquire the latest technology and learn to replicate emerging industry practices.
This type of investment has become easier over time. CNOOC attempted and failed to acquire the U.S. petroleum company Unocal (now part of Chevron) in 2005, which exposed fears in the United States that China would make major investments in strategic sectors. More recently, however, Canada welcomed China’s involvement with CNOOC’s $15.1 billion purchase of Canadian oil and gas company Nexen and the $2.1 billion acquisition of the bankrupt Canadian oil sands developer OPTI in 2011.
Although China’s national oil companies have gained political confidence in navigating the North American energy landscape, it is unclear whether they will be major players in the North American energy revolution in the future. CNOOC appears to be pulling back in North America, while Sinopec’s energy activity looks to be increasing.
As China’s demand for crude and petroleum products for feedstock and fuels grows, it is eyeing new supplies from Russia’s many different oils, Canada’s oil sands, Venezuelan bitumen, Brazil’s pre-salt oil, and supplies elsewhere in Latin America, the Middle East, Africa, and beyond. Moreover, the Chinese refining sector—which is currently unequipped to convert extra-heavy oil sands and heavy oils to diesel and jet fuel—will be making key investments to handle the array of global oils.
Growth in China’s Refining Sector
At 13 million barrels per day in refining capacity as of 2013, the Chinese refining sector is second in size only to that of the United States. And the government’s 12th Five-Year Plan calls for the production of an additional 2 million refined barrels per day by 2015, with preliminary indications suggesting that China may actually exceed those production targets and could end up with more than it needs domestically.
China alone will account for about 40 percent of the global growth in refining capacity in the next five years. Much of that added capacity will be used to satisfy growing demand coming from the East Asian region. According to the U.S. Energy Information Administration, China’s current production levels are insufficient to meet demand growth there.
While China is catching up to the United States in total refining capacity, it continues to lag significantly behind in refining quality. Given the heavier and waxier nature of China’s domestic oils, Chinese refineries produce more low-value, high-carbon residual products (pet coke and bunker fuel) than high-value diesel and jet fuel (or, to use a term of art, they have a higher ratio of cracking to crude distillation units).
Some of the newest Chinese refineries are equipped to process a wide range of inputs, but China’s refining sector is skewed toward small refineries (producing less than 40,000 barrels per day) that were not designed to handle the more complex oils China aims to import. These so-called “teapot” or “teakettle” refineries account for nearly one-half of China’s total refining capacity, are primarily concentrated in Shandong Province, and are privately owned. They are also extremely energy intensive, inefficient, and polluting. The NDRC pledged to close the teapots in 2012, but local opposition has so far stymied the central government’s efforts.
As China is a net oil importer, there will be strong investment pressure for it to process every possible type of crude oil input, but not necessarily optimally. Due to the high cost and long lifetimes of oil infrastructure, it will be important for China to take local pollution and climate change measures into account. Lighter oils will have fewer environmental downsides while yielding more diesel—the refined product with the highest demand growth in Asia. Heavier oils will have more environmental downsides that will require significant investment to mitigate.
Moreover, fostering sector-wide “lock-in” of dirtier petroleum products today will make it difficult and expensive to retrofit facilities in the future. China must carefully weigh climate change and other environmental implications of its oil policies. The types of oil, refining, and products China chooses to develop domestically, invest in abroad, and ultimately consume will shape the global oil sector and its worldwide impacts for decades to come.
The Future Environmental Footprint
It is difficult to overstate the impact of China’s rising demand for oil on climate change, air pollution, and quality of life. The carbon footprint left by oil—especially if China produces or imports heavy oils or extra-heavy oils—is significant. As China expands its oil consumption, foreign oil investment, and refining capacity, it will play a pivotal role in shaping what oil products will be sold on the world market, especially elsewhere in Asia.
Even with a slowdown in economic growth, China’s oil consumption continues to grow at about 5 percent per year. To satisfy that demand, China will have to work with dirty and difficult oils, which are often cheaper to buy but more damaging to use. Without new oil regulations that take climate change into consideration or a carbon price designed to take climate change into account, China’s growing oil demand may gravely jeopardize efforts to mitigate further deterioration of air quality and climate change.
Another large environmental challenge facing China is water, which is essential for fracking and steam-assisted recovery of heavier oils. China’s first national “water census,” undertaken in 2010, reveals a serious national water shortage. The development of unconventional oils will have to compete for these limited water resources with agricultural, industrial, and urban users. And the huge volumes of water produced in the fracking process will make it more difficult for China to safely dispose of the contaminated water so that it doesn’t taint clean drinking water or induce earthquakes, as some disposal methods are thought to do.
There is a growing awareness among China’s leadership that something must be done to better manage the environment. Official state growth objectives intend to better balance energy demand, economic growth, and public health. At the March 2014 National People’s Congress, Premier Li Keqiang announced in his work report that China will “resolutely declare war against pollution as we declared war against poverty.” The growing air and environmental pollution across China is “nature’s red-light warning against inefficient and blind development,” highlighting the need for China to not only reduce emissions but also shift to a more sustainable model of development. The NDRC proposed further limits on air and water pollution and greenhouse gas emissions.
But regulating industrial outputs will not be enough. If China developed those oils with the lowest climate impacts, it could reduce its greenhouse gas emissions and ensure that more problematic carbon-laden oils are left in the ground. The same prudent strategy should figure into choosing which overseas hydrocarbon plays to invest in or take direct ownership of. In addition, the government must do more to promote demand reduction through greater energy efficiency, vehicle electrification, urbanization, and expanded use of renewables.
As investors, the big three currently lack new significant domestic economic reserves, the latest technology, and the most innovative cost-saving practices of the Western supermajors. But they make up for that deficit with their sizeable clout and financial backing that often allows them to bundle oil agreements with development assistance.
China has been particularly interested in providing this “no strings attached” assistance to states that Western supermajors deem too risky. Chinese firms enjoy a comparative advantage in states where political drawbacks make Western investment unlikely.
China has formed close contractual relationships with national oil companies from Venezuela to Kazakhstan and has signed a number of controversial loans-for-oil deals with countries such as Iran and Sudan. From Africa to Central Asia, Chinese investments have made the state’s goal of market diversification a reality and have given China unprecedented political leverage.3
While China has yet to displace other nations in terms of their geopolitical influence over global energy, security concerns have been raised regarding the political repercussions of some Chinese investments. China made oil investments in Sudan in the 2000s as violence raged in Darfur and has more recently invested in Iran. Both undertakings earned Beijing a substantial amount of negative publicity overseas. But Chinese doctrinal positions that hold state sovereignty and noninterference as virtually sacrosanct make it unlikely that China would completely sever oil ties with countries that face Western criticism over human rights abuses or other malfeasance.
In addition, Chinese oil firms are increasing their investments in some of the world’s heaviest oils without paying sufficient attention to climate considerations. Some believe that this practice will end up straining relations between the producing states and China due to growing public environmental concerns in the producing states. China could mitigate these escalating political risks by taking climate change considerations into account when pursuing overseas investments.
China also faces potential political blowback over how it handles possible oil exploration in waters of the East China and South China Seas. Many surrounding nations have territorial disputes in the waters off China that include oil reserves (see map). Although those resources are not considered recoverable today, they may become so in the future.
To date, China has given little indication of when or if its strategic thinking on energy security will shift. It is clearly reluctant to take on new political or security commitments, especially when other states—particularly the United States—continue to guarantee overall stability and access of oil to markets. However, oil relationships could shift. China’s economic importance to the Middle East is growing, and the country’s reliance on the region’s oil stands in stark contrast to U.S. “war weariness” after a decade of fighting in Iraq and Afghanistan. The United States’ reduced dependence on Middle Eastern oil due to its growing domestic energy production could serve to reshape China’s future role in the region.
There are significant fears that exercising Chinese power overseas can stoke anti-Chinese sentiment and undermine China’s overall position in the world. But either by gradual evolution or by a sudden crisis, the Chinese leadership will likely be forced to play a more interventionist role in the future. A sudden crisis in one of China’s resource centers, as seen in South Sudan in 2012 or in Ethiopia in the 2000s, may compel Beijing to react. In the longer term, as China begins to commission a true blue-navy fleet, there will likely be calls from some segments of the military establishment to assume both symbolically and strategically a greater role in protecting energy shipping lanes in the Indian Ocean.
China’s Role in Global Oil Development
China’s oil consumption is rising just as the oil sector is experiencing a paradigm shift that is unlocking an assortment of expensive and complex unconventional oil sources. China is making massive investments to retrofit and expand the globalizing oil value chain, from extracting and transporting to refining and marketing new oils.
The capital infrastructure built today is expected to last well into the twenty-first century. As such, those financing today’s oil developments—from CNPC and Exxon to Dutch-owned Vitol and the American Carlyle Group—must take geopolitical and environmental considerations into account. The investments and new oils China pursues, both domestically and abroad, could have significant economic, environmental, and security implications.
To date, China has focused largely on joint investment projects with Western supermajors and on acquiring equity oil abroad to secure its oil imports despite a budding awareness of its substantial domestic unconventional oil (and gas) resources. This may well change in the years ahead.
A farsighted management strategy—one that accounts for the potential volatility of international oil markets and mounting externalities of climate change, air pollution, and water concerns—must guide China’s future oil decisions. If China’s economic growth is to follow a sustainable path, Beijing’s leadership will need to carefully steer oil supply and further reduce demand. The promise of stability will require a thoughtful oil policy to create a better future for China and the world.
1 Sinochem Corporation is another Chinese oil conglomerate that is primarily engaged in the production and trading of petrochemicals. The big three could be expanded to include Sinochem, depending on the company’s future investments in oil exploration and production both domestically and abroad.
2 Oil’s densities vary widely by oil type. Conventional oils range from 6.6 to 8 barrels per metric ton (1 metric ton = 1.1 ton) and extra-heavy oils/bitumen range from 5.8 to 6.4 barrels per metric ton. See conversion chart at http://www.gnc.org.ar/downloads/Unit%20Conversion%20_%20Oil%20Indus...pdf
3 China also often overpays for oil-related assets, though these oil deals frequently include intangibles, such as well-trained workforces and state-of-the-art technology. See Russell Gold and Chester Dawson, “Chinese Energy Deals Focus on North America,” Wall Street Journal, October 25, 2013, http://online.wsj.com/news/articles/SB10001424052702304682504579153350379089082