China trying to manage low oil prices and import status

Prices forced to match international market

Wang Ming Wu
Contributing Editor
Beijing

CNOOC and CPC will jointly explore this area off the Pearl River Mouth. [41,743 bytes]

The State Council for the People's Republic of China made a decision allowing domestic prices to match the international market recently. The new price structure went into effect June 1, 1998 and prices rose to international levels by June 5, 1998. China's oil industry stepped out from behind a planned economy and is now faces keen competition on the international market.

Both petroleum and petrochemical group companies will decide prices through consultation. Factory costs of crude oil must be about the same or slightly lower than the cost of imported crude oil, or prices will be coordinated and adjudicated by State Planning for Development (SPDC).

Opening the oil market to international pricing, after oil prices fell, has brought huge price pressures to China's domestic market. Over 3,700 wells in the China National Petroleum Corporation (CNPC) system were shut in, a cumulative decrease of 1.4 million tons. Rising oil prices are favorable, though, because they:

Boost the competitive power of domestic crude oil
Confirm the domestic oil market as the standard
Provide resistance to smuggled products
Reverse a trend of "cornered" production and sales.

Spurring reform

The move to international pricing is an important part of reform for China's entire oil industry. It is the beginning of an updated dis tribution system, which will overcome deficits and increase surpluses in the petroleum and petrochemical industries. The income target for 1998 has been increased by ¥4.2 billion.

Increasing prices created a glut of oil on the domestic market making it necessary to change the oil import policy. China set up the following measures to maintain the stability of the domestic oil product market:

Motor fuel imports are suspended for 1998
Import quota indexes are stopped
The domestic oil price increase is delayed
Oil for Three-Capital enterprises in the special economic zones will be domestically supplied.

The old mechanism of oil production and distribution received a fierce blow. China's petroleum industry was advancing toward the world and its oil prices were closing on the international level step by step. The oil price drop that began last fall caught the industry off guard and unprepared, both mentally and structurally, with ineffective import/export and pricing mechanisms. The ensuing crisis revealed three weak links:

Little operational flexibility to deal with market changes due to poor communication between upstream and downstream operations
Limited market flexibility due to high production costs and regulated pricing
Inadequate preparation for market risks.

It was common knowledge that the market changed from a seller's to buyer's market. However, China only became a net importer in 1997 and has had little experience with the need to import crude oil.

Crisis to opportunity

The shock of the oil price drop was a stern challenge and created opportunities. The price shift created a "warm-up game" for China's future entry into the World Trade Organization.

Second, petroleum groups had to operate as one to deal with it. Third, the low oil price quickened the pace of adjustment to international standards. Fourth, some low-efficiency enterprises and oil refineries can be eliminated and contribute to the realignment of the industry's structure.

For China's rapidly developing economy, low oil prices support continued growth. For China's oil industry, the way out of the crisis is to move toward the market, disposing of resources, speeding up reform oil distribution, prices and taxes, and create new market driven mechanisms suited to the economy. Market consciousness, risk consciousness, and risk monitoring will be enhanced after this passes.

Historic cooperation between China, Taiwan

In April of this year, China National Offshore Oil Co (CNOOC) and Chinese Petroleum Corp (CPC) of Taiwan agreed to jointly explore an area off the Pearl River Mouth. The two companies will explore a 15,400 sq km block by shooting seismic, jointly interpreting the data, and choosing oil prospects (see Geoscience column for details).

For both organizations, the cooperation will be difficult. Representatives of both commented that maintaining faith with a partner is difficult in a sensitive political environment. Both sides say they will need to exercise foresight, openness, and pragmatism in order to seize opportunities and meet difficulties head-on.

In 1994, cross-straits conditions gradually improved for economic activity and trade between mainland China and Taiwan. With Chevron International acting as intermediary, CNOOC and CPC sent deputy CEOs to talks in Singapore in April 1994, opening up cross-straits cooperation. CNOOC fully informed CPC about all Chinese waters and gave CPC the option of joint exploration. CNOOC and CPC then signed a memorandum of understanding with the Overseas Petroleum Investment Corp (OPIC).

In March 1995, Wang Yan, CEO of CNOOC, and Zhang Ziyuan, President of CPC, met in Hong Kong and chose the Tainan Basin and Chaoshan Sag as a joint prospecting zone. The final agreement was signed on 11 July 1996.

Correction: The Bohai Bay, Zhao Dong Block is controlled by CNODC, not CNOOC, as referred to in an article published earlier this year. Partners in the production sharing contract are Apache China and XCL. Rowan has no involvement.