China oil and gas reform: analyzing the upstream opportunity
Proposed reforms could level the playing field between diversified companies and the 'Big 3'; but thresholds for entry remain high, and new players need to work with others, including the 'Big 3', to capitalize on opportunities
Published: 6 July 2018
The second report in the Deloitte China oil and gas reform series argues the sector's upstream could be revitalized by reform which potentially puts diversified players on a near-equal footing with national oil companies. China has issued the oil and gas reform guidelines (The Opinions) with the clear intent of introducing a more relaxed business environment and encouraging more production sharing, however, the fine print has yet to be revealed.
Proposed reforms of China's upstream oil and gas sector are rooted in policymaker's desire to stabilize output, especially in an environment with expected oil price increase and growing geopolitical uncertainty.
"Already, the state monopoly on exploration and development is loosening somewhat," said Christopher Roberge, Deloitte China oil, gas and chemicals sector leader. "There are plans to auction about 30 oil and gas blocks in the northwest region of Xinjiang in 2018 to non-state investors to boost private participation, and the wave of reform could create new opportunities for the industry to integrate and reallocate existing resources."
Although state-owned oil companies have typically benefited from reform, a set of Opinions released in May last year, and proposed new mineral rights legislation, could change the equation, Roberge added.
The Opinions say the upstream should be opened up, encouraging qualified market players to participate in conventional oil and gas projects. A new granting mechanism, meanwhile, would require that upstream block rights be subject to tender, and winning bidders would have to give up their blocks once the exploration period expires.
On the legislative front, the government has been promoting competition in natural resources exploration and development. For example, in addition to requiring competitive tenders, 2017's Mineral Rights Granting System Reform program also imposes strict restrictions on the granting of mineral rights via agreements.
The report suggests three main types of oil and gas companies could be set to benefit most from the relaxed market environment: provincial SOEs in oil and gas resource-rich provinces; private oil and gas companies with overseas assets and exploration experience; and oilfield service companies with domestic experience.
As well as the pull factors of market loosening, oilfield service companies are also being pushed to consider the upstream sector as a way of improving their financial performance, having been squeezed for the last several years by distressed global oil prices.
But it will not be as simple as a head-to-head contest between the new players and the 'Big Three' (CNPC, Sinopec and CNOOC), but a competition with the synergy of cooperation, according to the Deloitte report. For the new players, who may not be strong enough to compete with that trio of giants, still can succeed if they identify a niche in an increasingly competitive and market-oriented post-reform environment, and possibly through M&A, consolidation and restructuring to increase their competitiveness.
And what about foreign firms? For now, the appeal of possible exploration and development joint ventures with domestic players is dampened by China's complex geological conditions and limited oil and gas resources, as well as remaining hurdles in its regulatory environment. More widely, there are still barriers to raising capital, which is key for new investors in this most capital intensive of sectors.
"Thresholds for entering China's oil and gas upstream remain high," concluded Roberge. "This means it might be better for companies to collaborate and work together, rather than go it alone. Furthermore, detailed reform plans have not emerged yet, so investors should watch out for these so they can quickly understand the opportunities, and the risks."