Petroleum Politics: China and Its National Oil Companies

09/2014

China’s energy security is characterized by a progressive divergence of energy supply and demand since its transition to an oil-importing country in 1993. Over the years, oil consumption has steadily increased from 6.5 million barrels a day (bbl/d) in 2005 to 10.88 million bbl/d and 10.7 million bbl/d in 2012 and 2013, respectively. However, China’s oil production has only increased modestly from 3.9 million bbl/d in 2005 to 4.5 million bbl/d in 2013, a significant sign that China’s oil fields are maturing and that oil production has peaked. This implies that the net total oil imports have also subsequently increased to 6.2 million bbl/d in 2013 and is forecasted to reach 6.6 million bbl/d in 2014, overtaking the United States as the world’s biggest net oil importer.

With an economic growth that averaged 10% per capita from 2000 to 2011 and a population of 1.3 billion increasingly wealthy citizens, China’s petroleum demand has mainly been upended by imports coming from petroleum-rich countries around the world. Deemed as a pillar industry, the oil sector has always been in the forefront of China’s energy security policy. The long held belief that the ownership of equity oil could enhance the country’s security of supply entails that the Chinese national oil companies (NOCs) are the core instruments of this policy. The internationalization of these oil companies do not just reflect their importance to a broader economic strategy, but also underscores the government’s control and support towards its state-owned enterprises.

 

A vertical system of control

 

The current political economic direction of the Chinese petroleum industry has been shaped by ideology, history, political culture and macroeconomic landscape that provide contextual and path-dependent foundations and a continued influence over the direction of the interaction between the state and the NOCs. From the establishment of the Ministry of Fuel Industry in the 1950s, to the Great Leap Forward and the agri-industrialization developments by Deng Xiaoping, the evolution of the Chinese petroleum industry flowed along with the gradualist approach to macroeconomic reforms1.

Though over the years, the state’s institutional regulatory body of the energy sector has been decentralized over different government ministries and entities, the NOCs still remain in the heart of the Chinese national energy policy agenda. For instance, in 2010, the State Council created “a super ministry”, the National Energy Commission (NEC) that acquired jurisdiction over China’s energy development strategy, energy security and development issues, and the coordination of domestic energy exploration and international energy cooperation2. Though the NOCs have succeeded in centralizing their organizational structures and command centers, their ministerial rank within the government is inferior to that of the NEC. Consequently, the devolution of the state’s direct control over the NOCs was not a by-product of the oil companies’ interest in seeking autonomy but by the gradual allotment of authority as orchestrated by the state. Because the NOCs operate in a “strategic industry” it follows a path-dependent, state-led development that receives a steady and substantial support from the government and remains to be at the heart of energy security policy. Even though the NOCs have received massive structural changes through corporatization and marketization following China’s membership in the World Trade Organization (WTO) in 1997, it did not entail a transfer of ownership of the entities. The state remains to be the majority shareholder of both locally and internationally listed companies and thus able to wield effective corporate control over the NOCs.

The issue of ownership and administrative control of the Chinese national oil companies can be further investigated through the state’s institutional arms, the State-owned Assets Supervision and Administration Commission (SASAC) and the Central Organization Department (COD). The SASAC with its ownership and regulatory responsibilities over the NOCs is directly under the authority of the State Council while the COD has powers to appoint NOC executives to senior leadership positions. These functions give these agencies and the CCP enough political clout to control the management of NOCs.  Thus, under its institutional arms, the CCP has power and control not just to set NOC interests, priorities and agenda but also to wield NOCs to further the party’s economic and political interests. Consequently, the transference and mobility of executives within the corporate and the government spheres and the duality of roles of these executives as both corporate chairmen and party secretary provide the central government an effective instrument to issue top-down control.

The political trajectory of executives in the petroleum industry shows how the state use official positions to incentivize those who follow its interests. For instance, after closing a US$7 billion deal with Brazil’s Repsol, then CNPC chairman Su Shulin was appointed governor of Fujian Province, a position that catapulted him to the 18th Central Committee in 2011. The careers of Zhou Yongkang, Jiang Jiemin and other petroleum executives also reveal this opaque system of political appointments within the Communist Party of China (CCP). Additionally, the existence of traditional ties such as guanxi further delineate the vague process of executive recruitment that issues from preferential treatment of those who belong in a particular network of influences.

The banking system

 

The administrative control over NOCs is not only limited to the oil sector but is also spread across the SOE network. A closer look at the Chinese banking system reveals that its administrative governance and policy-setting mechanism do not deviate from that of NOCs.  As state-owned enterprises, the banks, dominated by the “Big Four”, the Bank of China, (BOC), the China Construction Bank (CCB), the Agricultural Bank of China (ABC) and the Industrial and Commercial Bank of China (ICBC) are under a similar control structure although they do not belong to the SASAC. The similarities of the executive appointments and incentive mechanisms within the banking system subsequently confirm the authority of the State Council’s institutionalized instruments of vertical control.

This centralized level of influence is further employed to establish a horizontal financial support system in between SOEs. In 2004, a special credit support notice was released by the National Development and Reform Commission (NDRC) and China Exim Bank expressing financial support to foreign resource acquisitions that included deals done by the NOCs. The CNOOC Ltd bid to acquire Unocal3, an American company in 2005 is one of the most controversial cases that demonstrate this extent of state support to the petroleum industry. The bid CNOOC made was US$18.5 billion, outranking Chevron’s offer of US$16.5 billion. However, the CNOOC bid included a $4.5 billion subordinated loan at the below-market interest rate of 3.5% and a $2.5 billion subordinated two-year bridge loan at zero interest from its state-owned parent company4. Thus, the NOCs continuously receive substantial preferential credits and financing from the state-owned banks, a manifestation that a higher coordination and a centralized policy-making body exists and in pursuit of its fundamental interests.

 

SOES and Chinese Foreign Investment Policy

 

This is further revealed through the analysis of the Chinese outward foreign investment and the pursuit of the state’s Going Out Policy5. Backed by government support, SOEs where encouraged to pursue investment interests in strategic industries, especially in oil and gas explorations. Although the Going Out policy does not explicitly dictate the geographical direction of Chinese OFDI, its energy security interests creates a trend where capital is heavily invested in a certain region at the certain period time. The substantial portion of this OFDI is specifically allotted to resource-based acquisitions and geared towards NOC expansion.

Particular oil-rich regions, especially unconventional sources of petroleum products such as countries like Venezuela, Sudan, South Sudan and even Canada have seen a massive influx of Chinese OFDI in the past decade. China’s oil and gas companies OFDI was US$92 billion in 2009 and a record of US$35 billion in 2012. Through the use of policy banks such as the China Development Bank (CDB) and China Exim (China Export-Import Bank)6, the government has issued an effective means of financial support towards NOC expansion. Consequently, the Chinese policy banks also issues loans-for-oil, preferential credits to petroleum-rich countries in exchange for a long-term supply of oil. 

For instance, in 2010, the Chinese policy banks issued a total of US$37 billion of loan commitments to Latin American countries, an amount higher that the loans allotted by the World Bank, Inter-American Development Bank and the United States Export-Import Bank combined7. The overall amount of loans supplied by Chinese banks to these countries from 2005 to 2011 was US$75 billion, CDB accounting for 82% of issued loans while China Exim and ICBC contributed 12% and 6% respectively. This amount includes US$10 billion loan to Petrobras in return for Sinopec's access to 200 mb/d8 of oil and a US$4 billion deal with Venezuela to finance projects that will increase Venezuelan exports to China from roughly 350 mb/d to 1 mmb/d by 20159.

Thus, the coordination of functions between the policy banks and NOCs reveal that the policy direction of state-owned enterprises adheres to the course set by the Going Out Policy. International investments made by Chinese NOCs both follow the commercial objectives of the petroleum industry and the more diversified commercial objectives of the central government.

The internationalization of Chinese NOCs transactions’ subsequently required the government to embark on petroleum diplomacy, a state-led diplomatic support for the acquisition of NOC assets in petroleum-rich countries. Taking the Chinese official visits in these countries as a primary sample of diplomatic presence, these trips reveal that the state visits often entail loans-for-oil agreements, allotment of preferential credits and other petroleum-based contracts. It has also been observed that the largest NOC acquisitions were done behind bilateral channels and not commercial ones, indicating that NOCs’ overseas expansion is one of the agenda of the Chinese diplomatic relations. For instance in March 2013, President Xi Jinping’s first overseas tour since taking office brought major oil deals and resource agreements to the countries he visited namely,  Russia10, Tanzania, South Africa and the Republic of Congo.

The long-lasting central State control

 

Consequently, the analysis of the institutional structure of NOC international activities leans towards a central government control. The NOCs may embark on overseas expansion themselves, but the system of government control remains in place. Because they are still fundamentally state-owned, any significant investment of NOCs are subject to the approval of the National Development and Reform Commission (NDRC). As the main government body tasked for designing, regulating and coordinating national economic and development policies, the NDRC has strong influence in directing NOC policies and pursuing state interests11. China Exim Bank also needs NDRC’s approval if it has to provide preferential loans for NOC transactions and for investments above US$200 million12.

Moreover, the Ministry of Commerce (MOFCOM) is another government body that plays a significant role in the implementation and supervision of Chinese OFDI. It is the state’s representative in bilateral and multilateral investment and trade negotiations and holds the key in issuing investment licenses to the NOCs. Together with the NDRC, the MOFCOM issues a list of countries viable for overseas investments where nearly all oil rich-countries that are essential to China are on the list. Consequently, the alignment of diplomatic and economic interests is coordinated by the MOFCOM and Ministry of Foreign Affairs (MOFA), the later also being responsible for the organization of high-level visits. The State Council, the highest ranking body of the central government sits on the top of these ministries and agencies. It directs and regulates policy and controls the economic strategy and its implementation.

Though might be driven by corporate interests, the policy direction of NOCs are still by far largely influenced by the central government as the State Council holds the policy decision-making process, the coordination and implementation through NDRC and MOFCOM, the diplomatic relations and its alignment with the economic strategy through the MOFA, the financing through the policy banks and the ownership through the SASAC. Thus, the Chinese government’s administrative control mechanism over its NOCs remains to be in place despite the reforms and functional fragmentation of energy policy-making within the energy ministries that have given the NOCs operation autonomy.

China’s gradual approach to its economic development has brought it to new heights. The devolution of the state’s authority over oil industry did not come accidentally but followed a familiar trend of measured reforms. As long as China considers the petroleum sector as its strategic industry, the primacy of authority over it will continue to remain in hands of the state.

Full article is available here

• 1. The establishment of China National Offshore Oil Corporation (CNOOC) in 1982, the incorporation of the state controlled Ministries of Petroleum, Chemical and Textile to form the China National Petrochemical Corporation (Sinopec) in 1983, and the restructuring of the Ministry of Petroleum Industry to form the China National Petroleum Industry (CNPC) in 1988 were all in lined with the existing economic ideology of building a socialist planned commodity economy.
• 2. Kong, B. (2010). China's International Petroleum Policy. Santa Barbara, CA: Praeger Security International.
• 3. The CNOOC Ltd attempt to acquire Unocal led to protests from other oil companies and eventually to a US Congress inquiry over the ownership structure and preferential funding of CNOOC.
• 4. Downs, E. & Evans, P. (2006, May). Untangling China's Quest for Oil through State-backed Financial Deals. Brookings Policy Brief Series N°154 of 186.
• 5. The declaration of then President Jiang Zemin at the 16th Party Congress in 2002 marked the onset of the Chinese government’s Going out Policy. By “"bringing in" and "going out" a number of strong multinational enterprises and brand names, China should take an active part in regional economic exchanges and cooperation while paying great attention to safeguarding its national economic security”.
• 6. Currently, the CDB boasts total assets of RMB 7.52 trillion in 2012 making it the world’s largest development bank by total assets. Exim on the other hand holds RMB 1.56 trillion in total assets. Together, CDB and Exim are China’s biggest providers of currency loans, foreign aid packages and state financing.
• 7. Gallagher, K., Irwin, A. & Koleski, K. (2012, March). The New Banks in Town: Chinese Finance in Latin America. Inter-American Dialogue Report. Washington, DC.
• 8. Millions of barrels per day (mb/d).
• 9. Mohamedi, F. (2009, September 11). China: A new model in overseas oil strategy.
• 10. In Russia, a deal was signed between China and Rosneft, securing oil supplies of 1 mb/day starting 2018. Rosneft and CNPC agreed the delivery of 34 million tons to around 50 million tons (1 million barrels per day) by 2018. The deal also included giving CNPC access to Arctic resources. Rosneft also secured a loan of US$2 billion from China Development Bank, which is backed by 25 years of oil supplies.
• 11. Huang, W., Wilkes, A. (2011). Analysis of China’s Overseas Investment Policies. Working Paper 79. CIFOR, Bogor Indonesia.
• 12. Andrews-Speed, C. P., & Dannreuther, R. (2011). China, Oil and Global Politics. Abingdon, Oxford: Routledge.