China Gas Is Fuel for Doubts

THE WALL STREET JOURNAL: China Gas Is Fuel for Doubts

“Shell, Unocal Withdrawal From Project Highlights Sector Problems in China: “In August, a Shell-led consortium pulled out of China’s multibillion-dollar, west-to-east gas-pipeline project.”

By ANDREW BROWNE in Hong Kong, MATT POTTINGER in New York and PATRICK BARTA in Bangkok.

Staff Reporters of THE WALL STREET JOURNAL

October 1, 2004; Page B3

The withdrawal of two foreign energy companies from a multibillion-dollar gas project in the East China Sea has raised fresh doubts about the area’s chance to be an oil-and-gas bonanza able to meet China’s surging energy demand and take pressure off global oil prices.

The pullout by Royal Dutch/Shell Group and Unocal Corp., the second high-profile exit from China by foreign energy companies in as many months, underlines deep structural problems besetting the country’s gas industry even as Beijing pours investments into pipelines and liquefied-natural-gas terminals. Faced with commercially questionable projects and a tangle of legal and regulatory hurdles, foreign investors no longer appear willing to pump money into China just to get a foot in the door.

Unocal, El Segundo, Calif., said Tuesday that it and Shell would abandon the Xihu Trough project for commercial reasons, leaving China National Offshore Oil Corp, or Cnooc, and China Petrochemical Corp., also known as Sinopec, to go it alone. In August, a Shell-led consortium pulled out of China’s multibillion-dollar, west-to-east gas-pipeline project.

With its largest domestic oil fields in decline and its economy expanding by nearly 10% on a year-to-year basis in the first half, China is scrambling to secure sufficient energy supply. This year, China is expected to account for 7.7% of global oil demand, according to Standard Chartered Bank. China’s oil producers have turned to offshore prospects such as the South China Sea and Bohai Bay. Many had hoped that the East China Sea would yield a mother lode, reducing pressure for China to prospect in less familiar and riskier terrain overseas.

But foreign companies apparently don’t believe there is enough gas in the area to make their participation in the Xihu project commercially viable, industry analysts said. A Sinopec official said the two sides couldn’t agree on “assessments of reserves, market outlook and income divisions of the project.”

“They pulled out because they have a different value assessment of the project,” said the official, adding that Sinopec’s move to adjust down its gas reserves six months ago, including Xihu reserves, had further complicated negotiations.

Indeed, some analysts were beginning to doubt the area’s energy potential even before the latest pullout. In April, Deutsche Bank analyst David Hurd slashed his estimate for gas production in the planned Xihu Trough fields as it became clear that the market’s initial hopes were too optimistic. He cut his forecast for peak production to about 25 million cubic feet of gas a day in 2010, compared with a previous peak estimate of 80 million cubic feet.

Mr. Hurd said that for Cnooc, the smallest of China’s publicly traded oil majors, the area still should be big enough to generate some growth. But that might not be true for companies such as Unocal, which has other sizable investments in Asia.

Sun Yu, an energy analyst with Everbright Securities Co., said one possible factor behind the pullout was disagreement between the foreign and Chinese sides over shareholding arrangements in the Xihu project and how to divide the output — the same problems that scuttled cooperation on the west-east pipeline. The two foreign companies each held 20% stakes in contracts to explore, develop and market Xihu gas, while Sinopec and Cnooc each had 30%.

“It is not a pure business dispute, but something related to politics and the control of natural resources,” Ms. Sun said.

China has no coherent body of law governing the natural-gas industry, and foreign investors are faced with a jumble of ministries and regulators with a claim on the sector. In the confusion, Chinese state-controlled oil companies often set their own rules, leading to conflicts of interest and muddying the waters in negotiations with foreign companies, industry analysts said.

Some analysts contend the west-east pipeline is driven more by the politics of Chinese energy security than commercial considerations. They say China’s listed oil companies are more interested in the credibility that Western partners would bring to the project than the funding or technology.

China has made a strategic decision to try to reduce its overwhelming reliance on coal, which causes big pollution problems, and develop natural gas. In addition to the west-east pipeline and exploration in the East China Sea, it is investing massively in LNG terminals and has signed a $17 billion contract for Australian gas.

Growth in gas demand between 2003 and 2005 will entail $28 billion of new investment, according to a research report by brokerage firm CLSA. Another $78 billion may be needed to satisfy demand until 2010.

Even as Western companies show a new pragmatism in walking away from Beijing’s pet projects, Chinese oil companies appear prepared to shoulder more risk in projects of national importance. Ms. Sun says Cnooc and Sinopec will easily be able to raise cash from internal reserves and banks to go ahead with the Xihu project.

Mark Qiu, Cnooc’s chief financial officer, said in an interview last month that China might not have as much oil and gas offshore as some might hope. But he said it still has a lot of untapped potential.

“How much more can offshore China produce to increase global supply? Probably not much,” he said. But “can offshore China be expected to deliver enough reserves to support my company’s growth? Absolutely.”

Qiu Haixu contributed to this article.

Write to Andrew Browne

at [email protected]

Matt Pottinger

at [email protected]

and Patrick Barta

at [email protected]

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