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    China Business
     Jul 30, 2009
China's oil partners hang onto assets
By Wenran Jiang

The growing outreach of Chinese national oil companies (NOCs) has stoked concerns that Beijing is maneuvering to lock up global energy assets. Yet recent agreements with Russia, Kazakhstan, Brazil and Venezuela for a combined value of nearly US$50 billion in Chinese capital indicate oil-producing countries have maintained control of their assets.

China has grown to become the world's second largest consumer and importer of oil, and the government has been pushing its NOCs to implement a "go-out" strategy to secure overseas energy supply. [1]

This new strategy is taking the shape of a formula of "loans-for-energy", which involves a mix of state-owned and private actors. These complex arrangements indicate that China's expansion of


overseas-energy assets is a long-term goal and that it is increasingly interested in securing Chinese outward investments with its international partners.

In February, China National Petroleum Corporation (CNPC), the country's largest oil company, signed a raft of agreements with Moscow, in which China would provide $25 billion in soft loans to Russia in return for a long-term commitment to supply China with oil. In the same month, China and Venezuela agreed to double their joint investment fund to $12 billion by injecting an additional $4 billion from China, in return for Venezuela's state-run oil company PDVSA's commitment to sell CNPC between 80,000-200,000 barrels of oil per day (bpd) by 2015.

On February 19, China Development Bank, a financial institution under the State Council primarily responsible for raising funds for large infrastructure projects, sealed a similar deal with Petrobras - the Brazilian state-owned oil major - for a Chinese loan of $10 billion in exchange for a 10-year oil supply memorandum. This agreement will allow China Petroleum & Chemical Corp, known as Sinopec, the largest refining company in Asia, and CNPC to receive up to 150,000 bpd beginning this year, increasing to 200,000 bpd in the next nine years.

China's fourth "loans-for-oil" deal, which was also signed in February, was with Kazakhstan. Under the terms of the contract, Kazakhstan will receive $10 billion in financing for its oil projects. China's Export and Import Bank (Exim Bank), the official export credit agency of the Chinese government, lent the state-owned Development Bank of Kazakhstan $5 billion, while CNPC extended a $5 billion loan to its Kazakh counterpart KazMunaiGas.

Complex "loans-for-oil" formula
The four aforementioned deals all entail extensive and complicated negotiations between the parties involved, and they all involve arrangements in what the Chinese call "loans-for-oil" (daikuan huan shiyuo).

China's $25 billion deal with Russia, for example, is comprised of four separate core agreements - two loan agreements between China Development Bank and Russian oil firms Rosneft and Transneft, respectively; one oil-supply agreement between CNPC and Rosneft; plus one oil pipeline construction and operation agreement between CNPC and Transneft.

Under the provisions of the two loan agreements, Russian firms must use Chinese loans for projects related to oil supplies that are going to China, but Rosneft is also permitted to use part of the loan to repay its debts to other non-Chinese financial institutes. These agreements could potentially secure oil supplies amounting to 300 million tons over 20 years. The supplies are worth almost $90 billion at current prices.

Yet it would be inaccurate to presume that China is buying $90 billion worth of oil with $25 billion of loan. Instead, China is expected to buy the oil at market price at the time of delivery, and Russia will pay back the loans separately in cash, under an adjustable interest rate. In other words, it may be somewhat misleading to describe the deals as "loans-for-oil".

These arrangements also mean that the construction of a 300,000 bpd link from the Eastern Siberia-Pacific Ocean (ESPO) oil pipeline to China can now be materialized. The long-awaited 1,030 kilometer pipeline starts from Skovorodino in the Far East of Russia and ends at the Daqing oilfield in China's Heilongjiang province. Once finished at the end of 2010, the pipeline will have a capacity to transport 15 million tons of oil to China every year, enough to meet around 4% of China's current oil needs. Rosneft expects to send crude to China under the new deal beginning in January 2011.

The Petrobras-CNPC/Sinopec deal departs from the former's usual practice of not entering into contracts committing future production and supply in its new agreement with China. It demonstrates that Petrobras is eager to keep financing on track for its pre-salt exploration in newly found oil reserves (for 8 billion barrel potential) deep beneath the ocean floor off Brazil's southern coast. The entire project requires a $174.4 billion investment, and $28.6 billion input for this year alone. On the Chinese side, the 150,000 bpd that Petrobras has promised Sinopec for 2009 would be equivalent to around 4.2% of China's overall intake in 2008.

The agreement with Venezuela is the least definite in contrast to the other three, as it contains no firm commitment of increasing its supply of oil, but is only based on loosely-phrased terms "calling for" PDVSA to sell CNPC between 80,000-200,000 barrels of oil per day". Venezuelan President Hugo Chavez announced during his April 2009 visit to China that his country aims to increase oil shipments to China to one million barrels per day by 2010. It is worth noting that Caracas's petroleum shipments to China only reached 168,000 bpd by December 2008, which fell way short of Chavez's original target of 400,000 bpd for 2008.

China's new venture with Kazakhstan also deviates from the "oil-for-loans" formula. The $5 billion loan from CNPC will give Chinese oil firms a 50% stake in the joint purchase of MangistauMunaiGaz (MMG), Kazakhstan's biggest private oil and gas company. This deal is more like a "loan-for-oil assets" transaction than one of "loan-for-promised-oil supply," which characterizes the previous three contracts. CNPC will receive half of the oil that will be produced by the jointly owned MMG (the other 50% will be owned by the Kazak state-owned firm KazMunaiGas).

This model is more in line with the Chinese government's preference for financing acquisitions, since it gives Chinese NOCs direct ownership of resources - in contrast to the other three deals, whereby Chinese NOCs could only extend loans to foreign NOCs for guaranteed oil supplies or possible special access to future exploration projects.

China's inability to obtain outright equity oil assets stems mainly from the oil exporters' tight grip of their national resources. The increasing nationalistic sentiments evoked by oil-producing countries and the use of energy as a national foreign policy tool suggest that - at least in the short term - these deals are far from signaling a major breakthrough in China's energy security. China was only able to secure a 50% interest from Kazakhstan's MMG, and uncertainty remains as to whether the promised oil supplies are sustainable on a long-term basis without occasional disruption.

Underlying conditions
The "loans-for-oil" deals are unfolding against the backdrop of the global financial crisis and abated global oil consumption. Take Russia for example. Rosneft, 75% controlled by the government, was burdened with $21.2 billion in debt and Transneft with $7.7 billion. For Rosneft, its $15 billion share of the $25 billion loan from China will comfortably cover its $8.5 billion debt maturing this year.

In addition, China's capital injection complements the emergency capital needs of national oil firms in Venezuela and Brazil, allowing them to further expand their market shares and turning resources into capital. As for Kazakhstan, Xue Li from the Chinese Academy of Social Science points out that China's $10 billion loan could help the Central Asian country initiate its $14.6 billion economic recovery policy.

Zhang Guobao, vice minister of the National Development and Reform Commission and head of the National Energy Administration (NEA), had pointed out in a signed article published in December 2008 in the People's Daily (a strong indication of being authoritative statements of government policy) that China should seize the timing of the oil price slump on the international market to increase imports and Chinese enterprises are encouraged by the government to expand overseas.

Accompanying such appeals is a call is to take advantage of China's fast-accumulating foreign reserves. The global economic crisis has presented China with a rare opportunity to trade its abundant foreign currency reserves for oil, mineral and other resources around the world. China now has roughly $2 trillion in foreign exchange, ranking number one in the world, and many state firms are also flush with funds.

Beijing is considering setting up an oil stabilization fund to support purchases of overseas resources by Chinese oil companies. The plan was submitted at NEA's National Work Conference on Energy held in March 2009.

China offers oil-producing nations, especially Russia and Venezuela, an alternative to Western and US markets, thereby giving them more political clout in the international community and reducing potential vulnerability from their existing buyers.

The Russian government plans to increase its crude oil exports to the Asia-Pacific region from three percent in 2000 to 30% by 2020, amounting to 100 million tonnes a year. [2] Similarly, Venezuela regards China as a key link in its strategy of diversifying oil sales away from the United States, which still buys about half of Venezuela's oil despite years of political tensions between the two countries.

The rationale also applies to Kazakhstan. In addition to pipelines extending to Russia and Europe, sustainable oil supplies through the existing China-Kazakhstan oil pipeline can enhance Kazakhstan's energy transit potential by diversify its exporting routes, thereby reducing political and commercial risks.

Assessments and prospects
The recent large energy activities are not the first time Chinese NOCs have entered "loans-for-oil" deals. In 2004, Chinese banks financed Rosneft's acquisition of Yuganskneftegaz with a $6 billion loan and CNPC received a pledge of long-term supply contracts via rail in exchange. Beijing's continuous efforts to secure long-term oil supplies demonstrate that Chinese national oil firms are increasingly using a powerful tool to obtain overseas assets: loans from government banks to resource-rich but cash-strained nations in maintaining access to oil supplies.

Yet even under economic pressure, oil-producing countries have kept Chinese oil companies at arms' length during the negotiations. For the former, these four deals represent an optimal outcome - let China provide the financing while they maintain the control of the energy assets. The terms of the agreements only give China the "right to purchase" the oil, but not the "right to own" the oil through equity purchase.

These "loans-for-oil" activities will remain an active component of the Chinese overseas resource acquisition strategy given the current global economic and energy conditions. They are accompanied by other commercial deals and acquisitions, such as the latest commitment of $7.2 billion by Sinopec to buy Toronto-listed Addax which has large holdings in West Africa and Iraq. The Sinopec-Addax transaction, if finalized, will be the single largest energy asset purchase by the China's NOCs, demonstrating the dynamic nature of China's overseas energy security drive.

(The author would like to thank Simin Yu for his research assistance.)

1. Chinese NOCs normally refer to the China National Petroleum Corporation (CNPC), China Petroleum and Chemical Corporation (Sinopec), China National Offshore Oil Corporation (CNOOC), and their subsidiaries.
2. Shoichi Itoh, "Russia's Energy Diplomacy toward the Asia-Pacific: Is Moscow's Ambition Dashed?" Slavic Research Center, Sapporo, Japan, 2008.

Wenran Jiang, PhD, is the Mactaggart Research Chair of the China Institute at the University of Alberta and a Senior Fellow at the Asia Pacific Foundation of Canada.

(This article first appeared in The Jamestown Foundation. Used with permission.)

(Copyright 2009 The Jamestown Foundation.)

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