Beijing faces long haul in reaping benefits of oil and gas reform

Beijing is mulling sweeping policy reforms in the state-dominated oil and gas industry that could heighten competition through greater private sector participation, but analysts say the impact will only be felt in the long term as barriers abound.
Source:scmp     Time:02 Dec 2013


Beijing is mulling sweeping policy reforms in the state-dominated oil and gas industry that could heighten competition through greater private sector participation, but analysts say the impact will only be felt in the long term as barriers abound.

Execution of some of the reforms also hinges on further progress of oil and gas price liberalisation, they say. Refined oil prices are largely liberalised but that of natural gas is still at an early stage.

According to a reform plan drafted by the State Council's Development Research Centre made public in October, Beijing wants to relax restrictions on the import of crude oil, refined oil products and natural gas, build crude oil spot and futures markets to trade mainland product-benchmarked prices, and establish independent oil and gas pipeline operators.

The plan, published the week before the third plenum of the Communist Party's Central Committee, is the new leadership's broad roadmap of long-term policy reform for the industry, which analysts say will take years to realise.

The National Energy Administration last week said it would "remove policy obstacles for private capital to participate in energy development" and provide a fair competitive environment.

In particular, it would simplify approval procedures for coal-fired power generation and power distribution projects, support private investment in oil and gas exploration and development and allow refineries to import crude oil subject to criteria that it has not yet specified.

It would also accelerate rule-making on the construction and operation of gas transport and storage infrastructure, the agency said, paving the way for establishing mandatory open third-party access to gas pipelines currently mostly built and owned by state energy giants.

"With the new government, more has been accomplished in [the past] six months than was accomplished in the previous decade," said HSBC oil and gas analysts Thomas Hilboldt and Si Tingting in a research note. "We believe reform will continue over time and in small steps. But we do not foresee drastic measures challenging PetroChina, Sinopec, CNOOC and Sinochem's market leadership."

Currently, the import and export of oil and gas are predominantly conducted by five state-backed firms because of administrative barriers. They are PetroChina, China Petroleum & Chemical (Sinopec), China National Offshore Oil Corp, Sinochem and Zhuhai Zhenrong.

China is projected to import about 285 million tonnes of crude oil this year, but the official import quotas for non-state firms are just 10 per cent of the volume.

The non-state volume has been rising at 15 per cent annually between 2002 and 2010 to meet the mainland's commitments to dismantle trade barriers as part of measures to enter the World Trade Organisation, but stopped growing since 2011.

Most of the import quotas of non-state firms were not used by these companies themselves but were sold to the state-backed oil and gas giants.

This is because most of the companies that got these quotas do not have refineries and are only allowed to sell their imported crude to PetroChina and Sinopec, which together account for more than 80 per cent of oil refining volume.

Under the state giants' stranglehold, refiners controlled by local governments and entrepreneurs have to import fuel oil - a semi-processed product - to feed their refineries, and suffered from low plant utilisation and profitability. They account for about 15 per cent of the national refining volume.

Industry regulator National Development and Reform Commission issued a circular in September requesting all refineries on the mainland to report on their assets, production, operating efficiency and environmental protection performances.

This is seen by industry executives as a precursor to a policy review. However, they do not expect Beijing to make it easier for private refiners to enter the industry.

Among the about 10 non-state applicants for import quotas this year, only three to five were expected to win some for next year, reported China Oil, Gas & Petrochemicals, a newsletter published by Xinhua, quoting industry portal chem365.net analyst Zhang Yonghao.

Of the firms tipped as likely winners, three are subsidiaries or joint-venture partners of Beijing-backed majors.

Small private refiners are expected to face tougher restrictions under reforms in the short term because of regulations other than crude import quotas and some are not expected to survive.

The National Energy Administration last week issued a draft policy on the barriers of entry for crude oil importers and refiners. It requires them to have at least 5 million tonnes of annual processing capacity, debt-asset ratio of not higher than 70 per cent, and meet other benchmarks for operating and environmental protection.

"This makes a lot of sense since Beijing has been trying to consolidate the refining sector by allowing big and financially strong refiners to scale up," said BNP Paribas head of Asia energy research Por Yong-liang.

Beijing is also looking to set up crude oil spot and futures markets based on Chinese benchmarks. This is aimed at creating so-called "China prices" for oil that would help bolster China's influence on global pricing dominated by benchmarks in Europe and the United States.

Gordon Kwan, the head of regional oil and gas research at Nomura Securities, said having futures trading based on Chinese benchmarks was not meaningful unless the mainland had a deregulated energy market. "Otherwise, futures trading is prone to manipulation," he said.

A more controversial reform, with potentially the most far-reaching impact on the industry, is a proposal to set up regional independent natural gas pipeline operators by hiving off existing pipeline assets from their owners. PetroChina owns the majority of the gas pipelines.

A new regulatory system is also proposed to prevent unfair trading and market manipulation.

Robert Blohm, the Beijing-based editor of International Petroleum Economics Monthly and who has been an adviser to Beijing, said such restructuring aimed to separate gas production, transport and marketing.

The goal is to have independent pipeline operators that would carry gas for many producers and traders, resulting in a competitive and efficient market.

This reform was mooted in 2008 as part of the draft energy law, which in addition to stipulating that energy prices be primarily set by market forces, had a clause requiring energy transmission firms to offer "fair and non-discriminatory" access to energy users and traders.

The latter would be executed by a "specialised regulator" tasked to protect consumer rights, with those failing to comply to be fined two to five times the economic losses suffered by injured parties, said the draft law put forward for public consultation in early 2008.

Blohm said the draft did not become law because changing state-stipulated energy pricing to market-based pricing was not a priority at the time amid overheating of the economy and the surge in international crude oil prices to nearly US$150 a barrel.

PetroChina dominates all three segments of the gas sector. Heavily regulated prices much lower than regional prices have prevented it from making huge profits in recent years as hefty losses on imports offset gains on mainland-produced gas.

But Beijing in July kicked off a long-awaited reform on gas pricing, with a target to close most of the gap between domestic and overseas prices by 2015. That in turn implies significant price rises in the next few years that would benefit PetroChina.

Analysts said gas price liberalisation should come hand-in-hand with a dismantling of PetroChina's dominance in pipeline transmission because it would not make economic sense for its rivals to build duplicating pipelines.

"Imagine if most highways are built by General Motors and if non-GM cars are charged higher tolls or not allowed to use the highways," Blohm said, referring to the danger that PetroChina could use privileged information about its rivals and customers' trading to undercut them on price, or refuse to carry their gas.

Currently, there is no regulation on third-party gas pipeline transport fees and mandatory open access of pipelines.

The alternative was to create a "firewall" between PetroChina's gas pipeline transport and marketing operations in an attempt to create independence between the two, but which could be hard to implement, Blohm said.

Por said given PetroChina was listed and some of its pipeline assets had been partially sold to other firms, a state-engineered hive-off of its pipelines needed approval by its partners and public shareholders.

"The question is how the assets should be valued and who does the audit, [governments] never nationalise anything at a premium," he said, referring to a possible scenario that gas assets from existing operators will first be bought by state-backed entities before they are privatised.

He noted that other nations in Asia also faced a similar situation, where gas pipelines were nearly all owned by state-backed firms.

"Over the years, there have been a lot of talks about separating the pipelines from the national oil and gas firms, but it never happened," Por said.

The US gas industry took over 60 years to evolve into a structure with independent pipeline operators, through compulsory break-up of dominant and vertically integrated firms, he said.

Blohm said given the challenges to break PetroChina's dominance, the reform might take a "bottom up" approach.

This is despite some market watchers' belief that recent probes into alleged corruption by some top PetroChina officials could serve to wear down PetroChina's resistance to reform.

Blohm pointed out that Guangdong a few years ago became the first province to have an "open access" regional gas pipeline network. It is owned by 30 players, including distributors and major users such as power plants. He said this model might be copied by other provincial networks and then interconnect with neighbouring networks and offer reciprocity on access by each other's owners.

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