New Offshore Players, Minimal Impact in China

The recent addition of new players in China's offshore exploration and production sector won't change the seascape much, unless the government further relaxes its restriction on these companies forming joint ventures with foreign partners.

The Chinese government recently granted offshore exploration and production, or E&P, licenses to China's top and second-ranking oil and gas companies - on paper threatening the dominant position held by CNOOC Ltd. (CEO).

But analysts say that the change won't have any significant impact any time soon on CNOOC, China's largest offshore oil and gas producer, and its third-ranked oil company.

That's because CNOOC remains China's only offshore oil and gas company allowed to form joint ventures with foreign parties, and as the newcomers have very limited experience in offshore work.

In July, PetroChina Co. (PTR), China's largest oil company, was given licenses for blocks in the South China Sea.

While PetroChina has overseas production assets, the offshore approvals mark its first domestic move away from its traditional areas of activity - the onshore hydrocarbon basins mostly in northeastern and northwestern China.

Four months later, rival China Petrochemical Corporation, parent of Hong Kong and New York-listed China Petroleum and Chemical Corp. (SNP) or Sinopec, was given licenses for deep-water oil and gas exploration.

Most of Sinopec's E&P activities have up to now been in onshore regions in southern and eastern China, or overseas.

Piece Of Paper Not Enough

However, converting a license into a tanker full of oil or pipeline full of gas takes something that neither of the energy giants have much of - offshore technology skills.

"I don't think these two companies have any experience and expertise in offshore E&P," said a senior official of an oil-related business company.

"My guess is that they will need to do what CNOOC has done - to invite international E&P companies to participate and for them to provide the expertise needed," the person said.

But under current regulations and under the new licenses just issued, PetroChina and Sinopec can't work with foreign companies in domestic offshore waters, unless it is done through CNOOC.

CNOOC's parent, China National Offshore Oil Corporation, has exclusive right to sign offshore exploration and production sharing deals with international companies, and to sell the oil and gas in China, the 1999 and 2001 prospectus issued by its listed unit, CNOOC, noted.

And in the past five years, CNOOC group's exclusive position hasn't been eroded.

CNOOC group has the right to acquire, at no cost, up to a 51% interest in any successful discovery made by its foreign partners offshore China.

"Because exploration costs are incurred solely by the Group's foreign partners...and the Group evaluates the possibility of acquiring a participating interest only after a successful discovery has been made, the Group is able to minimize its finding costs and exploration risk," the company said in its prospectus.

CNOOC Cooperation With Sinopec

All this gives CNOOC a definite edge over its potential competitors.

"CNOOC's competitive advantages in offshore exploration should remain intact in the near future, given its exclusive right to enter production-sharing contracts with foreign companies," said Gideon Lo, an analyst at DBS Vickers (Hong Kong) Ltd.

He cited China National Star Petroleum Corp. as an example of the failure of a company to make significant inroads by itself in offshore fields.

Founded in 1997, CNSPC was the only other company up to this year, to get an offshore E&P license.

CNSPC, which did some work in the East China Sea, was subsequently acquired by Sinopec in 2001 from its parent China Petrochemical Corporation.

In August 2003, Sinopec, CNOOC, Royal Dutch/Shell Group (RD) and Unocal Corp. (UCL) agreed on the joint exploration, development and sales of natural gas, petroleum and condensate in the East China Sea

. The agreement included five areas in the Xihu Trough area covering 22,000 square kilometers.

Although Sinopec and CNOOC each owns 30% of the project, CNOOC is the operator. Sinopec is responsible only for the marketing and sales activities. Production is due to start in the middle of next year. CNOOC Insulated, For Now Just how long CNOOC can hang on to its exclusive position remains to be seen.

Some analysts argue that given China's deteriorating energy balance as domestic oil output has peaked and imports continue to rise, the change will likely be sooner, rather than later.

"Given the increasing tight domestic oil supply, China will probably bring in more domestic competition to accelerate offshore E&P activities," DBS Vickers' Lo said.

"To achieve this, China's government will eventually terminate CNOOC's monopoly with regards to its production sharing contracts with foreign parties," he said, adding this would adversely affect CNOOC's long-term oil reserve growth and production.

Even so, there are plenty of unexplored areas for Sinopec and PetroChina to search.

CNOOC has been involved in some 51% of China's estimated total offshore exploration area of 1.3 million square kilometers, so in theory about 49% remains for newcomers to prospect.

CNOOC currently has an interest in 143 offshore exploration blocks covering approximately 670,635 square kilometers.

Stock market investors have shown no doubts about which of China's major oil and gas companies seem to have the best prospects.

Since PetroChina received its offshore permits in early July, its share price has risen 14.6% to HK$4.325 on Nov. 23. Over the same period, Sinopec's share price has gained 7.6%, to HK$3.175.

By contrast, CNOOC has seen its share price in Hong Kong climb by an impressive 33.1%, to HK$4.525.

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