Commodities Report: China's Big Oil Shows Reserve

BEIJING, Jul 23, 2007 (From The Wall Street Journal via Dow Jones Commodities News)

Conventional wisdom says Chinese oil companies are buying every oil barrel in sight -- no matter where, no matter the cost. Mr. Conventional is sometimes wrong.

The parent company of Hong Kong-listed PetroChina, China National Petroleum Corp., turned down a chance to buy a stake in the South American assets of Spanish oil company Repsol YPF SA. People familiar with the proposed deal said CNPC, China's leading oil-and-gas producer by output, feared the wave of nationalization spreading across South America could imperil the return on investment.

"In terms of the Chinese, the name surfaced amongst many others," says William Gartland, a spokesman for Repsol, confirming that Repsol had talked to CNPC. Instead, Enrique Eskenazi, an Argentine banker with close ties to the government, is likely to win the stake.

To some analysts and industry consultants, the only way for Chinese oil companies to grow significantly is to buy overseas firms. Any gains at home are quickly gobbled up by China's fast-growing economy. But Chinese oil companies, despite backing from the state and access to lots of cash, are finding their choices abroad limited -- often for political reasons.

Two years ago, China's No. 3 oil-and-gas producer, Cnooc Ltd., withdrew an $18.5 billion bid for California-based Unocal Corp. after a protectionist backlash in Congress. Since then, the three Chinese oil giants, including China Petroleum & Chemical Corp., the country's No. 2 company commonly known as Sinopec, have made more-modest ventures abroad -- a move some analysts fear could stunt their growth potential.

Even as global oil prices near records, international oil companies are finding it harder to bring more production on stream. The majority of the world's reserves are either controlled by the national oil companies of the Middle East or extremely expensive to develop. Chinese oil companies have, in some cases, helped the global energy balance as they were willing to go places Westerners couldn't, such as Sudan, against which the U.S. government has imposed sanctions. The Chinese now appear to be making more-tempered bets.

In recent years, China's companies have spent more time and money investing at home than abroad. According to oil consultancy Wood Mackenzie, China's three biggest oil-and-gas companies spent $21.5 billion last year on domestic exploration and development, compared with $12.6 billion in 2004. By comparison, the total spent overseas in 2005 and 2006 combined was $8 billion.

The results on the domestic front have been impressive, with some major discoveries of oil-and-gas fields helping to boost reserve-replacement ratios -- a measure of how much oil is found to replace each barrel pumped out and sold.

That may not be enough for longer-term growth, some analysts fear. "They're running to stand still," says Bradley Way, Beijing-based analyst for BNP Paribas. "They have lots of cash, but they will need new reserves to balance volume and margin declines in their domestic fields." Mr. Way has a 12-month target of 13 Hong Kong dollars (US$1.66) for PetroChina shares, which he downgraded to "hold" from "buy" earlier this month.

Many oil-industry analysts argue the only way for China's oil companies to really grow is through overseas acquisitions. That's where a Repsol deal would have come in.

On offer: a 25% stake in Repsol's Argentina-based YPF unit, whose collection of aging oil-and-gas fields has been valued from $2 billion to $4 billion. Repsol acquired YPF in 1999. Facing shareholder pressure to reverse underperformance, the Spanish company is looking to sell a stake in YPF and then list 20% in the Argentine stock market to raise cash.

The deal could have played to CNPC's strengths. CNPC engineers have a reputation for being able to squeeze supply out of old fields -- an expertise that dates from long practice on the company's flagship Daqing oil field, a nearly 50-year-old find in northeastern China. As well as substantially increasing oil reserves -- and aiding China's energy security -- the YPF stake also would have offered CNPC access to Argentina's growing domestic market, say people familiar with the proposed deal.

CNPC and PetroChina declined to comment.

It is surprising CNPC didn't buy. Chinese oil-and-gas companies have no shortage of cash. By some estimates, CNPC has the capacity to make a $40 billion acquisition. On top of that, it has access to cheap loans from China's state-owned banks. China's leaders have also suggested using some of the nation's trillion-dollar foreign reserves to buy overseas energy assets.

There is also apparently a high tolerance for risk. CNPC continues to develop fields in Sudan, Venezuela and other places where Western oil companies have had less than a warm welcome.

Yet, in Argentina, CNPC has passed up what people familiar with the proposal believed would have been a good deal. In part, its hesitation is tied to the wave of nationalizations sweeping South America, spearheaded by Venezuela where last month, Exxon Mobil Corp. and ConocoPhillips walked away from their multibillion-dollar investments after refusing to sign over majority stakes to the government-controlled oil company.

Another factor that may be keeping PetroChina and its parent away from a big acquisition now is that its forecasts for long-term oil prices remain very conservative.

Oil futures in traded in New York have breached $76 a barrel, and some analysts are predicting that prices won't fall below $60 anytime soon.

That could also be a factor in CNPC's reluctance to invest more in Canada's tar sands, a costly-to-develop oil that needs to be processed before it can be refined into fuel. On Friday, CNPC issued a statement denying it was scaling back in Canada. The statement appears to be an attempt to deflect comments widely reported in the Canadian press from a CNPC official saying the company would reduce its presence in Canada because of rising production costs and tougher regulations.

In the background in China is the Communist Party Congress in the fall, a meeting held every five years at which big leadership changes and policy initiatives are announced. The heads of top state-owned companies, including CNPC and its listed unit, are appointed by the government, which is essentially the same as the party. That has quashed any ambitious plans, some industry observers say.

Jason Singer in London and Kate Linebaugh in Hong Kong contributed to this article.

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