Sinopec and Shell China planned to found a new company with a registered capital of $200 million to build 500 gas stations in Jiangsu Province, the third largest province in terms of energy consumption. It is estimated that the first group of gas stations will start to operate within three months after the contract is signed and the construction of 500 gas stations will be completed in three years. Sinopec will hold 60 percent of the shares and Shell China will hold the remaining 40 percent.

China has promised in the protocol on accession to the WTO that before the end of 2004 it will truly open the oil product retail market to foreign investment. China will lift restrictions on the entry of foreign capital that limit the location, number, ownership or institution of corporation. Its oil product wholesale market will open by the end of 2006.

Shell has been waiting for this moment for years. Since 1994, the Chinese Government has granted no applications from foreign companies for constructing gas stations. But foreign-funded companies have acquired some privately owned gas stations through various means such as buying a certain number of shares or granting franchises to some partners for using their brands.

In 2000 when Sinopec was listed overseas, Shell bought about 3.17 billion shares, or 3.7 percent of the capital stock, at about HK$5 billion.

At the end of the same year, the two companies signed an agreement on their strategic alliance and included in their cooperation package the founding of a joint venture in Jiangsu Province in oil product retailing.

A year later, Shell and Sinopec submitted a feasibility study to the State Council on joint construction of gas stations, which didn't win approval until November 2003. After that, they started negotiations over the details.

Professor Chang Xiuze at the Institute of Macroeconomics under the National Development and Reform Commission (NDRC) believes that this reflects Shell's ambition to vie for as large as possible a portion of the market before it is fully opened.

Uncertainty looms over Shell's ambition though, as two other foreign giants-BP and ExxonMobil-are competing for gas stations contracts as well.

According to the Beijing Youth Daily, in February BP signed an agreement with PetroChina on selling oil products. According to the agreement, BP and PetroChina will jointly construct 500 gas stations in two heavy energy-consuming provinces, Guangdong and Zhejiang. The feasibility study of projects in Guangdong has already won approval from the State Council.

BP has done even more to grab a portion of the oil product retail market in China. In October last year, for example, BP and one of its Chinese partners built an oil depot with a capacity of 363,000 cubic meters, and thus became the first international petroleum company to build an oil depot in China.

When BP reached an agreement with PetroChina, ExxonMobil also signed a framework agreement with Sinopec that aims to strengthen their strategic alliance. A large part of the agreement, which involves a total investment of over $3 billion, deals with the joint construction of gas stations.

To date, all the three international giants in the petrochemical industry-Shell, BP and ExxonMobil-have disclosed their joint venture plans in building gas stations.

Money in Oil Products

Over the last three years, automobile sales in China have maintained double-digit growth and are projected to keep that rate to 2010. With sales escalating and the economy developing rapidly, the Chinese market has lured Western oil companies. Also, as the majority of gas stations in China provide only the refueling service, there is much room for developing other products and services.

"Foreign oil giants are attracted to the un-tapped profits so they are constructing gas stations as quickly as possible in China," said Chang Xiuze.

Chen Yijia, President of the Shell Group of Companies in Northeast Asia, indicated that Shell plans to build 1,000 gas stations in China, bumping its investment from its current $1.6 billion to $5 billion. Chen said the global revenue of the company in 2002 was $9.2 billion and the average return on capital was 14 percent.

The business revenue of Shell China for the past year was $485 million, constituting only a small portion of its global revenue. "Shell just began investment in China so they anticipate that in five years the company will see remarkable growth in its China market," explained Chen.

Dr. Gary Dirks, Group Vice President and CEO of BP China, said recently that BP plans to invest an additional $3 billion in China in the next five years.

Moving Downstream

In less than a month, BP sold its entire stake in PetroChina and Sinopec, causing a stir in the capital market. People started to speculate that BP would withdraw from the Chinese market causing uncertainty among Chinese oil enterprises.

After BP gobbled up some of PetroChina's shares in 2000, it bought 1.8 billion shares of Sinopec at HK$2.86 billion when Sinopec sought an initial public offering overseas in October the same year, becoming the third of the big three to invest in it.

There is a consensus among analysts that the purchase was motivated by BP's confidence in the rapid growth of demand for oil products in China.

But when BP became deeply involved in the China market, its strategy changed. One important aspect has been its shift in focus of investment from upstream to downstream sectors, or from raw material processing to gas station services. BP's redirected investment is the likely immediate reason for the sale of its stake in PetroChina and Sinopec.

BP, a seasoned veteran in the oil industry, has suffered from a sub-par performance in recent years and hence the adjustment in its global strategy, including in China. As a result, BP's investment worldwide has undergone dramatic change. Following the decrease of oil production in Britain's North Sea, BP directed more investment to Russia and African countries.

The strategic adjustment means an exodus of BP capital from China: The company withdrew a large amount of investment from east Asia and poured it into Russia and Africa that have greater reserves of oil and gas resources than China.

BP now focuses its investment in China on the retail market of oil products, which has great potential for growth, so as to maximize the return on capital.

BP also picked a smart time to sell its stakes in the upstream sector. BP earned HK$8.5 billion when it sold its 2 percent stake in PetroChina on January 12 and another HK$2.8 billion when it sold its 1.8 billion shares in Sinopec on February 10. In less than four years, BP earned over HK$11.3 billion from its investment in China.

Refine Crude Pricing System

As the oil product market opens to foreign investment in 2004, the petroleum industry will enter a stage of full market competition, causing present oil prices to respond accordingly.

"In a couple of years, public hearings will be held on the price of oil products," said an official from the Department of Economics and Trade under the NDRC.

The oil price was basically subject to government regulation in China before the country became a net oil importer in 1998, which forced China to peg crude oil prices to international market rates.

In 2000, the government introduced a new pricing system that does not directly peg prices to international oil rates-domestic oil price should remain unchanged when international oil rates fluctuate within the range of 5-8 percent. Moreover, domestic oil price was not only pegged to the rate in Singapore, but to the rates in Rotterdam and New York.

After the two reforms, problems undermining the pricing system of oil products in China have become even more obvious. Over-transparency, insensitiveness to market changes and lack of fairness could lead to over-speculation and the playing up of oil prices in the absence of future oil markets in the country.

The distorted pricing system of oil products in China reflects to a large extent the past pattern of monopoly on the oil market.

A manager of an oil product business in Shenyang, Liaoning Province complained about the system, "The buyer is not on equal footing with the supplier because of the distorted supply and demand. The buyer is subject to the monopoly of Sinopec and PetroChina and has no other supplier, type, price, and supply arrangement options. "

The official from the Department of Economics and Trade under the NDRC also noted that as foreign investment pours into the oil product retail market breaking the monopoly, the pricing mechanism would undergo significant changes.

The official also disclosed three oil price reform plans now under discussion. First, the government would supervise only the factory price and CIF (cost, insurance, freight) while other prices such as the wholesale price, the regulated price and the retail price would be open to the market. Second, the government would supervise the retail price and keep it unchanged within a certain fluctuating range of the wholesale price. Third, the government would only control the price of oil for military use, aviation, railway and national reserves.

According to Fu Bingqi, another official with the Department of Economics and Trade under the NDRC, the department is considering the establishment of price safety range and price early-warning system.

The government will analyze and forecast oil price trends over certain periods, then determine the threshold and maximal prices in the domestic market for the next two or three years as a safety range.

The government will decide when to put oil product reserves into the market according to price fluctuations on the oil market.

(Beijing Review March 18, 2004)