"The oil industry is being reformed," says Yang Qing from the Energy Research Institute of the State Development Planning Commission. "The issue of oil security is related to both the market for oil and the stability of oil supplies. Overall, it's a matter of structural reform."

Oil market reform

China's oil industry faces a particularly complex set of circumstances. A lack of effective and flexible mechanisms has held back development. A long-standing monopoly in energy has kept oil and gas prices under state control with rigorous restrictions imposed on access to these markets.

To break the monopoly in the industry, a 1998 restructuring led to the establishment of the China National Petroleum Corporation (CNPC) and the China Petrochemical Corporation (Sinopec Group). These two now operate alongside the original China National Offshore Oil Corp. (CNOOC) and China National Chemicals Import & Export Company (Sinochem Corp.) and provide some measure of competition in the country's oil and petrochemical industries. However, this does not mean that effective competition has already emerged in the domestic market.

Serious shortcomings still remain in the market structure of China's oil industry. The rapidly growing demand for oil has been in sharp conflict with the monopoly enjoyed by the suppliers. With the advent of China's market economy reforms, control over commodity prices has been largely relaxed. Nonetheless, the supply of both crude and refined oil is still subject to CNPC and Sinopec Group monopoly and the price-fixing mechanisms are far from fully reflecting the natural operation of supply and demand in the domestic oil market.

Consequently, moves aimed at stimulating the country's oil industry favor the relaxation of controls on access to the markets for the supply and sale of oil. Against a background of abundant global energy supplies, establishing an open market is an important channel for China to secure stable and cheap oil supplies. The reliability of oil supplies cannot be increased in the absence of a truly effective domestic market capable of attracting international energy resources.

Nevertheless, before opening up its oil market to the outside world, experts suggest the nation should do two things. Firstly set up a macro-adjustment and control system to improve market management while at the same time relaxing control over oil prices. Secondly break the territorial monopoly in the oil market and develop a rational competitive structure. In addition, in order to revitalize the oil market, independent oil sales corporations could be established in the railways, communications, civil aviation, agriculture and forestry sectors. The experts envisage that in addition to engaging in sales these corporations would also enjoy oil import-export rights and that private funds would be encouraged to enter the oil market.

Given the realities of economic globalization, major oil importers must take a market-oriented approach in addressing problems of oil supply. China, the world's most rapidly growing major oil-consumer, has enormous regional differences in oil demand. This is why it is so important to establish a price quotation system and an oil spot and futures market if effective risk management and market macro-control are to be realized. Meanwhile it has been suggested that the scope of the existing futures market should be extended to include oil transactions.

The 'go-out' strategy

The latest statistics indicate that the rate of growth in oil and gas production in China continued to slow in 2003. At the same time, domestic consumption and consequent imports of crude oil increased significantly.

In 2003, China produced some 169 million tons of crude oil (up 1.5 percent year-on-year) and 34 billion cubic meters of natural gas (up 6.8 percent).

Meanwhile in that same year, crude oil imports were 91 million tons (up 31.3 percent). Imports accounted for 36.1 percent of national consumption that reached 252 million tons (up 10.2 percent). Total oil consumption was 274 million tons (up 11.5 percent).

Faced with substantial growth in the demand for oil, Chinese firms have not only been tapping more domestic oil sources but have also been energetically pursuing a "go-out" strategy, looking for new and stable sources of oil in the international market.

Tan Zhuzhou -- president of the China Petroleum and Chemistry Industry Association (CPCIA) -- says, "This involves Chinese firms proactively going out to other parts of the world such as Africa and South America and applying their technical expertise and financial resources to the exploitation of oil resources there. This will enable us to secure multiple sources, avoid the risks of over-dependency on any one source and reduce the effects of price fluctuations. In this way, given abundant overseas oil production, the impact of high oil prices on the domestic economy can be offset or buffered to a considerable extent, which will be conducive to the development of the domestic petrochemical industry."

To date, China's overseas oil and gas cooperation has extended to Russia, Azerbaijan and Kazakhstan in Central Asia; Indonesia and Myanmar in Southeast Asia; Iran and Oman in the Middle East; Venezuela in Central/South America; and Libya and Sudan in Africa. In its overseas oil cooperation projects, China will normally secure a share of the annual oil output by virtue of becoming a direct investor or shareholder. As a result of this practice, oil imports will not be significantly affected by price fluctuations. It has been commonly held that going out to tap oil is better than going out to buy oil.

CNPC is China's biggest player in crude oil and refineries and has been active in opening overseas markets. Benefiting from the "go-out" strategy, the company has produced a total of 60 million tons of crude oil from overseas with investment projects spreading across Asia, Africa, North America and South America. CNPC has set up three investment centers covering: the Middle East and North Africa; Central Asia and Russia; and South America. Its overseas business extends to oil and gas exploitation, pipeline construction, oil refining, sales of petrochemical products and so on.

In 2003, CNPC completed the colossal Muglad oilfield project in Sudan. This involved the construction of a huge oilfield with an annual production capacity of over 10 million tons, a refinery processing 2.5 million tons of oil a year and a 1,506 km pipeline. Based on the experience of this overseas operation, the largest of its kind, CNPC moved on to open North African and Middle Eastern markets in Libya, Algeria, Oman, Syria and Iran.

On January 30, 2004, CNOOC Muturi Limited, CNOOC's wholly-owned subsidiary, signed a Sale and Purchase Agreement (SPA) with the BG Group to acquire an additional 20.77 percent interest in the Muturi Production Sharing Contract (PSC) for a consideration of US$98.1 million. This purchase increased CNOOC's interest in Muturi PSC from 44.00 to 64.77 percent and brought a corresponding increase in its interest in the Tangguh LNG Project from 12.50 to 16.96 percent.

The refinery-heavy Sinopec Group has been active in searching for overseas oil reserves to feed its refineries. The company's crude oil imports account for nearly 80 percent of the country's total and more than half of these come from the Middle East. In recent years Sinopec has increased its investment in the Middle East. In January, 2004, Sinopec signed a contract with the Saudi Arabian Ministry of Petroleum and Mineral Resources for the exploration and production of natural gas in a 38,800 sq km area in the vast Rub al-Khali, the desert known as the "Empty Quarter". Initial investment in the project is planned to reach US$300 million. Currently, Sinopec is bidding for rights to exploit 16 Iranian oil fields, despite obstacles created by the United States.

Answering the "go-out" call, Sinochem Corp. that is playing a key role in China's oil security strategy also embarked on overseas exploitation for oil and gas. Liu Deshu, Sinochem's president, suggests that the country should adopt a series of measures to encourage domestic firms to support the "go-out" strategy. In particular he advocates the use of preferential tax policies to support Chinese firms' overseas oil and gas development activities. What's more, he says that the legislative work relating to oil and gas development, including the enactment of the "oil law", should be carried out as soon as possible.

Building up strategic oil reserves

Along with oil market reform and the implementation of the "go-out" strategy, China's project to create a strategic oil reserve is now getting into gear.

Last year, in order to set up an oil reserve system, an oil reserve office was established within the State Development Planning Commission (SDPC). On Dec. 6, 2003 the SDPC announced that China was to build four strategic oil reserve facilities on the coast. So far, work has started on the first-phase capable of holding an oil reserve of 10 million cubic meters.

CNPC, the Sinopec Group and Sinochem Corp. have all participated in developing the country's strategic oil reserve blueprint. Given commercial consideration, since the oil reserve plan will have some adverse financial effect on these companies, experts have suggested that they should be compensated accordingly.

At a global level, the existence of oil reserves has become an important factor in stabilizing supply and demand. After experiencing global oil crises in 1973-1974 and again in 1979-1980, one after another the developed countries established their own strategic oil reserves.

In 1975 Congress empowered the government of the United States to build an enormous contingency oil reserve. By 1991, a total of US$19 billion had been allocated to secure strategic oil reserves. This supplied the market with 1.12 million barrels of crude oil per day during the 1991 Gulf War, stabilizing oil prices. By 1997, the US's actual physical strategic oil reserves reached 564 million barrels, equivalent to 67 days' imports.

Maintaining oil reserves has also become a fundamental matter of national policy for Japan. So far, Japan has built 10 oil reserve facilities and invested a total of 2 trillion yen in establishing its national oil reserves. By 1997 Japan's strategic oil reserves were enough for 154 days' supply. Taken together with the country's commercial oil reserves this would allow for domestic demand to be met for half a year or so if oil imports were to be totally suspended.

Experts have pointed out that due to the high costs involved, the underlying rationale for maintaining strategic oil reserves is not based on their ability to stabilize oil prices but on the need to ensure continuity of oil supplies in the event of war or natural disaster. Thus the aim of China's strategic oil reserves should be to ensure uninterrupted oil supplies and ultimately the security of the national economy.

(China.org.cn by Shao Da, April 28, 2004)