Oil’s historic price crash is presenting an uncomfortable dilemma to China’s energy majors: follow market signals to cut drilling, or heed President Xi Jinping’s orders to boost output.
While China’s main influence on global oil is as the world’s largest importer, it also produces 3.8 million barrels a day, more crude than all but two of OPEC’s individual members. The last time crude slumped this low, in 2016, China’s response was to cut spending at old and expensive fields, and output slumped.
That may not be an option this time, after trade tensions with the U.S. prompted Xi in 2018 to order an increase in domestic exploration and production to safeguard the country’s energy security. The longer the price collapse lasts, the more the government’s push for energy sufficiency will be tested, with state-owned firms like PetroChina Co., Sinopec Corp. and Cnooc Ltd. caught in the middle.
“The Chinese government still wants to produce more to enhance its self-sufficiency rate,” said Dennis Ip, an analyst at Daiwa Capital Markets Hong Kong Ltd. “Lower oil prices are definitely going to hurt the cash flow for those Big Three oil majors. Whether they execute 100% of their capital plan this year, or try to defer, really depends on how long this lasts.”
Crude prices have tumbled by nearly half since the beginning of the year as the coronavirus outbreak saps demand and Saudi Arabia and Russia unleash supply in what appears to be the start of a price war. U.S. drillers like Occidental Petroleum Corp. and Diamondback Energy Inc. have already announced plans to slash spending amid the rout.
China’s drillers are particularly sensitive to lower prices, because its fields are older and require more work to sustain production, said Parul Chopra, vice president for upstream research at consultancy Rystad Energy AS. The price needed for new wells to break even in the country is about $41 a barrel, compared to $13 for Saudi Arabia and $11 for Iraq, he said. PetroChina, the country’s biggest oil company, described some of its fields as having “no hope” of being profitable during the 2016 price crash.
China’s oil production plummeted during the last crash, from a peak of 4.3 million barrels a day in 2015, when it was the world’s fifth-biggest producer, to 3.8 million barrels in 2018, when it fell to No. 8.
By then, the country had surpassed the U.S. to become the world’s biggest oil importer. With trade tensions boiling, Xi instructed state-owned energy firms to boost output. China National Petroleum Corp., the majority owner of listed PetroChina, said it would adopt “revolutionary measures” to ensure stable or increased production.
The country’s three oil majors raised spending the following year by 18% and managed to reverse the decline in production. It came at a cost, though. PetroChina’s shares fell 20% even as the MSCI Asia Energy Index rose 6% and it was accused of putting national service above shareholders.
China’s economic recovery from the coronavirus outbreak will add more incentive to keep drilling activity elevated, said Max Petrov, a principal analyst with energy consultancy Wood Mackenzie Ltd.
“Beijing will want to keep energy flows and employment levels running high as economic activity returns to normality after the impact of Covid-19,” he said. “This suggests spending will remain high or accelerate during the second half of the year.”
In the wake of this week’s price collapse, analysts have been busy marking down their forecasts for the listed units. While the big oil firms enjoy government favor — and subsidies — they’re not protected from market circumstances. PetroChina, for example, imports gas at a loss to facilitate China’s switch from coal to the cleaner burning fuel.
Of the Big Three, Sinopec may be best placed to ride out the oil market’s meltdown, according to Citigroup, because of its huge refining operations, which benefit from cheaper crude. At the same time, the value of its oil inventory will have been crushed by the collapse, and that’ll weigh on profits.
Cnooc, the biggest offshore explorer, is the only one of the three to announce spending plans this year, saying in January it would boost expenditure to the highest level since 2014. Daiwa’s Ip said all three companies are conducting internal analysis on spending levels following the recent price crash, and have yet to decide a course of action.
Sinopec declined to comment on its spending plans. PetroChina and Cnooc didn’t respond to requests for comment.
While the oil crash will hurt drillers’ profits, it offers another way for the country to boost energy security, said Tian Miao, an analyst at Everbright Sun Hung Kai Co. Plunging prices are creating an opportunity for China to import cheap crude to fill its strategic reserves, which it can tap if its supplies are ever threatened.
“China’s commitment to boosting domestic oil and gas production will stay unchanged for the long term,” she said. “Domestic oil majors’ incentives for higher output and more capex will inevitably be reduced if oil prices remain weak for the rest of the year, but that can be offset by higher imports.”