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Why Declining Chinese Oil Production Is Good for Global Prices
Fields in China are drying out, expensive to pump
By BRIAN SPEGELE in Beijing and JENNY W. HSU in Hong Kong
Updated Feb. 10, 2016 12:49 a.m. ET
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China’s role as a big oil consumer has become a crucial factor in energy markets in recent years. Now, its role as a major producer is gaining attention as well.
China is among the world’s top five oil producers, but its fields are growing depleted and are increasingly expensive to pump. The country’s leading companies are choosing to leave more of their oil in the ground and some analysts now say Chinese oil output may have peaked.
China Petroleum & Chemical Corp., better known as Sinopec, recently said its crude production fell nearly 5% last year. Its rival, state-owned behemoth PetroChina Co., said oil output fell by 1.5% over the first three quarters of 2015—the company hasn’t released fourth-quarter data yet. Together, Sinopec and PetroChina account for about 75% of Chinese oil production, according to research firm Energy Aspects.
Cnooc Ltd., China’s third-largest oil producer—which produces most of its oil from offshore fields—also said last month it expected output to decline by 5% this year, after years of rapid growth.
As China’s production starts to decline, demand for oil from overseas should remain firm, which would be good news for prices, which have been languishing near multiyear lows amid a global supply glut and weak demand in the rest of the world.
“The situation in China is that they know there is significant below-ground potential in China but it is cheaper to import,” said Peter Lee, an energy analyst at BMI Research, a unit of Fitch Group.
In recent months, oil markets have been fixated on the standoff between the U.S., Russia and members of the Organization of the Petroleum Exporting Countries. Markets are waiting for a major producer to signal it will start cutting output in a bid to stoke prices.
But while production cuts elsewhere have been minimal to this point, industry analysts say China’s output could fall by between 100,000 and 200,000 barrels a day this year. Domestic production reached a record high of about 4.3 million barrels a day in 2015, according to government data.
“China’s declining crude production will help narrow the supply surplus in the global market,” said Nelson Wang, an oil analyst at brokerage CLSA in Hong Kong.
China’s production has fallen before, on a year-over-year basis, but analysts now doubt domestic production will rebound soon due to scant investment by China’s oil giants in domestic projects: Cnooc says its capital spending will be down 40% this year from its 2014 peak. Many of the country’s oil fields are old, having been discovered in the 1980s, which makes them expensive to maintain.
The marginal cost of production at some China’s most expensive fields is now around $40 a barrel, well above the $30 mark at which oil has been selling in recent weeks. That makes it unprofitable for Chinese oil companies to keep producing: The country’s oil output could be entering a period of “structural decline,” says Gordon Kwan, an oil analyst at Nomura in Hong Kong.
For sure, a drop in Chinese oil output on its own won’t be enough to rebalance global oil markets. Worldwide supply will likely exceed demand by about 1.5 million barrels of oil in the first half of this year, the International Energy Agency says.
The more likely impact from the slowdown in China’s domestic production is that it will increase the country’s demand for oil from overseas. PetroChina’s state-owned parent, China National Petroleum Corp., projects the country’s dependence on foreign oil will hit a new high of 62% this year.
Peaking production today reflects a shift in attitude from the Chinese government. Not long ago, economic planners were devoted to domestic self-sufficiency in oil. While officials remain keen about local exploration, oil companies today have greater leeway to buy from where it is cheapest.
China also remains thirsty for oil as more local refiners are allowed to import crude directly from foreign sources. The government is taking advantage of current cheap supplies to build up its ballooning strategic petroleum reserves.
Moreover, with a new pricing mechanism that essentially sets a floor for domestic retail fuel prices at $40 a barrel, Chinese refiners have more reasons to import to capitalize on current low prices, said Michal Meidan, a China energy analyst at Energy Aspects, a London-based research firm.
To be sure, there are limits to how far Chinese production can fall. Unlike oil giants such as Exxon Mobil Corp. in the U.S. that answer to investors, Chinese oil producers are controlled by the government.
Kang Wu, vice chairman for Asia at energy consultancy FGE, said state-controlled oil producers’ pressure to avoid huge layoffs meant they were limited in how far they could cut unprofitable output.
China’s national oil companies “have a mandate to maintain stability,” said Mr. Wu, who projects China’s production will nonetheless fall by about 100,000 barrels a day this year.
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