By Fareed Mohamedi, PFC Global Risk
China has seized the global recession as an opportunity to secure long-term deals that will make inroads into previously closed markets and enhance its energy security. The costly and often unsuccessful strategy of capturing equity barrels through direct investment is being complemented by a new model: loan-for-oil deals with governments in search of financial assistance. China has begun to lock in future supplies while establishing a large foothold in key producing states like Brazil, Kazakhstan and Russia – deepening its trade partnerships and opening new opportunities for its National Oil Companies (NOCs) and domestic service companies.
New model emerges
Several years ago, policymakers in the United States and Europe began to view China's overseas energy investments with alarm. China was investing heavily in Africa and making forays into Kazakhstan and even Latin America, with Chinese NOCs receiving strong diplomatic and financial backing by the government. Skeptical observers viewed China's investments in energy and mining as a resource grab that would lock up supplies and crowd out investment from western countries.
Those fears, not surprisingly, proved to be unfounded. China faced familiar obstacles in its overseas oil investment, including difficult contract terms, rising service sector costs and operational risks for personnel – all of which contributed to project delays. Its energy investment in Africa is a case in point. Although the three Chinese NOCs acquired acreage in a wide range of African countries, many of those projects remain in the exploration stage and results have often been disappointing. Technological shortcomings largely prevented the Chinese NOCs from competing in the deepwater, and China's late entry into the game resulted in less promising onshore opportunities. A large share of the NOCs' assets were held in politically risky states like Sudan (still a very large component of CNPC's overseas production) or countries with much smaller resource potential and limited exploration history like Mali and Niger.
The Chinese NOCs' mandate to go abroad has not subsided. International operations are still viewed as a vital means for CNPC, Sinopec and CNOOC to build operational skills and gain access to advanced technology. Overseas operations also provide opportunities for Chinese seismic and drilling companies, in keeping with China's goal of building a world-class service sector.
Although direct investment by Chinese NOCs will continue – with each maintaining a distinct investment strategy – the bilateral deals signed by China in the past few months mark an opportunistic effort to take advantage of current economic conditions. In the short term China has shifted its focus to a loans-for-oil strategy that will capitalize on opportunities to diversify its supplies and increase its energy security.
The Chinese government has finalized bilateral deals with Russia, Brazil, Venezuela and Kazakhstan that will collectively provide $50 billion in Chinese loans in exchange for future oil supplies. Under the terms of the bilateral deals, China would receive at least 1.2 mmb/d in future supplies within the next ten years. The loan-for-oil deals have three distinct advantages for the Chinese: they allow China to lock up future supplies, extend its presence in countries that have been difficult for the Chinese NOCs to penetrate, and create opportunities for Chinese service sector companies.
The most tangible benefit is that China has secured sizable export commitments. In a February agreement, the Chinese Development Bank (CDB) signed two 20-year loan agreements with Rosneft and Transneft (the Russian state transport monopoly) that will provide $25 billion in financing in exchange for 300 mb/d of oil shipments via the East Siberia-Pacific Ocean (ESPO) pipeline. In a deal finalized in May, the CDB agreed to a $10 billion loan to Petrobras in return for Sinopec's access to 200 mb/d of oil beginning in 2010. A $4 billion deal with Venezuela will finance projects that will increase Venezuelan exports to China from roughly 350 mb/d to 1 mmb/d by 2015. Finally, a bilateral deal with the Kazakh government gives China a 50 percent stake in Mangistaumunaigaz (MMG) – which holds roughly 370 mmb in reserves – while ensuring sufficient financing for the 3,000 km Kazakhstan-China pipeline. Several of these bilateral deals stipulate that China will be repaid in cash rather than in barrels, with its borrowers simply repaying principal and interest.
Aside from the supply commitments, the loan-for-oil agreements will expand China's footprint in a handful of key producing states. In Russia, for example, the Chinese deal represented a significant step forward after several years of contentious renegotiations of a 2005 export deal between the two countries. The newest deal between China and Russia took months to negotiate, as both sides drove a hard bargain. The final agreement met Russia's core objectives – it alleviated Rosneft and Transneft's short-term financing difficulties and freed up cash for Rosneft to consider acquisition opportunities. It also met China's primary goals of ensuring stable crude supplies, guaranteeing enough cash to finance phase one of the ESPO pipeline, and earning loan guarantees from Russia's state-owned bank Vnesheconombank. In the end, the Russia-China deal strengthened a relationship that both sides view as a strategic priority in the coming years.