The China Petroleum and Chemical Corporation - Case Study Example

The SINOPEC Company The China Petroleum and Chemical Corporation or the SINOPEC Corporation, was incorporated on the 25th of February, 2000 and is State owned. The Company issued 16.78 billion H shares in the Hong Kong, New York and London Stock Exchanges on 18th and 19th November 2000, and it also floated 2.8 billion A shares in the Shanghai Stock Exchange on 16th July, 2001. By late September of 2002, the Company had drilled and completed 259 exploratory wells through August, which included 132 successful wells. Within a one year period, the company controlled about 787,800 sq km, which represented an increase of 280,000 sq km as compared to the previous year and consisted of 93.9% of land area and 6.1% of offshore area. (Rach, 2005). Since then, the Company has grown to the point where it is now the largest chemical company in Asia, the fourth largest oil refiner and the sixth largest ethane producer in the world and the second largest crude oil producer in China (Jun, 2008). The Company has a strong core of business in oil and petrochemicals, and the scope of its business activities include oil and gas exploration, extraction, pipeline transmission, refining, production, marketing, storage and transportation of petrochemicals, as well as export/import of crude oil, natural gas and refined oil products, petrochemicals, chemicals and other technologies and commodities. The Company has rapidly built up its activities to emerge as one of the leaders in the industry and one of the country’s biggest oil refiners. When fuel shortages hit China in 2007, Chinese leaders approached SINOPEC and requested them to make every effort to ensure that supplies were maintained and to cooperate with independent oil refiners in supplying crude oil and buying oil products.(Anonymus, 2007). The Company has also been strengthening its efforts in terms of joint stock reforms, by adding quality assets to the public company listed on the stock exchange, while also engaging in the process of collection of funds, from domestic as well as international capital markets (Wang, 2008). In China, upstream spending on oil and gas has increased, notably by Sinopec, which is one of the three major oil companies in China. As reported by Normal Valentine, Senior Analyst at Wood Mackenzie Ltd, Edinburgh, the rate of domestic field development investment in China has been much higher, “Sinopec’s and CNOOC’s domestic investment rates of around $12 per boe were greater than the average rate of the international large caps, at $11 per boe.” (Anonymous, 2007b) As this report also points out, this increased level of domestic upstream spending has been very beneficial to Sinopec, because it resulted in a major discovery – the giant Puguang oilfields, which significantly increased the value of the Company’s portfolio, which is mostly composed of established and maturing oil fields. Company Strategy and activity in Iran: It must be noted that during the 1960s and 1970s, the Middle East oil markets were almost exclusively controlled by Western oil companies, who were carrying out 90% of the prospecting, exploitation and production work in these areas (Peoples Daily, 2004). But after the oil crises in the 1970s, the oil industries were nationalized and restrictions were placed on foreign upstream spending in oil. The oil rich countries of the Middle East joined together to form a conglomeration to set up an embargo on oil, which in turn caused an economic crisis in the United states. From the 21st century onwards, foreign companies have been allowed to participate in upstream spending on oil, but there are still numerous restrictions which are still in place. The war in Iraq was a significant turning point. According to Pan Jiping, examining the war in Iraq from an economic standpoint, it “opened a cleft in oil resources prospecting and exploitation market in the Mid-East. The western oil companies now can enter the region on an extensive scale as they did in the 1960s and 70s.” One of the strategies adopted by countries of the Middle East to prevent America from monopolizing oil in the Middle East after the Gulf war is by opening up the domestic oil market and encouraging oil companies from Russia, China and India to invest in domestic oil development. The Middle East has been the major source of oil for China so far. Saudi Arabia and Iran are the No: 1 and 2 suppliers of oil respectively, for the country and Sinopec, being one of the major oil Companies in China, has absorbed about 80% of the imports of high sulfur content oil into China from the Middle east. Sinopec was able to achieve a breakthrough in 2003, when it was able to drill a high yielding oil well in the Kashan oil area of Iran. The success Sinopec was able to demonstrate on this project was one of the reasons why the Company was invited to submit a bid for exploitation rights in 16 new Iranian oilfields, as well as the Azadegan project, which is for oil exploitation on Iran’s second largest oilfield. There is a high level of resistance from the American Government to the activities of Chinese oil companies in the Middle East. In order for Sinopec and other Chinese oil companies to be listed on the American Stock Exchange, they had to enter a deal with the American Government to not enter into oil prospecting in certain countries, of which some were Middle east countries. As a result, most of the overseas oil exploration and exploitation activities of the Sinopec Company have been carried out under the name of a parent Company. While Chinese oil companies, including Sinopec, had been establishing a strong position for themselves in the African and South American markets, both considered untenable sources by Western oil companies. But in recent years, these Companies have also started on a campaign to enter African territories; and competition in these regions is becoming fierce. China is therefore looking to sources that it may not have considered in the past, i.e, the Middle East, especially since it is now being wooed by Middle east countries such as Iran. One of the problems for Chinese oil fields that choose to enter into the Middle East is that it’s very hard to secure an advantageous position and good oil areas, as Pan Jiping has pointed out (Peoples Daily, 2004). The Company Contract in Iran: In October 2004, Iran signed a Memorandum of Understanding with Sinopec to develop the Yadavaran fields in Iran. Under the terms of this deal, China agreed to buy 10 million tons of Liquid Natural Gas from Iran for a period of two and a half years.(Dittrick, 2008). This was followed by a three year negotiation period, and on December 9, 2007, Iran and Sinopec signed a $2 billion agreement; a buyback contract for upstream activity, setting out the development of Yadavaran in two phases, with production expected in 2009. During the first phase, projected estimates of production are 85,000 barrels a day for a four year period, followed by another 100,000 bpd in the next three year period.(Xinhua, 2007) Iran offered only buyback contracts as an option to foreign investors in the petroleum industry. Unstable conditions in Iran, coupled with the lack of flexibility in cost escalations and the low rate of return all coupled to make up a combination of unattractive commercial terms for serious foreign players. But the terms which are included in the buyback contract with Sinopec rank on a different scale. Firstly, the payback period is four years, which is half of what was offered earlier. Secondly, the rate of return was raised to 14.98% with no risks involved, which represents a premium of 3% as compared to earlier contracts. Thirdly, Sinopec was also allowed flexibility in the terms of the buyback contract, in terms of probable cost escalation and in reducing risks. Under the agreement which Iran has signed with Sinopec, China would pay Iran about $100 billion over a period of 25 years for liquefied natural gas and oil, while holding a 51% controlling stake in the Yadavaran oilfields. The Iranian constitution does not permit foreign companies to hold equity shares in its oil fields, hence investors are compensated only through buyback arrangements. The terms that Sinopec has been able to procure in its deal on the Yadavaran fields are much more favorable as compared to those offered earlier by Iran. This deal represents a very favorable development for Sinopec, because it provides the Company with an undeveloped oil field to balance out its existing portfolio of developed or mature oilfields. There is added flexibility offered to the Company under the buyback contract, the rate of returns offered is good and the payback period is shorter. It also allows the Company to tap into the oil rich Middle East (Calabrese, 2005), and it has already begun initiating deals with other oil producing countries such as Libya. Moreover, since American intelligence also suggests that Iran had stopped its nuclear weapons development in 2003, the Yadavaran area represents may now be a much less risky area for the Sinopec company to begin its oil prospecting, exploration, production and development activities. This deal is likely to ensure that a major part of China’s fuel requirements for the coming years are successfully met. Additionally, oil from the Middle East represents a higher level of reliability and stability as compared to Africa and Eurasia, since these economies are highly dependent upon oil revenue. China also faces problems in establishing strong contacts and energy links with Russia and central Asian countries because of the distrust generated in their past relations. Where African countries are concerned, such issues of distrust do not arise, but African countries pose other problems such as lack of political stability and lack of good infrastructure. Bearing all these aspects in mind, the deal with Iran offers an excellent opportunity for China to establish long term energy links with Iran. From Iran’s perspective, the deal represents a total triumph of its anti-American policy and the inability of the United States to build a global coalition to impose economic sanctions on Iran. From China’s perspective, the deal represents a triumph in its campaign to secure a hold on the Middle east at the expense of the United States. It also allows the country the opportunity to secure energy supplies from the ground up. In particular, the deal is a dismal outcome for the United States because it makes it all the more difficult to secure China’s vote in the event it needs to gain UN Security Council support to impose military or economic sanctions against Iran in the future. The deal represents the first step in a long term strategic relationship between the two countries. Iran benefits by gaining access to oil revenue which it hopes to use as a means to establish itself as a dominant power in the Middle East. For China, the production from the Yadavaran fields could help to fuel one of the world’s fastest growing economies. Data Collection and Analysis: The Sinopec deal with Iran on the Yadavara fields represents an important source of future fuel for China, because the Middle East has the largest share in world production, as per the chart below: (Source: BP Statistical Review) Reserve, Production And R/P Ratio Of Major Production Regions     Proven Reserves Share Of The World Production Share Of The World     (Bn Barrels) (%) (Mn B/D) (%) R/P Ratio Middle East 742.7 61.5 25.6 31.2 79.5 Africa 117.2 9.7 10.0 12.1 32.1 Europe & Eurasia 144.4 12.0 17.6 21.6 22.5 Most of the oil fields which are currently being operated by Sinopec are mature oil fields. Their potential reserves the potential production peak and other details are provided in the chart below: (Source: BP Statistical Review) In terms of potential reserves, as may also be noted in the graphical representation of the data below, Iran represents a significant source of oil for China, especially since initial production under the Sinopec deal will commence after 2010, by which time the currently high producing Puguang and Tahe may slide down in terms of fuel generated and can be balanced out by the production from Iran and Venezuala. While it is not possible to estimate the potential production peaks that can be expected from Iran at this stage, nevertheless the comparative chart below shows the estimated potential production peak levels from the other oil facilities operated by Sinopec. But the proposal to produce 85,000 barrels a day for the next four years and increase this to 100,000 barrels per day would rank this as a source of oil with potential production peaks ranking along the lines of Venezuela as shown in the chart below. SWOT Analysis for Sinopec: Strengths: The Company is one of the largest oil producing companies in China The Company has a wide portfolio of oil assets in various countries including African and South American countries Availability of government support and strong economic growth in China Availability of a strong and skilled labor base Weaknesses: History of tension in the country’s past relationships with other countries due to its Communist history Existing perception of China as a non democratic country Possible lack of awareness about Islamic culture Opportunities: Sinopec has a good opportunity to secure a source of fuel supply from the Yadavara oilfields Opportunity to establish a long term strategic partnership with Iran Opportunity to gain a foothold in the Middle East and increase its influence, to effectively compete with the United States and Europe Threats: Potential political instability in Iran Potential for nuclear build up by Iran and resultant destruction and damages to oil fields Foreign Direct Investment in Iran: A growth in foreign direct investment has been one of the most notable traits associated with the global economy. This is very beneficial to developing countries in particular, because investors follow a policy of long term productivity in their production activities. Foreign direct investment implies not merely an investment in the formation of capital or in production tools, it is also intended as a means for the less develop country to gain from technology transfers, in learning better production methods, promoting skills among the host country’s labor and gaining access to international markets and networking. (Leyla, 2002). Since 1956, foreign direct investment in Iran has been approved and encouraged in Iran through the passage of a law. But the barriers to FDI in Iran have remained because certain sections such as trade, agriculture, mines and the service sector are areas where foreigners are barred from investing. In addition, there are cultural and social barriers, for example, the lack of appropriate technology, difficulties in communication, lack of incentive for hard work among the people and a burdensome bureaucracy are some of the reasons that have inhibited FDI into Iran. (Layla, 2002: 7). There is a general lack of appreciation for the value of time and punctuality in Iranian society, coupled with a culture of wastage and FDI also enhances the risks of spreading corruption within the country. Iran appears an attractive destination from an economic perspective because it has a wealthy market base available, however there is protectionism and monopolies existing in some industries which are a strong discouraging factor for potential investors. As Layla (2002) also points out, the history of religious and political instability in the country is however the single most negative factor that has stood in the way of significant foreign direct investment into the country. The deal signed with Sinopec for the development of the Yadavara fields is thus a significant investment into Iran coming from a foreign country. Not only is the Company proposing to explore and develop the oil fields to generate oil, it is also interested in buying some barrels of oil for its own use. Sinopec is also expected to sub contract using Iranian firms, so that they are able to acquire the much needed expertise in terms of technology transfer and gain from China’s foreign direct investment. But in practice, it appears likely that the Chinese will use the Iranians mainly for manual labor rather than the transfer of sophisticated processes. Iran seeks to use this deal to propel itself into a better position in the world marketplace, but how effectively skills are going to be transferred in this instance may be an issue that remains open to question. There are bound to be religious, cultural and operational clashes that arise between the two countries. In addition, there is a continuing atmosphere of political and religious instability in Iran, as well as potential nuclear threat. Yet, the deal with Sinopec represents one of the most significant FDI inputs for Iran in recent years and offers potential advantages for both Iran and China is used well. There is a strong potential for a long term strategic partnership between Iran and China arising out of this deal, which will also result in higher levels of Chinese support for Iran when the United States seeks to impose economic or political sanctions against the country. These two countries could turn out to be allies, presenting a formidable front against the United States and Europe, especially if Russia also joins this alliance. The oil deal with Sinopec which is to last for at least a seven year period, after production is commenced in 2010 means that this is a strategic long term deal and as detailed above, it holds benefits both for Iran and for the Sinopec Company. The deal offers a golden opportunity for the Sinopec Company in that the Yadavaran fields is not a mature oilfield but one that has not yet been exploited while demonstrating the potential for yield of a sizable quantity of barrels per day. From a logistical and geographical point of view as well, Iran is better situated as compared to oil fields in African and south American countries and offer the potential of lowered costs for Sinopec. Most significant of all, it offers both countries the opportunity to stand together to provide significant opposition to the United States……………….3010 words. References: * Anonymous, 2007. “China orders refiners to boost diesel supplies”, Transport Topics, 3770 (37):1 * Anonymous, 2007b. “Chinese NOCs double domestic upstream spending”, Oil and Gas Journal, 105(32): 28 * BP, 2007. BP Statistical Review of World Energy 2007. * Calabrese, John, 2005. “The Risks and Rewards of China’s Deepening Ties with the Middle East,” Jamestown Foundation China Brief, 5(12) :3, at         http://jamestown.org/images/pdf/cb_005_012.pdf , * Dittrick, Paula, 2008. “Yadavaran buyback contract signals better Iranian terms”, Oil and Gas Journal, 106(2): 33 * Jun, Wang, 2008. “Gasoline Supplier Sinopec”, Beijing Review, 51(10):37 * Leyla, Sarfaraz, 2002. “Economic reforms and foreign direct investment in Iran”, http://mpra.ub.uni-muenchen.de/1480/1/MPRA_paper_1480.pdf; * Peoples Daily, 2004. “U.S. dissuades Sinopec from bidding in Iranian oil field”, Peoples Daily Online, 6 February 2004, http://www.mtholyoke.edu/acad/intrel/energy/sinopec.htm; * Rach, Nina M, 2005. “China pushes domestic upstream development”, Oil and Gas Journal, 103 (26): 35-43 * Xinhua, 2007. “China’s Sinopec, Iran ink oilfield deal”, http://chinadaily.com.cn/china/2007-12/10/content_6308302.htm; Read More