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China's oil majors feel the pinch of low prices

After years of rapid growth, China's oil majors are feeling the pain from low oil prices as they are being forced to slash spending and delay unprofitable new projects at home.

China's big three oil producers - Petrochina, Sinopec and China National Offshore Oil Corporation (Cnooc) - have spent big over the past decade fuelling an expansion abroad and at home. 

The companies have taken significant stakes in the world's largest oil plays, from Iraq's conventional oilfields to Brazil's offshore. While at home, high oil prices have allowed the companies to start producing from more complex and expensive oil and gas fields and open new unconventional and deep-water frontiers. 

But the companies' combined capital expenditures (capex) rose seven-fold over the last decade, from about $10 billion in 2004 to around $70bn in 2014. In the process, the companies' costs and break-even prices have risen sharply. 

JP Morgan analysts reckon Sinopec's all-in break-even cost is now around $55 a barrel (/b), rising to $80/b for some more marginal fields. PetroChina's breakeven is yet higher at around $60/b, the bank says. Cnooc's breakeven is likely to be slightly lower, but the company has been evaluating its projects based on an oil price assumption of between $80/b and $120/b.

That is making the adjustment to life at $50/b oil very difficult. "With a unit cost of production at around $50/b it is now cheaper for China to buy oil than to produce," Bernstein Research senior analyst Neil Beveridge wrote in a recent note. JP Morgan echoed the sentiment, saying this week that it was "surprised as to the extent to which profitability may have declined for some segments of China oils over the last month or so".

The price rout, then, will force unprecedented spending cuts on the Chinese oil sector for the first time. At the company's annual work conference, PetroChina head Zhou Jinping vowed 'revolutionary measures' to cut costs and said the company would focus on producing natural gas, which is fetching a higher price than oil at the moment. Sinopec chairman Fu Chengyu is thinking bigger after the oil price collapse, vowing to shift investment into new businesses such as solar, wind, biofuels and specialised materials.   

Bernstein reckons capital expenditures from the big three producers will be cut by around 15%, or about $10bn. That is equal to the total amount the companies were spending a decade ago. Although these levels are unprecedented China's oil majors, it is less aggressive at this point than many international majors.

Bernstein, however, warns that steeper cost cuts could be needed if prices remain depressed. Sinopec will see the sharpest spending decline - around 20% - while PetroChina and Cnooc are likely to cut spending by around 10%. Unlike its international oil company counterparts, however, the Chinese national oil companies are not planning layoffs. 

Most of the spending cuts will likely come from the companies' less profitable downstream and chemicals businesses. With Chinese oil demand slowing, the pressure to invest in new refining and transport infrastructure has eased after years of breakneck construction.

However, the spending cuts are likely to hit the country's oil production as well. China's upstream is often overlooked, but the country is the world's fourth-largest oil producer, pumping around 4.2 million barrels a day (b/d), more than oil powerhouses Iran, Canada and Mexico. China has maintained its output levels with relatively expensive infill drilling and enhanced oil recovery operations at the country's ageing oilfields, rather than major new finds, which may not be economic with a $50/b oil price.

PetroChina, for instance, has already said that production from its supergiant Daqing oilfield, the crown jewel of China's oil producing industry, will fall by 20% from around 800,000 b/d in 2014 to 642,600 b/d in 2020, with a decline of around 32,000 b/d expected this year. Other heavy oil projects in the Dagand Liaohe and Junggar basins are also likely to suffer. 

During the last oil price crash in 2009, China's onshore oil production fell by around 3% as investment was curtailed. A string of new Cnooc-operated offshore projects expected to come online this year could help offset the onshore declines. However, another 3% decline in 2015 could see China's oil output fall by more than 100,000 b/d. 

At the same time, the spending cuts could slow China's drive to develop new shale fields. The national oil companies are still under pressure from the government to meet ambitious shale-gas production targets, but as the focus shifts from growth to profitability, investment in shale could suffer, particularly if the government cuts natural gas prices to reflect declining international gas prices. 

While China's oil majors are feeling the squeeze from lower oil prices, China's oilfield services are in a world of pain. The push into more technically complex oil- and gasfields and reforms meant to open more space for private companies was expected to lead to rapid growth for China's growing crop of oilfield service companies. Analysts said hundreds of billions of dollars in new business opportunities could be created by 2020. Looking to capitalise on this opportunity, a number of Western service companies have formed joint ventures with Chinese companies.

But things haven't worked out that way for the oilfield services sector so far. China's oil majors have been reluctant to outsource work in the same way international oil companies do, preferring instead to award contracts to their own in-house service businesses. And the oil price crash, and subsequent capex cuts are only compounding the pain.

Anton Oil is a case in point. The company, which signed a joint venture with Schlumberger and was once a darling of Wall Street analysts, issued its second profit warning in the past three months on 19 January as its revenues and profits continue to erode. 

Moreover, the company has signalled a potential breakdown in its relationship with Schlumberger, saying it may not replace a departing Schlumberger representative to its board. The development 'suggests the relationship between the two companies is deteriorating and the synergy both companies expected when they established the [joint venture] two years ago was not materialising,'  Beveridge said. "The loss of Schlumberger as a strategic partner would be a further blow to Anton."

It could also presage similar troubles in other foreign joint ventures if the growth opportunities Western firms had expected are not available. Halliburton, for instance, has signed a similar deal with SPT Energy, and Baker Hughes had signed a cooperation agreement with driller Honghua. 

In a sign of the times, however, most service companies now say they are looking beyond China's borders for growth.

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