China still playing catch up with technology in the offshore
Cnooc needs to master the technology before it becomes a major player in the South China Sea's deep waters
When China National Offshore Oil Corporation (Cnooc) launched its first home-built deep-water oil rig - the HYSY 981 - in 2012 it was hailed in China as a major leap for the company and country into the South China Sea. State media even marked the occasion down to the minute the rig started operations: 09.38 on 9 May. "Large deep-water drilling rigs are our mobile national territory and strategic weapon for promoting the development of the country's offshore oil industry," Cnooc chairman Wang Yilin was quoted by Xinhua as saying at the time.
Building a deep-water oil and gas industry is a strategic priority for China. The government sees it as a way to assert sovereignty over contested areas of the South China Sea and secure more of its energy resources at home, a constant preoccupation for Beijing's policymakers. Cnooc, the country's offshore specialist, is at the vanguard of China's push into the South China Sea's deep waters and Yilin, who also holds the post of party secretary at Cnooc, is widely thought to have political ambitions.
Yet Cnooc's strategy for building a domestic deep-water industry came under criticism from close to home at a recent conference in the southern Chinese city of Shenzhen. Tian Zheng, a recently retired senior manager in charge of major projects at the company, argued that Cnooc's deep-water ambitions were at risk because the company is failing to foster domestic innovation and develop homegrown technologies.
In particular, Zheng took aim at the company's focus on going abroad to acquire deep-water technology, rather than investing to develop it at home. "We need to be patient if we want to build something big and sophisticated. We cant just buy technology, we need to focus on research and development (R&D) and being innovative," Tian said. "I don't like the transactions."
Cnooc has spent big abroad, often to acquire technology to bring back to China. In 2012 it paid $15.1 billion to buy Canadian independent Nexen, the biggest overseas takeover for a Chinese company. Cnooc has been widely criticised for overpaying for Nexen, but the company has justified the transaction largely by pointing to Nexen's deep-water technical and operational expertise gained through projects in the US Gulf of Mexico (GoM). Analysts say the deep-water fields in Nexen's portfolio were one of the primary reasons it acquired Nexen, and because it was a Canadian company it may have avoided some of the political heat in Washington DC that would have come with acquiring a US-based GoM player.
More recently, Cnooc took a 10% stake in the Libra pre-salt deep-water field off Brazil, which is expected to be one of the most costly offshore developments in history. Cnooc has also taken stakes in West African deep-water oilfields in Angola and Nigeria in recent years. The acquisition strategy has seen Cnooc move in to every corner of the so-called deep-water golden triangle - West Africa, GoM and Brazil - regions that have produced the world's largest offshore discoveries. Chinese policymakers have said they want the South China Sea's deep waters to join the ranks of those other regions.
In focusing abroad, Tian argues, China risks neglecting work that needs to be done at home. "We have to develop home-grown technology to bring down costs. We have to be more self-reliant," he said, adding that after years of effort and billions of dollars China still does not have the capacity to build sophisticated deep-water systems.
While Cnooc has spent heavily abroad, domestic investment in R&D has been minimal. Cnooc spent $171 million, just 2% of total capital expenditure, on R&D in 2012, according to figures from the European Commission. That lags far behind many others in the industry, and even China's other national oil companies. PetroChina was the oil industry's biggest investor in R&D, spending $1.7bn in 2012. Sinopec was sixth, spending just over $700m, beating out Western supermajors BP and Chevron.
A comparison for Cnooc is another offshore-focused national oil company: Brazil's Petrobras. Petrobras invested $930m on R&D in 2012, making it the industry's third-biggest spender.
In many ways Petrobras's strategy is a mirror of Cnooc's. Rather than go out to acquire deep-water technology to help it tap pre-salt fields at home, it has invested heavily over the last decade to turn Rio de Janeiro into a hub of offshore research and innovation. Government policy has helped pull foreign investors and Brazilian industry and academe into the effort. Rather than go out to acquire technology, Petrobras has used the technological prowess gained at home to find opportunities abroad.
For all of its deep-water ambitions, China has not managed anything like this coordinated effort to establish the industry. "The weakest link in China is that we don't have a systematic approach to developing the industry," said Tian. "I hope the government will emphasise development of the domestic industry in the next five-year plan." The 13th such plan will begin in 2016.
China has made some important breakthroughs. The launching of the 981 offshore rig, which is capable of drilling in water depths of up to 3,000 metres, marked the first major step. The second came this year when the country started production at its first deep-water gas project at the Liwan field. The project is operated by Canadian-listed Husky Energy, which is majority owned by Hong Kong billionaire Li Ka-Shing, and is expected to provide a major boost to offshore production levels.
Yet industry players say China's deep-water industry still does not have the advanced technology it needs to deal with many of the challenges of deep-water drilling, such as high pressure, and high temperatures. And although Chinese manufacturers built the superstructure for the 981 rig, many of the core technologies were imported. "China surpassed Singapore to become the world's second-largest offshore engineer last year, but we are a large manufacturer, not a high-quality manufacturer," said Zhao Zhiming, an advisor to the China Petroleum Equipment Industry Association.
Building domestic capabilities is especially important for China. Western supermajors with the deep-water technology China needs are likely to steer clear of the South China Sea's stormy politics, especially as Cnooc tries to push exploration further into disputed waters.
China claims around 80% of the South China Sea as Chinese territory through its so-called nine-dashed line map. The claim has triggered increasingly tense territorial disputes between China and its neighbours. The area around the Spratly Islands, which are thought to hold significant oil and gas deposits, is claimed by China, the Philippines and Vietnam. China and Vietnam, meanwhile, are facing off over the Paracel Islands.
In 2012, Cnooc opened up bidding for nine blocks in a section of the South China Sea also claimed by Vietnam to international companies. Vietnamese officials decried the auction as illegal and foreign firms shied away from bidding for the acreage.
Still, China is convinced that the South China Sea will be a key source of energy for China's economy. "A lot of foreign companies and southeast Asian countries have found fields in the South China Sea that are larger than the Daqing field," said Wang Zhenfeng, a deputy manager at Cnooc, referring to China's largest oilfield. In November 2012, Cnooc said that the South China Sea holds around 125bn barrels of oil and 500 trillion cubic feet of gas. That is significantly higher than other estimates, but the company is keen to ramp up exploration. "We are just waiting for the order from the central government," said Wang.