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China reforms could mean opportunity for private capital

President Xi Jinping has revealed a new mixed ownership model for the state sector

Historic reforms in China’s state-owned oil sector are for the first time cracking the door open to private capital in a potentially big way.

In a bid to make China’s lumbering state-owned enterprises (SOEs) more profitable, efficient and competitive, president Xi Jinping and his premier Li Keqiang are championing a new mixed ownership model for the state sector. The reforms fall well short of privatisation. But they do aim to open the way for private capital and more entrepreneurial investors to play a direct role in SOEs.

China’s leadership has been alarmed as the lagging economic performance of its SOEs has started to hold back the Chinese economy. The return on assets for private sector industrial companies, for instance, were around 11% in 2013, compared with less than 5% in the state-owned sector. It is a fine balance China’s leadership is trying to strike, though. The government wants to bring the best of the private sector into the state sector, without giving up the control it enjoys through state ownership of vast swathes of the Chinese economy.

The oil sector has been a testing ground for the reforms, which has opened new opportunities for private capital to invest in the industry. It has also opened new avenues of financing for China’s oil majors PetroChina, Sinopec and China National Offshore Oil Corporation.

In September last year, Sinopec sold a 29.99% stake in its retail fuel business, a struggling operation that includes 30,000 petrol stations and 23,000 convenience stores, to 25 investors for $17.44 billion. It was by far the largest experiment in mixed-ownership yet. Most of the investors were Chinese investment funds, but they also included Tencent, a major Chinese technology player, and RJJ Capital, a foreign private equity firm. The private investors will get three seats on the board of the new company as part of the deal.

Sinopec said the deal aims to make the business more market-oriented and to improve its management and operations. Some analysts also pointed out that it allowed the company to raise a substantial amount of money to reinvest in its more profitable upstream business. The next step for the venture will likely be an initial public offering (IPO) of the unit in Hong Kong, which could raise more than $50bn.

Sinopec also hived off a group of its engineering business into a new company in 2013, which it listed in a $1.9bn IPO in Hong Kong.

New business model

PetroChina has also been testing out the mixed-ownership model to bring in private capital. In June 2013, it spun off pipeline assets in western China into a new joint venture with Chinese investors Taikang Asset and Guolian Fund. The two funds paid a combined $9 billion for a 50% stake in the new venture. The deal injected both private management expertise and private financing into the project.

The company has announced plans to spin off part of its west-east gas pipeline next, which it has valued at between $4.7bn and $6.3bn, though progress has been slow on the deal.

PetroChina is even piloting mixed ownership of oil- and gasfields in Xinjiang, in far west China. The company plans to bring in local state-owned and private companies as minority partners for the Tarim oilfield first, which will help raise funds for the field’s development. Other fields are expected to follow. Zhou Jiping, the chairman of CNPC board, has said the company has set up six investment and cooperation “platforms”, for pipelines, conventional fields, unconventional resources, refineries, overseas operations and natural gas terminals.

More such deals are likely to come as China’s oil majors increasingly turn their focus away from breakneck expansion to consolidation and restructuring. In the process, the government hopes to wean the oil companies off their reliance on cheap state financing from state-owned banks and development funds. The China Development Bank alone had more than $70bn in outstanding loans to the petroleum sector at the end of 2013.

The oil SOEs, analysts say, could become more like asset holding companies, managing individual divisions that raise private funding and operate independently, potentially one day even with private managerial oversight. For now, the private capital has almost all come from within China. However, if the reforms continue apace, and the process becomes better understood, foreign capital could one day start to flow. 

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