When China National Petroleum Corporation
(CNPC) planned China’s first horizontal shale-gas well in 2011, it didn’t have the advanced drilling and hydraulic fracturing technology it needed to complete the well. It could have brought in an international major or North American oilfield service company, which have cut their teeth in US shale fields, but it didn’t. Instead CNPC turned to little-known domestic oilfield services group Anton Oil
to do the work.
It marked the start of a trend that is expected to see a rapid rise in the fortunes of China’s independent oilfield service companies. Two factors, analysts say, are providing new opportunities for domestic services firms. China’s major national oil companies (NOCs) need to tackle increasingly complex unconventional and deep-water projects to increase production at home, but don’t have the technology to do so by themselves. At the same time, the government is pushing economic reform that is opening up the services market to a wider range of players.
CNPC, Sinopec and China National Offshore Oil Corporation, which dominate China’s exploration and production business, have historically relied on their own engineering and drilling units to meet most of their services needs. Barclays analysts estimate that those businesses carry out as much as 80% to 90% of oilfield services in China. But that model, analysts say, is quickly breaking down. The state companies’ share of the market could fall to just 50% in just five years, according to Barclays.
At the same time, the market is expected to see huge growth. “With a sharp rise in non-conventional wells to be drilled and robust spending on oil and gas fields, we see an oil services market worth circa $250bn by 2020,” analysts at JP Morgan, an investment bank, wrote in a recent report. That is up from just $20 billion in 2012 and would make China the second-largest market for oilfield services, behind just the US.
China is thought to have some of the largest shale oil and gas deposits in the world. The US Energy Information Administration estimates the country has 32 trillion cubic metres (cm) of technically recoverable shale gas and 32bn barrels of shale oil. Some industry players in China have questioned those estimates, but the scale of China’s shale prize is likely to be very large.
The government sees this resource as crucial to addressing China’s growing energy insecurity. The country is already the world’s fourth-largest oil producer, and natural gas output is rising quickly, but output is not keeping up with the economy’s insatiable appetite for oil and gas. “China imports 40% of its gas needs and 60% of its oil that is consumed, which is economically unsustainable and will lead, we believe, to an acceleration over time of unconventional activity in China,” says Barclays.
Total oil and gas production is forecast by the Chinese government to double by 2030, driven by surging unconventional production, according to a recent Ministry of Land and Resources report. Oil production is expected to remain relatively steady at more than 4 million barrels a day (b/d), peaking at 5m b/d. Natural gas production, meanwhile, is expected to see steady and strong growth, more than doubling to 300bn cm a year. The ministry expects unconventional oil and gas output to account for a third of total production by 2030.
Pursuing China’s shale prize will see natural gas drilling grow by around 40% a year from 2013 to 2015 and around 25% per year through 2020, reckons Jefferies analyst Jack Lu.Yet China’s early experience with shale gas and oil has been marked by frustration and slower than expected progress. CNPC and Sinopec, the two companies leading China’s shale exploration, have said that water shortages, complex geology, mountainous terrain and unattractive economics are all hindering development.
One major reason is that the state oil companies lag far behind their international competitors when it comes to technology. In spite major investments in US shale projects aimed at learning the new technologies, industry players say the NOCs are as much as much as five years behind when it comes to unconventional technologies. It still takes about three times longer and costs about three times as much to drill a shale well in China than in the US.
And the companies have been slow to accept outside help. Convincing the historically cautious and bureaucratic state oil companies to embrace new methods and technology has been one of the major difficulties for both domestic and international oilfield service companies, say industry players.
That could be changing as pressure grows to improve profitability and show progress on shale development. “The higher operating efficiency and lower cost base of independent oilfield service companies have provided the national oil companies with a cheaper and more efficient alternative, which has resulted in the outsourcing of jobs,” according to Barclays.
The government’s market reforms are helping to open up the sector to private companies. It is pushing the upstream majors, along with other state-owned companies, to improve profitability, which should encourage them to look for more efficient and cost-effective oilfield services than their relatively inefficient in-house units can provide.
A major corruption investigation into CNPC, which has also ensnared several domestic engineering and service companies, is likely to change the way business is done between service companies and the upstream majors. Tendering processes, analysts say, will likely become more transparent and contracts awards more merit-based. If so, it would level the playing field and allow those companies with superior technologies and lower costs rise to the top, rather than those with the best connections.
The government is also making a general push to increase competitiveness in key sectors, including energy. And although the state is likely to keep its grip on the upstream, it is keen to see more competitiveness at the services level to drive investment and innovation in China’s oil patch. “The Chinese government is actively promoting local oil services,” says JP Morgan. The companies that can set themselves apart by introducing new technology, higher end technology, greater efficiency and integrated services are best placed, says Barclays.
Hong Kong-listed Anton Oil is a consensus standout among Wall Street analysts. The company has been the most successful among the Chinese oilfield service companies in bringing to China the integrated business model that has been so profitable in recent years for companies such as Schlumberger, Halliburton, Baker Hughes and others in North America. The company offers a wide range of services, and aims to be a one-stop shop for all stages of a project from planning to drilling to well completion.
The company has also benefitted from its partnership with Schlumberger, which has injected cash and new unconventional drilling technology into the company. Schlumberger bought a 20% stake in Anton Oil in July 2012, ensures long-term cooperation between the companies and Schlumberger’s investment in Anton Oil’s success.
Other companies, analysts reckon, will follow in Anton Oil’s footsteps in emulating the integrated services model. “In the long term, we expect the sector to gradually transform into a US model, albeit far less developed and technologically advanced,” says JP Morgan.
Teaming up with Chinese services firms is likely to offer the best opportunity for Western services companies looking to crack the Chinese market, with a number of cooperation agreements already signed. Honghua, a land rig provider, has signed a shale-gas focused memorandum of understanding with Baker Hughes. SPT Energy, an integrated oil services company, has signed a cooperation deal Halliburton for specific projects in the Tarim basin. Halliburton has also signed a deal with oilfield services provider Petro-King to provide horizontal drilling and fracturing technology.
The relationships are likely to deepen over time. “As new Chinese companies look to raise capital to fund investment in non-conventional gas services, we expect increased partnerships or direct investment from US oil services companies,” said JP Morgan.
Chinese services companies are also set to see a wealth of new opportunities abroad as they ride the coattails of the national oil companies (NOCs) that have snapped up projects around the world in recent years. The government has encouraged China’s NOCs to award lucrative deals at its international projects to Chinese contractors. Anton, for instance, has won contracts in Iraq and in Latin America. SPT Energy has won contracts from CNPC in Turkmenistan and Kazakhstan.
China, like the rest of the world, is relying on more advanced technology to meet its soaring energy needs, and that is opening up new opportunities for oilfield services companies. “China will rely on independent service companies to provide technology and innovation,” says Lu.