Commodities, Currencies, Emerging Markets, Energy, Stocks

China Struggles As Oil Losses Climb

China Oil

By Michael Lelyveld

China’s biggest oilfield is suffering huge losses as the government seeks to avoid layoffs despite prices that have dropped below production costs.

On April 8, the official Xinhua news agency reported that the Daqing oilfield in northern Heilongjiang province lost over 5 billion yuan (U.S. $769 million) in the first two months of the year.

In spite of the costs, production in the first quarter held steady at year-earlier levels of 9.28 million tons (755,800 barrels per day), according to PetroChina, the listed subsidiary of state-owned China National Petroleum Corp. (CNPC).

Output has been declining for years at Daqing, China’s mainstay oil resource, which has fueled the economy for over six decades.

Annual production of 50 million metric tons (1 million barrels per day) lasted 27 years until 2003 before slipping to the 40-million-ton range, the official English-language China Daily and Global Times said.

In December 2014, PetroChina announced plans to cut output by 1.5 million tons and scale back production at the depleted field to 32 million tons by 2020.

But even at lower levels, production at Daqing with enhanced recovery methods is proving uneconomic.

Production costs stand at U.S. $45 (292 yuan) per barrel, said Jiang Wanchun, Communist Party secretary of the oilfield, according to The Wall Street Journal. China’s average production cost is $40 (260 yuan) per barrel, China Daily said.

With benchmark oil prices falling below $45 since early December, Daqing has been losing money on every barrel it pumps.

Prices dipped below U.S. $28 (182 yuan) per barrel in February before staging a partial recovery. Even after international prices approached the $45 range last week, the prospects for profits at Daqing appeared marginal at best.

Mixed signals

In February, China’s second-ranked producer Sinopec announced it would suspend operations at four small oilfields in eastern Shandong province due to the price slump, but bigger shutdowns do not seem to be an option for Daqing.

Jiang reportedly complained about the losses to President Xi Jinping during China’s annual legislative sessions in March but was told that further cuts and layoffs would not be approved.

“Today’s economic restructuring cannot come at the cost of workers’ well-being,” said Xi, as quoted by Heilongjiang’s official newspaper. “We must guarantee the incomes and treatment of the front-line employees,” he said.

The insistence came as a mixed signal for China’s oil capital after Xi visited the northeast last July and told officials that the field was over-producing in a down market.

Operating so many oil rigs was “a waste of electricity,” Xi said, according to Japan’s Nikkei Asian Review.

The contradictions from Xi may be signs that both Daqing and China are stuck between bad choices.

Unless oil prices rise substantially, continued production at the faltering field is likely to be costly.

But the government fears that production cuts and layoffs will allow social instability risks to get out of hand.

Nikkei estimates that one-tenth of Daqing’s 2.7 million residents are employed at the oilfield. About 300,000 people depend on the field, including current workers, retirees and their families, the party-affiliated Global Times said.

Contrary to reform

The government’s policy of producing unprofitably flies in the face of its reform pronouncements.

“It seems that there is no immediate plan to aggressively restructure the national oil companies and lay off workers,” said Philip Andrews-Speed, a China energy expert at the National University of Singapore.

By publicizing their losses, Daqing officials may be making a pitch for government subsidies, similar those paid to oil companies in previous years when they were forced to sell fuel at a loss due to government-set rates.

The government has gradually adjusted its controls over fuel pricing to more closely reflect market forces. But it continues to subsidize the companies, Andrews-Speed said, citing reported combined payments of some 4.8 billion yuan (U.S. $738 million) to CNPC and Sinopec in the first nine months of last year.

Higher oil prices are not necessarily welcome, either, at a time when China is facing economic pressures.

China already depends on imports for 60.6 percent of its total oil consumption, CNPC’s Economics & Technology Research Institute estimates. Higher prices could exert a greater economic drag.

The Daqing dilemma is also likely to be seen as a sign that the government is not really serious about reforming its other bloated state-owned enterprises (SOEs).

That concern has figured largely in recent warnings from international bond rating agencies that China may face a downgrade of its sovereign debt later this year.

Growing concern

While the government publicized its SOE reform plans at the March legislative sessions, it has only talked about idling 1.8 million workers in the steel and coal industries so far.

In March, Moody’s Investors Service voiced concern that the government’s target of 6.5-percent average annual economic growth through 2020 “may slow planned reforms, including those related to SOEs.”

Loss-making production at Daqing may serve the growth agenda, but it will do little for debt problems or SOE reform concerns.

It will also add to burdens on PetroChina, which recorded a 66.9-percent plunge in profits last year to 35.5 billion yuan (U.S. $5.4 billion), its worst performance since 1999.

The profit squeeze underscores a basic problem for China’s producers. The country’s domestic production costs are relatively high, largely due to difficult geological conditions.

Sinopec needs crude prices of at least U.S. $60 (390 yuan) per barrel to break even on its oil production operations, the South China Morning Post said. The company offset its losses on oil and gas production with profits from refining and chemicals last year.

The government took steps to support profits in January by announcing it would not reduce retail fuel prices when international crude costs fell below U.S. $40 per barrel, allowing the companies to pocket the difference.

Decisions on Daqing could also affect national security, since even with lower production, the field accounts for more than one-sixth of China’s domestic oil output at last year’s rate of 4.3 million barrels per day.

If China were to end loss-making production, it would only increase its reliance on oil imports, making it even more determined to project its naval power in disputed waters of the South China Sea.

But greater reliance on overseas oil investment may also incur political costs.

A controversial open letter to Xi from “loyal Communist Party members” in March raised objections to policies on both SOEs and investment under the government’s twin plans to promote foreign trade, known as the “Silk Road Economic Belt” and “21st Century Maritime Silk Road.”

The government’s policies have already led to “large numbers of layoffs at state-owned firms,” while the Belt and Road initiatives had “put a huge amount of foreign exchange reserves into chaotic countries and regions with no return,” the unidentified authors said.


Courtesy of RFA

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