China Energy Sector-- Opportunities and Challenges coexist

China Energy Sector-- Opportunities and Challenges coexist Shell, BP plc, and Far East Energy Co. reveal their secrets to success in China By Fei Wang www.China-AsiaStocks.com www.oilandgasstocknews.com http://www.naturalgasstocks.com/ November 2005 In addition to an economy that grew 9.4 per cent in the first three quarters of 2005 (compared with the same period last year), China features a thirst for energy that continues unabated. Many international energy firms, especially oil firms see China as a market full of potential. However with concerns that this market is a complicated business incorporating culture, regulations and restrictions, many companies may be reticent to enter this market. Are these concerns justified? Many concerns surround the perceived challenges that occur after entry to the Chinese market. Firms that have already survived in this market receive enormous benefits from this strategic move. What is their secret? Currently, foreign companies operating in China include Far East Energy Corporation (OTCBB: FEEC), ConocoPhillips, Shell (NYSE: RDS-A), Chevron, ESSO, BP plc. (NYSE: BP), Meiya Power Company Limited and AES Corp. Many companies such as Peabody Energy (NYSE: BTU) and Petroleos de Venezuela (PDVSA) are actively looking for opportunities in this sector. Opportunities Afforded By the Global Oil Shortage China National Petroleum Corporation (CNPC), China's largest oil and gas producer and supplier, through its wholly-owned subsidiary CNPCI, has purchased PetroKazakhstan at 55$ per share, for a total of 4.18 billion dollars. This is the largest oversea acquisition in China's industrial history. CNPC thinks that this move is a, "milestone of CNPC's international development strategy". Besides the benefits this acquisition has brought to both companies, it also brings light to China's energy-hungry market after the failure of China National Overseas Oil Co.'s planned purchase of Unocal Co. earlier this year. Surpassing Japan in 2003, China is the second biggest consumer for petroleum products, next to US. In step with China's economic development, the country's oil shortage is only getting more and more serious (see figure 1). Many leading international energy companies have established long term business relationships within the Chinese market. For example, Shell (NYSE:RDS-A), "...has been working in China for more than 100 years and have invested more than $3 billion so far..." said Nick Wood, External Affairs Director in China. Similarly, BP plc (NYSE:BP) also has a long commitment to this market. "The Chinese market is extremely important for BP", stated BP plc spokesperson David Nicholas, "we have been present in the market for over 30 years and have over $3 billion capital invested." Cooperating and building long term business relationships with local companies instead of competing is also crucial for doing business in this market. According to Shell's Nick Wood, Shell's "operational model in China is to build successful partnerships" he explained. "We believe that Shell has skills and strengths that are helpful in developing China's energy resources in a sustainable way, and we believe that Chinese companies have their own operational strengths as well as unparalleled experience of operating in China. We believe that in many cases, by combining those strengths you can create a partnership that is stronger than either partner going forward alone on a project." Shell China has built a successful partnership with CNOOC and Sinopec. Wood points out that, "partnerships can happen inside China as well as internationally where we can also pool expertise and experience." BP plc has a similar experience: "All of our activities in China are in joint ventures with Chinese companies. We have developed these by building on the strong and lasting relationships with Chinese companies during our lengthy presence in China. We expect to continue building on these relationships to further increase our activities in China" said BP's Nicholas. Working in consultation with advisors who have a lot of experience in the local market is the advice given by the Far East Energy Corporation (OTC BB: FEEC.OB), a Houston based energy company that owns the third largest CBM acreage holding in China. Bruce Huff, CFO for Far East, states," It is important to have good advice when investing in China so that the organizational structure and other business aspects can be given due consideration. Starting without good advisors could be quite foolish and causes unnecessary risk." When it comes to the future of this market, Bruce thinks," Obviously, the expansion is incredible and shows no signs of a let up for the near term future. We are very bullish on the future of the gas market in China and are very pleased to see the development of a more sophisticated gas market over the past couple of years." Shell's Wood also stated that to fuel the rapid 9.4% growth, "new cleaner fuel solutions, such as natural gas, liquefied natural gas, renewable energy and finding clean uses for coal" will have a lot of future potential in the Chinese market. To get ahead of this trend, "we introduced our clean coal gasification technology to China and we are working on coal to liquids projects with our partners Shenhua Group Corporation Ltd and Ningxia Coal Industry Co. Ltd. We are testing clean Gas to Liquids fuels in Shanghai and working on hydrogen. We have a growing Renewable energy business in China, and we are also looking at the feasibility of developing China's oil shale resources." Challenges Within the oil Sector Most companies exercise caution before entering the Chinese market. Of concern are the issues of: political instability, the language barrier, and local business culture. Some energy companies have just opened their office in China's major cities, focusing only on researching this big market. PDVSA is one of the examples. On Aug 22nd 2005, PDVSA inaugurated the PDVSA China commercial office in Beijing. "PDVSA is evaluating its business opportunities in the region, both upstream and downstream, and will be a bastion for the consolidation of relations with new business partners," said Rafel Ramirez, Venezuela's Minister of Energy and Mines and PDVSA President in his visit to Beijing. However, according to Shell, China is not more difficult than any other country in this industry. "In any country a company must adapt to the systems and processes and culture. China is no different to anywhere else in this respect." Nick Wood pointed out. A similar opinion was expressed by Far East Energy, "There are many regulations in China as you would see in any country", said Huff. One China specific challenge that firms are currently facing is the rapid growth rate, which also means that the market structure in China changes quickly. As pointed out by Shell's Wood: "The one thing that sets China apart is its rate of growth, which means the business landscape is changing fast as processes and policies alter to facilitate that growth. An example of this is the changes that WTO is bringing." The biggest challenge Far East is facing is blending the business cultures between companies and effective communication. According to Huff, "growing an organization is a challenge as we add both workers from China and expatriates coming to live in China with a variety of industry specializations". Opportunities Within The Coal Sector As oil prices shoot up sharply, many investors and industries focus their attention upon coal. Many foreign coal companies have entered or are seeking opportunities to get into this hot market. China is the largest country in both coal consumption and coal production. During recent years, even though the percentage of reliance on coal has decreased, the absolute amount still increased sharply. With the big increase in oil price, coal usage is expected to increase even more. Also, China is becoming more open to foreign investment within the coal sector, particularly in the area of modernization of existing large-scale mines and the development of new ones. Furthermore, China shuts down many problematic mines; improves workplace safety; establishes modern corporate systems; and increases efficiency and productivity in most medium and large state owned enterprises. Many companies are looking for opportunities: Peabody Energy (NYSE: BTU), the world's largest private-sector coal company, officially opened its office in Beijing, China on September 20th 2005. "China has the fastest growing economy in the world, and its coal demand continues at record levels," said Peabody President and Chief Executive Officer Elect Gregory H. Boyce in a recent news release. "Peabody's China presence is a natural extension of our mission to be a world-wide supplier of low-cost energy..." Challenges within the Coal Industry Although a lot improvement has been witnessed, old machinery, problematic mines, workplace safety, efficiency and productivity are still major problems for the Chinese coal industry. Furthermore, due to the fact that this sector is still highly controlled by the state government; entry for foreign investors remains difficult. Asian American Coal Inc. (AACI) entered the Chinese market through a joint venture company Shanxi Asian American-Daning Energy Co. LTD (SAADEC) in the year 2000 with a business and mining license from the Chinese government, which is one of the first coal mining licenses to be issued to a foreign direct investment company in China. The company's operation officially began this past August. Even if AACI's entry into China is successful, the language barrier continues to be problematic. According to a Paradigm case study (http://www.parasoft.com.au/images/Daning-Case-Study.pdf) the problems include: 1. No management feedback; (lack of production and historical information) 2. Hard to train, manage and cooperate with work force that speaks a different language. 3. Shortage and high cost of interpreters. 4. Inaccurate reports and information needed to make management decisions Opportunities within the Electrical Industry Another reason for coal sector being such a hot subject is the serious power shortage China is currently facing, even though China's power generation market is expanding at an annual rate of 15% - one of the fastest growth rates in the world. Many foreign investors quit this market during the early 21 century despite the tremendous opportunities in this market. During the first half this year, China produced 1.128 trillion KW, while consumption equaled 1.148 trillion KW, a shortage of 0.02 trillion KW. Many companies were ordered by the Chinese government to stop its operation as long as one full week to save power. This cause many businesses to suffer financially. On October 28th 2005, Meiya Power Company Limited (MPC) announced that it had recently obtained approval from the ministry of Commerce of PRC (MOFCOM) for the establishment of a joint venture investment company with Hunan Economic Construction Investment Company (HRCIC) to invest in power projects. Officiating at that day's ceremony, Mr. Colin Tam, Chairman and CEO of MPC said "We are particularly excited by the prospect of the region's hydro potential and we are confident that this exciting venture will provide further growth and diversification opportunities to MPC's portfolio." Hydroelectric Challenges However, foreign investment in China's electricity generating market fell from 14.5% in 1997 to 7.5% in 2002. Many firms left the industry due to intense competition from rising local power companies. Unstable policies and inconsistent administrative and legal systems were to blame, a senior researcher at Beijing Economic Research Institute of Electric Power said in the Asia Times. "Typically," he said, "Foreign companies regard the policy and administrative system as murky, fickle and unreliable, they cannot be assured of a clear outlook of the industry." More importantly, foreign companies were unable to understand the rules of the game in the Chinese market. They did not understand the importance of the Chinese government's role in the electricity industry. Local government coordinates the generation of electricity and sales, fuel transportation and supply, environmental issues and land use. Therefore, the power industry is more of a political issue than an economical one. Comments: It is clear that energy market in China is growing fast. However, it is also necessary to fully consider the risks and difficulties ahead before investing in this market: how to communicate effectively considering the language gap; how to adapt to the local business culture; how to successfully set up operations in this country; how to deal with the Chinese government - especially for certain energy sectors that are still highly controlled by the government, such as coal and electricity; and how to deal with the local competitors, whether to cooperate or compete. "Proceed with caution" is our conclusion. Fei Wang Fei Wang holds an Honors Bachelor of Commerce from University of British Columbia Sauder Business School, with double major in Finance and Marketing. She has experience in investment banking and advertising in Canada, China and Korea, with a firm academic background. Disclaimer: www.InvestorIdeas.com/About/Disclaimer.asp