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.
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