IEEJ: April 2007

Asia’s National Oil Companies
International Expansion andCompetitive Implications
Mikkal Herberg
The National Bureau of Asian Research

The Institute of Energy Economics, JapanTokyoApril 5, 2007

IEEJ: April 2007

AgendaWhat’s driving Asia NOCs international expansion?
Government energy security policy
Commercial drivers
International investments and activities– China– India– Japan, Korea, Malaysia Petronas
Strategy assessment and issues
Competitive implications

IEEJ: April 2007

Asia NOC International Drivers
Government Energy Security Strategy
Limited domestic E&P opportunities
Increasingly commercial drive andstrategiesIEEJ: April 2007

Government Energy Security
Strategy Drivers
Booming oil demand and import dependence– China, India new arrivals; Japan, Korea no domestic resources

Growth in gas imports, LNG post-2010
Sourcing to be dominated by Persian Gulf, Eurasia/Russia,Africa, LatAm, Canada
Deep sense of vulnerability to supply disruptions– Government legitimacy rooted in economic prosperity, nationalism– Economic nationalism – old-fashioned “mercantilism”– Growing fears of long-term oil and gas “scarcity”– Geopolitical risks, long distance transport– Regional rivalries fueling competitive supply acquisitions

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Source: Chatham House, Oil for Asia, 2007

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China’s Growing ImportDependence

Source: IEA WEO 2004

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Response: Energy Nationalism
National security agenda – top leadership concern
Zero sum competition: Geopolitics of Asia
Response: Creating stronger “National Champions”– Encouraged to go abroad and secure supplies– Diversified equity stakes in global E&P– Long-term crude and gas supply contracts– Sponsor new pipelines to diversify transit risk
– “Oil Diplomacy” to secure alliances: esp. Beijing– Vertical integration: upstream-downstream links, cross-investment– Sea Lanes – gradual naval, submarine build-up (China, India,Japan)– New SPR’s China, India – Japan, Korea IEA reserves

All converging on Mid-East, Central Asia, Russia,
Africa, LatAm, Canada

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Commercial and Competitive Issues

IEEJ: April 2007

Recent Major M&A Deals

Company

Year Country

CNOOC
2006
CNOOC
2004
CNOOC
2003
CNOOC
2003
CNOOC
2002
CNPC/ONGC 2005
CNPC2005
CNPC//Sinopec 2005
PetroChina
2002
ONGC
2004
ONGC
2003
Petronas
2003
Petronas2003Petronas
2002
Petronas
2002
Sinopec
2005
Sinopec
2004
Sinopec
2004
Source: WoodMac

Nigeria
Indonesia
Australia
Indonesia
Indonesia
Syria
Kazakhstan
EcuadorIndonesia
Sudan
Sudan
Egypt
Sudan
Indo/Myanmar
Indonesia
CanadaKazakhstan
AngolaAsset
OML 130
Tangguh (BG)
N.W. Shelf LNG
Tangguh (BP)Repsol-YPF
AFPC
PetroKazakhstan
Encana Ecuador
Devon portfolio
Block 5A & 5B
Greater Nile Oil
W. Delta Deep
Block 5A
NSBA/Yetagun
JabungNorthern Lights
Sazankuruk
Block 18

Price (US$ million)
2,268
105
348
275
585
574
3,950
1,420250
115
771
1,740
143
270
170
84153300

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Source: Chatham House, Oil for Asia, 2007

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Chinese Companies
CNPC – PetroChina
Upstream, onshore oil, mainly northeast, western region
Some refining, gas
Trying to integrate downstream domestically
Led early international growth
Sinopec
Downstream dominant, coast and southeast
Trying to integrate upstream
Recent international expansion
CNOOC
Established for offshore development 1980s
Mainly gas
Lead role in China’s LNG development
Recently joining international expansion
Sinochem: refining investments, crude supply
Zhuhai Zhenrong: Iran crude supply, LNG talks

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NOC Investment Patterns: ChinaNOC expansion increasingly commercially-driven
Most deals driven by NOC assessment of opportunities
But significant state-NOC investment coordination, support,diplomacy: most active of Asian cases– Govt. where geopolitical ties or sensitivity overlap energy: Kazakhstan,Iran, Sudan, Myanmar, Russia– Supply security weighed against returns, economics

Focusing on all major petroleum basins globally: 30+ countries– PetroChina largest: leads Sudan, Kazakhstan, Venezuela/LatAm, Russia,
upstream oil– Sinopec seems to lead in Iran, PG, Saudi, refining JVs– CNOOC leads in LNG, gas, SE Asia
– CITIC (Kazakh), Sinochem (refining) recent arrivals– Beginning to see partnerships (CNOOC-Sinopec)– CNPC, Sinopec most active in Africa, Canada

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NOC Investment Patterns: India
Substantial state-NOC coordination, state MOUs signed
many countries
But more commercially-driven than China: trust in markets– Policy-makers stress bottom line and set profit requirement– Recommended target of 66% of overseas projects financedwith private capital

Later arrival, often outbid by Chinese but trying to partner
ONGC Videsh main player– Production and development: Sudan, Syria, Sakhalin 1, Venezuela– Exploration: Iran, Myanmar, Qatar, Cuba, Vietnam, Libya, Iraq,
Ivory Coast– GAIL, OIL, OICL beginning to expand– Reliance also a major new player

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Source: Chatham House, Oil for Asia, 2007

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NOC Investment Patterns
Japan: reinvigorating long-term effort– Raised target for Japan oil to 40% from 15%– Have consolidated JNOC: Inpex, Japex main players– Injection of substantial new “risk capital” into E&P abroad– Mainly financial diplomacy, seeking to boost competitiveness inindustry– Competition with China part of motivation– Recent setbacks in Iran, Sakhalin– Active in Libya bid round

South Korea: modest player but government raising targets– KNOC, KOGAS beginning to move more aggressively– Large trading companies biggest investors

Malaysis – Petronas– Strong global business, very competitive– Much more commercially driven– The future of Asian NOCs?

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Unfocused Strategies of New Rising
Asian NOCs
New NOCs generally ranging widely over oil, gas,
LNG
Regional focus tends to be scattered
Limited coordination, partnering among
companies: often competitive
Chinese companies often working in same
countries separately
Each company on individual learning curve
Many acquisitions have little upside, not very
attractive to IOCsIEEJ: April 2007

Competitive Advantages
Willing to pay premiums, accept low returns, bidding up producer
rents
Low cost of capital
Willing to do standard field development, service contract-styleOften willing to do uneconomic downstream or related investments
Affinity among producing, consuming country NOCs:– Common management mindset, shareholder interests– Avoid direct competition with IOCs

Relatively high tolerance for political, security risk
Frequent direct diplomatic support: assisted by strategic deals withbroader economic, aid benefits to producers
Home govt. Realpolitik: advantage of non-interference
Convergent home and host government geopolitical interests– Containing US hegemony, hyper-power – “multi-polar world”– Cement important regional alliances: China-Kazakhstan, India-IranIEEJ: April 2007

Competitive Disadvantages
Late arrivers a critical weakness: opportunity constrained
Limited large project management skills, experience
Lack global downstream integration, market options, refining
flexibility
Limited technology capabilities: deepwater, unconventional oil,high-tech enhanced recovery, extreme reservoirs
Geopolitical baggage, sometimes instrument of state diplomacy– Vulnerable to swings in political relationsSometimes govt. pressure to take on uneconomic deals
Weak LNG position, skills (China, India)
Downstream domestic subsidies financial drain (China, India)
Lack of portfolio diversification

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Asia NOC Assessment
Not yet major competitive threat in industry terms (exception Petronas)– Technology, project management, large-scale development

Accessing quality reserves has been key weakness
But: sharpening focus on major reserves, basins, major bid rounds
Rapidly growing but relatively unfocused portfolios
Key advantages– State support and growing economic power– Willingness to overpay, do marginal deals, cheap state capital– Strategic alternative to IOCs

LNG competitiveness highly differentiated: Japan/Korea/Malaysia vs.
China/India
Consciously climbing learning, experience curve
Moving to access new E&P technology, deepwater E&P
Building from M&A to exploration, grassroots expansion, company deals
Better access to closed reserves? Remains unclear
Financial performance likely to become more binding over long term:commercialization pressures, government disillusionmentIEEJ: April 2007

How Should IOCs Respond?
Asia NOCs another constraint on
opportunity set
Driving up reserve access costs
Compete or partner? What combination?
Where?
BP, Shell developing strategic partnerships
combining domestic reserve or downstream
access with new JVs abroad– China, India
Contact ：report@tky.ieej.or.jp