The Chinese road to energy liberalization

The Chinese road to energy liberalization

Elenoire Laudieri di Biase
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New growth requirements have encouraged the Asian giant to launch a reform process in the energy sector which may soon allow access to foreign companies, particularly in the field of gas production and distribution

As predicted, the recent Chinese Communist Party congress confirmed Xi Jinping’s position as the supreme leader of the party and the nation, endorsing the policy of reform at home and growing relevance internationally which has distinguished his government since he came to power five years ago. Xi Jinping’s China is a self-confident nation, aware of the enormous influence it exerts over the global economy, while also recognizing the complexity of the challenges ahead, particularly in its only partially successful attempt to combine a political system based on a one-party state with the dictates of the market economy. Since 1978, the year when Deng Xiaoping imposed a capitalist reform on the Chinese economy, the country’s GDP has increased dramatically, rising by 147.3 billion dollars a year to 11.2 trillion dollars (2016). The pace of growth, which remained in double percentage figures for a long time, has fallen back in recent years to between 6 and 7 percent, remaining significantly higher than the increase recorded by advanced Western countries, including the United States. As a result of the global financial crisis, big Chinese industries, which are still for the most part controlled by the State, have expanded to the point of over-production. The constant increase in internal consumption has to a great extent made up for the negative effects of falling exports on GDP.

Energy focused increasingly on gas

However, in the face of a persistently solid general economic picture, there is an imperative need for China to give new impetus to a reformist policy that will expand the free market, particularly in sectors that are heavily dominated by public companies.

One of these is the energy sector, which is currently controlled almost entirely by three State monoliths: China National Petroleum Corp. (CNPC), China Petroleum & Chemical Corp. (Sinopec), and China National Offshore Oil Corp. (CNOOC). During the period of major industrial expansion, most of their activities were focused on finding, producing and importing oil and minerals for industry, but over the past decade, for reasons related to atmospheric pollution and to China signing the international climate change treaty, the drive to using natural gas and liquefied natural gas has accelerated, making China the third biggest gas consumer in the world. The country currently uses 180 billion cubic meters a year and the forecasts are for this to grow to 600 billion within the next thirty years. In order to fulfill this demand, China needs to liberalize the gas market, opening the doors to private foreign companies and free competition, particularly among distributors.

An oligopoly that is about to be broken

Currently, 75% of natural gas is produced by CNPC, which owns almost the whole network of gas pipelines. CNOOC was the first company to import liquefied natural gas and is likely to remain the biggest importer for a long time to come.

The government has gradually allowed private investments to be made in these companies, but the State continues to own a majority of their share capital. Other small and medium companies operate in the sector but have very limited access to the gas market and supply a small number of users, or are forced to sell the production to CNPC. There are no restrictions, however, on importing liquefied natural gas. The downstream sector is populated by a variety of local distributors who generally receive the gas in close proximity to urban centers, through CNPC pipelines, and have no direct access to the production sources. These distributors are besieged by the three big companies, which are trying to take control of them, thus reducing the small amount of competition they manage to exert. Overall, therefore, the current situation is far from compatible with the free market, which can only be achieved by having a larger number of private operators and wider competition, particularly in gas distribution. The experience of countries belonging to the IEA, International Energy Agency, shows that in markets dominated by one or a few production companies, a completely open downstream sector is needed in order to encourage more operators to enter the market and increase competition on prices and services. The experience of the United States shows how the reform which in 1985 sanctioned free access to gas pipelines and their liberalization was crucial for creating a highly competitive gas market.

A reform project to unlock the energy market

The government and the Chinese Communist Party (CCP), to which the government belongs, are aware of this and, following a long incubation period, have stopped hesitating and given the green light to a reform plan aimed at unlocking the energy market. A directive issued on May 21 this year by the Council of State (China’s main administrative body) and the Central Committee of the CCP lists a series of measures “intended to give the market a decisive role in the [energy] industry”. The directive hinges on attracting private investments in the aforementioned three State companies and freeing up distribution.

According to the State press agency Xinhua, the market “has to perform a decisive role in the distribution of resources and the government must act more incisively to fulfill the nation’s energy needs, boost productivity and satisfy people’s requirements”. More detailed information about the reform is expected in the coming months but clearly, in order to be more incisive, it will have to involve a socially painful restructuring of the three big State energy companies, the management and operational efficiency of which are heavily burdened by an army of employees, for the most part hired to support the government’s employment-focused social policy.

There is then the issue of the so-called “mixed ownership” promoted in the past, which allows private investors to acquire interests in State industrial companies provided that their control remains in public hands. The investments have been modest and have therefore had little effect on improving the economic performance of the companies jointly owned companies.

A transformation awaiting concrete results

It remains to be seen, therefore, whether Xi Jinping’s China will progress from words to action. There is no doubt that the commitment to reducing the use of oil and coal for energy production and steadily increasing the use of natural gas is serious. A transformation of the energy market is clearly under way and in fact, during his first visit to China, US president Donald Trump has seized the opportunity, offering massive supplies of liquefied gas which, in addition to meeting the country’s changing energy needs, would rebalance the huge deficit in the US trade balance with China.

Part of this picture is the initiative taken two months ago by Eni when it signed a collaboration agreement with CNPC. The Italian energy giant has acted promptly to play its part in the Chinese reform process declaring its readiness to work with CNPC in various fields, including natural gas prospecting and product. Eni, which has an office in Beijing, already has other cooperation relationships with CNPC including a joint venture in the major offshore gas extraction and liquefaction project in Mozambique known as Coral South LNG.

 

 


Elenoire Laudieri di Biase is a Sinologist, Foreign Affairs Writer, Chief Analyst at Nato defense college Foundation, Editor in Chief at Segmento Magazine, Australia.