China has long been a major hydrocarbon producer and now ranks as the world's fourth-largest oil producer behind Russia, the United States and Saudi Arabia. However, decades of oil production, the decline of easily exploitable resources and the rise of domestic natural gas consumption have forced China to develop more expensive and more technologically challenging resources. Overcoming these constraints will require a shift in the way the industry operates for a number of reasons. For example, many of the new resources China is developing are too expensive and/or risky for a single bloated company like China National Petroleum Corp. (CNPC) to develop, which has forced China to allow partnerships with other entities. Already, China National Offshore Oil Corp. (CNOOC) has signed more than 200 production-sharing contracts, and Chevron Corp. and others have been actively partnering with China Petroleum Corp. (Sinopec) and CNPC onshore.
While partnering with international oil companies has been successful in many ways, China is moving toward allowing private companies to invest without partnering with these international firms. China first allowed this in 2012 when the country launched its third-round shale auction, in which domestic private companies were allowed to bid. Unfortunately for Beijing, the bidding round has not produced successful results in exploration activities. First, because of the historical dominance of the Big Three, China never developed private oil companies with access to the technologies needed to unlock shale gas resources that even the Big Three had little to no experience with. Now, China is aiming to take private investment freedom one step further by allowing foreign firms to secure and operate oil and natural gas blocks in some areas.
Second, and more important, CNPC and Sinopec hold almost all of the promising areas for any hydrocarbon production potential. It should be no surprise, then, that China's winners in the third round have had little success. Moreover, foreign companies would not be interested in buying up blocks with little potential. There are only two solutions to this problem, and both put Beijing's interests squarely against those of Sinopec and CNPC: Reclaim some of the land owned by Sinopec and CNPC, or allow international oil companies to operate independently on Sinopec or CNPC land.
Beijing will use a combination of both options to solve the exploration problem. It likely will reclaim and auction off some of the land owned by Sinopec and CNPC. Moreover, Beijing is considering the establishment of a shale demonstration zone in an area roughly the size of Germany in the southern half of the country, where it will auction off rights to private companies in land likely currently administered by Sinopec or CNPC. The Chinese government is also considering a two-tiered system of oil and natural gas rights. The details are not clear, but it could involve letting Sinopec and CNPC retain the rights to conventional oil and gas deposits in a block while auctioning off the rights to underlying shale resources to other companies. Regardless of the extent of these plans, they will mark the first time that foreign companies have been allowed to invest directly in China's upstream sector alone — a fundamental shift in the way China's energy sector operates — and they will force Beijing to introduce rules and regulations for entities it has very little control over.
