The Fuse

China’s Oil Supply Declines Could Prove Critical in Rebalancing the Oil Market

by Nick Cunningham | April 22, 2016

China has overtaken the United States as the largest importer of oil in the world—a designation that makes its consumption patterns a key indicator for oil market watchers. Fluctuations in the Chinese economy can move the market, on the understanding that the country’s thirst for oil will have a significant impact on the global balance of supply and demand.

However, China is also a substantial producer of oil. China produced 4.3 million barrels of oil per day (mbd) in 2015, enough to rank it among the world’s top five global oil producers. China’s oil production has also steadily climbed each year for the past three decades, and today it produces about twice as much as it did in the 1980s. This achievement has gone largely unnoticed in the international press, which tends to focus on China’s ravenous appetite for crude oil and other commodities, rather than its contributions as a producer.

China’s oil production could finally decline

China’s successful run will likely come to an end this year as its large state-owned oil companies slash spending and production due to low oil prices.

Sanford Bernstein & Co. predicted that China’s oil production would fall by 5 percent this year, which would be equivalent to about 215,000 barrels per day. The losses are already becoming visible: With only the first quarter of 2016 in the books, China’s oil production has already fallen to 4.16 mbd, or a loss of 140,000 barrels per day from 2015 levels, according to the IEA. Further declines are expected.

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The cuts are coming as China’s state-owned oil companies struggle with shrinking revenues and high costs from aging fields. In March, PetroChina, a publically-traded subsidiary of the state-owned China National Petroleum Corporation (CNPC), reported net income of 35.5 billion yuan ($5.46 billion) in 2015, a 67 percent decline from 2014 and the worst result in years.

The company’s president also announced that PetroChina would see oil production fall this year, the first time that has occurred since 1999. The cutbacks will occur at some of the company’s aging and expensive wells that have “no hope” of making a profit, according to PetroChina’s President Wang Dongjin. PetroChina will trim capex by 6.1 percent this year, and investment in new projects will also be limited, Wang said, with scarce capital dedicated to efficiency and improving sales. That follows a 32 percent reduction in spending in 2015 from the year before. Daqing, China’s largest oil field, is projected to see output fall by at least 30,000 barrels per day, according to the IEA, down to 740,000 barrels per day as a result of the spending cuts.

The cuts are coming as China’s state-owned oil companies struggle with shrinking revenues and high costs from aging fields.

Cnooc. Ltd., another state-owned giant, expects to see output fall as well. Cnooc focuses on offshore oil production and it has much higher breakeven costs than some of its international competitors—Nomura Holdings Inc. estimates that Cnooc can break even with oil prices at $41 per barrel, compared to some oil companies in the Middle East who have breakeven points closer to $25 per barrel. Most of China’s large oil fields are aging and maturing, facing “structural decline,” as Gordon Kwan of Nomura describes. That leads to higher maintenance costs.

“We expect significant cuts in upstream production as the companies cut output at loss-making fields,” Neil Beveridge, an analyst at Sanford C. Bernstein & Co., told Bloomberg. “Chinese explorers need to take more radical action to cut operating costs and increase efficiency.” Following a 38 percent cut in spending in 2015, Cnooc will cut spending by 10 percent this year, which could result in production declines of 2 to 5 percent.

Sinopec is Asia’s largest refiner, but it also produces nearly 1 mbd, ranking it as China’s third largest oil producing company. Sinopec reported earlier this year that its oil production fell 5 percent in 2015 from a year earlier, and could fall another 5 percent this year. In March, Sinopec announced that it had shuttered four oil fields at its Shengli complex because, with breakeven costs at $52 per barrel, they were financially underwater.

China’s central government has moved to protect its domestic oil producers from the full vagaries of the international oil market, putting a fixed floor price for retail fuel prices, which will not decline when oil prices fall below $40 per barrel.

IEA sees China’s production falling by 135,000 barrels per day this year. However, given that the early data shows output down by at least that much in January and February alone, the IEA’s estimate could understate the coming losses.

But that only offers limited help and will hardly be enough to prevent significant spending cuts. With oil prices down more than 60 percent from the 2014 highs, China won’t be able to halt the decline in its oil production. With the spending reductions from China’s three state-owned oil companies, the IEA sees China’s production falling by 135,000 barrels per day this year. However, given that the early data shows output down by at least that much in January and February alone, the IEA’s estimate could understate the coming losses.

Demand steady, but slowing

Demand for oil continues to slow in China as its economy cools. The latest data shows that China’s economy expanded at a rate of 6.7 percent year-on-year, a figure that was in line with estimates, but still represents the slowest pace since the global financial crisis in 2009. As GDP growth tempers and China seeks to shift its economy from a heavy manufacturing and export economy to one that depends more on services and domestic consumption, oil demand is taking a hit. In 2015, China’s oil consumption grew by 370,000 barrels per day, but that is expected to slip this year to 290,000 barrels per day.

However, that is not insignificant, and due to China’s shrinking supply, it could simply end up importing more oil. PetroChina predicts that China’s import dependence is expected to hit a new high of 62 percent in 2016.

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From a global perspective, even though China’s position as a consumer-of-last-resort for commodity exporters is slipping, it could still make a large contribution to easing the malaise affecting global oil markets.

China could take 200,000 barrels per day offline from falling production this year, while consuming an additional 300,000 barrels per day in extra demand

Consider the fact that the world will be oversupplied with oil by about 1.5 mbd for the first half of 2016, according to the IEA. China could take 200,000 barrels per day offline from falling production this year, while consuming an additional 300,000 barrels per day in extra demand. That eats up roughly one-third of the global glut. Meanwhile, the U.S. is expected to lose 700,000 barrels per day in 2016. Combined, the U.S. and China could erase roughly four-fifths of the estimated supply overhang this year.

While energy analysts ponder the possibility of cheap oil for years to come, China should offer some reasons to second guess such assumptions.

 

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