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Shell’s China Moves – CNPC Partnership – Changbei Gas/Oil

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    basil parmesan

    Shell’s China Moves

    November 16, 2011 3:00 PM ET

    By Stanley Reed and Dexter Roberts

    The hilltop city of Yulin, about 500 miles southwest of Beijing, was once a strong point in the defensive wall that protected the Chinese heartland from the tribes to the north. An ancient fortress survives in the old part of the city, the Chinese characters for Suppress the Barbarians carved over its gate. Today, Yulins a boomtown in the oil- and gas-rich Ordos Basin. In the streets not far from the fortress walls, where men sell roasted goat heads from carts, young boys hand out brochures for apartment towers built for newly wealthy oil workers and coal miners. If fresh characters were carved into the old fortress gates now, they might say Resource Barbarians Welcome! Or they might simply be a pair of corporate logos: one for PetroChina, the publicly traded wing of CNPC, Chinas largest oil company, and a second for its foreign partner, Royal Dutch Shell, the second-largest Western oil company.
    A half-hour drive from the city is a new, white building that stands out in the desert scrubland. Clean and bright, it has offices, conference rooms, and a big second-floor terrace overlooking acres of neatly arranged tanks and piping. This is the Changbei gas field. An estimated $1.3 billion joint venture, the field is managed by Shell for PetroChina and produces more than 3 billion cubic meters of gas a year. Over a lunch of stir-fried chicken and snow peas, tangy local peaches, and green tea in the buildings high-ceilinged commissary, the plants two bosses, General Manager Xu Lin, a Shell man, and PetroChina veteran Xu Yanming, his deputy, banter about Changbei. Xu Yanming, dressed more like a local merchant than an oil manin slacks and a dark windbreakerribs Shells Xu, who has a degree from Oxford University and wears the standard blue, one-piece Changbei boiler suit.
    Shell has had four managersand the whole time it has just been me, Xu Yanming says. An earlier Shell manager, whom he dubbed a yangrenold-fashioned slang for Westernerassumed ridiculously high costs, including $20 per diems for Chinese staff. Shell had also factored in exorbitant costs for water. Some at Changbei think PetroChina had stronger cost controls than Shell, Xu Yanming chuckles.
    Changbei is the most visible playing field for a tricky high-stakes game Shell has entered into with the Chinese behemoth, an engagement that mirrors the larger global shift of power from the big petro majors to the fast-rising national oil companies. PetroChina wants Shells expertise to unlock the unconventional gas and oil resources, such as shale gas, that require new techniques to extract. Shell wants PetroChinas help in gaining access to the mainland, Chinas newly hot gas fields, and its energy-hungry consumers. The U.S. Energy Information Administration said in April that Chinese shale may hold 1,275 trillion cubic feet of gas, 12 times the countrys conventional natural gas. The technically recoverable reserves are almost 50 percent greater than the 862 trillion cubic feet estimated for the U.S., the EIA also said. Last year, China became the largest energy consumer in the world, surpassing the U.S., according to BPs Statistical Review of World Energy. China is expected to account for almost half the worlds growth in oil consumption in the next two decades, becoming the largest market for oil, and it is trying to more than double the use of gas in its economy, to 8 percent of the energy mix, by 2015.
    Shell isnt just angling for the natural gas and domestic Chinese market. As China and Asia surge in importance, the company wants to use its Chinese partnerships to help gain influence over the flow of all global resources destined for China, from the Middle East to Australia. It is a foreshadowing of the new energy landscape, says a former Shell executive. If you asked Shell 15 years ago if they would do a strategic partnership with CNPC, they would have laughed.
    No ones laughing now. The company is going all out to please Beijing. In June company directors visited Changbei and the Iron Man Wang Jinxi Memorial Hall, a shrine to an iconic 1960s oil worker, at PetroChinas largest field, Daqing. Shell executives believe theyve picked a winner in PetroChina. This is the most advanced Chinese alliance; this is about the future, says Jerry Kepes, a partner at the Washington (D.C.) energy consultant PFC Energy. Shell gets it. But Shell has to deliver. The relationship carries plenty of risk. For Shell, its that once PetroChina has absorbed its know-how, it will become a competitor that not only will take Shells share of the business but also will one day attempt to swallow the Anglo-Dutch giant whole.

    The Chinese have long known there was gas in Changbei, but they didnt think they had the skills or technology to extract it. So they went looking for a partner that did. Even though the pair seemed to be made for each otherboth are gigantic, bureaucratic, and eager to be top playersCNPC and Shell courted for more than a decade before getting serious in the late 90s. It was like getting elephants to dance, says a banker who negotiated deals between them.
    The two companies signed a production-sharing agreement in 1999, but Shells bosses dithered on giving the final go-ahead for investment. Shell executives changed their minds when China lifted gas prices and the market outlook improved. At roughly the same time, the company spurned an invitation to participate in the $12 billion West-East Gas Pipeline that China wanted to build to bring gas to its major cities. Shells management did not think the terms were adequate. It became clear that we did not share the same priorities and expectations, says Shell Chief Financial Officer Simon Henry. Some insiders were dismayed at passing on the chance to be an owner of Chinas most important piece of gas infrastructure. That was incredibly shortsighted and stupid, says a former Shell executive. That was an opportunity to own 40 percent of the spine of Chinas gas market. Shell is very cautious, and its top managers didnt give the green light on Changbei until 2005, after lower-level executives warned management the oil giant was on the verge of losing the deal, and another great opportunity.
    Since then, Shells expertise, coupled with PetroChina labor, has made Changbei work. The fields gas is tight, meaning its trapped in rocks that dont easily give up their treasure. Shell solved the problem with horizontal wells that level off when they reach the gas, which is deposited in layers about 10,000 feet below the surface. A two-pronged pipeline is then drilled out from the bottom of the well horizontally for about 6,000 feet so that the well can suck gas from a huge expanse of rock. So much gas flows into these pipes that Changbeis fields are highly prolific.
    Before teaming up with Shell, PetroChina used to take more than 250 days to drill a well like this. Now it takes about 130 days, slashing costs on the 25 wells that have been drilled so far from about $17 million to $10 million each. Xu Lin says rock-bottom development costs of less than $1 per barrel of oil-equivalent make Changbei highly profitable. Although Shell wont disclose the profitability of the project, one analyst, who asked for anonymity due to fear of repercussions, estimated that it earned at least a 30 percent return.
    While noteworthy, Changbei is merely the first step of a much larger plan. Shell, which has only $4 billion or so invested in Chinatiny, considering the size of Chinas economywants to be Chinas energy concierge, catering to the oil and gas industrys needs. CNPC is the only avenue available to fulfill such ambitions.
    The breakthrough in Shells China strategy occurred in August 2009 at a meeting held in the Hague, where Shell has its headquarters. Peter Voser had recently become Shells chief executive officer and had cut short his vacation to meet with a CNPC delegation led by Chairman Jiang Jiemin. The chemistry was good between Jiang and Voser, a hard-nosed Swiss who has instilled more financial discipline at the once loosely managed conglomerate. Since then, meetings have occurred every few months, either in the Hague or at CNPCs 25-story headquarters in Beijings Dongcheng district, in a conference room one Shell executive says is the size of an aircraft hangar.
    These meetings resemble high-level diplomatic summits more than business negotiationsnot surprising, perhaps, given the size of the respective companies. The chairman of CNPC, which has more than 1.5 million people on the payroll and revenue of $271 billion, is more like the governor of a major province than a CEO of a company. Each session follows the same format. The CEOs sit at the top end of a horseshoe-shaped table and converse through an interpreter hidden by a huge arrangement of flowers. Aides sit along the sides of the horseshoe. The CEOs reach agreements in principle on ideas to pursue and signal to aides to work out the details before the next meeting three or four months later. Invariably there are lunches and dinners and drinks. The talks recently have been enlivened by the fiery Chinese liquor Maotai. Every executive is expected to drain a toast to each person present, with no half measures tolerated.
    Shell executives have warmed to Jiang because he appears to be receptive to their ideas, unlike some of his counterparts at state companies. CEOs of Chinese state companies are political animals whose decisions arent driven strictly by profit motive. These are talented, tenacious people that should not be underestimatedbut at the end of the day they are still government functionaries, says Jeff Layman, a partner at law firm Baker Botts in Beijing. They may be looking at their futures beyond the companies they are managing.
    The powwows between the two companies have produced a list of projects, some of which are already under way. If they all come to fruition, they could be investing $50 billion together, not only in China but also in Qatar, Australia, and elsewhere over the next decade or so. Shell also let CNPC into a small joint venture in Syria that the Chinese company hoped would be an entre into the Arab world. The deal has fizzled, and Shell is no longer lifting crude since the Syrian regime was hit with international sanctions following its bloody crackdown on dissidents.
    For Shell executives, this elaborate courting of the Chinese reflects a growing awareness of the energy markets new realities. Forty years ago major Western oil companies such as Shell controlled more than 60 percent of the worlds oil reserves. Thanks to waves of nationalizations and depletion of oil fields in the West, the producing countries now control the bulk of that oil. With few exceptions, the only way to make an impact in such placeswhether Venezuela, Russia, or Abu Dhabiis through partnerships with the national oil companies. China is the biggest of these. According to Xinhua, Chinas official news agency, China plans to invest $828 billion in its power industry by 2015, developing oil and gas fields, building refineries and pipelines across the country, and adding power plants, wind farms, and nuclear reactors. Green energy production is a priority because China also wants to cut carbon emissions and reduce the energy intensity of its economy by 2015.

    PetroChinas plans are ambitious, too, and its objective is clear: It wants to be on the level of Shell someday and is pushing its partner to help it become a global player. For instance, Shell sponsors a leadership development program for senior Chinese executives run by Peter Nolan, a professor at the Judge Business School at the University of Cambridge. The company supplies materials and speakers for the program to build relationships with the Chinese executives and prepare them to work on joint ventures. A former Shell executive in China says the Chinese are eager to hold seminars with their Western counterparts, not just to learn about technology but also to talk about issues such as corporate governance. PetroChina executives have even visited the Hague to learn how Shell complies with U.S. Securities and Exchange Commission regulations.
    The big question is: Can Shell keep riding this tiger? What prevents PetroChinas parent, CNPC, from exploiting the Western producer for what it wants and then tossing it aside or perhaps even taking it over? For now, CNPC appears content to see what it can gain through the partnership. Shell CFO Henry, who manages the PetroChina relationship, said in an interview that there is a quid pro quo for being permitted to work in China: helping the Chinese company acquire oil and gas resources outside of China. Qatar, the little emirate that is the worlds leading gas exporter, is a place where Shell is playing the energy concierge with considerable skill. In 2008 the company sold more than one-third of the output of its Qatargas 4 plant in Qatar to PetroChina in long-term contracts.
    That deal impressed Shells majority partner in the project, Qatar Petroleum, and has led to two others: Shell, Qatar Petroleum, and PetroChina are planning a refinery and petrochemical complex in Chinas southeastern Zhejiang province. And Shell has brought in PetroChina as a 25 percent partner to explore for yet more gas in Qatar. If that arrangement yields a big find, it could lead to a new $10 billion to $15 billion liquefied natural gas plant. This tripartite relationship is important to us, says Andy Brown, Shells Qatar chief. We can play a role between a major energy-producing country and a major energy-consuming one.
    Shell is delivering not only in Qatar but also on Curtis Island, a 30-by-15-mile strip of land within Australias Great Barrier Reef World Heritage area. In 2010 it joined forces with PetroChina to buy Arrow Energy for A$3.6 billion ($3.7 billion). Arrow has plans to build a $20 billion LNG plant to feed gas to China. Henry says being able to buy an energy company in a developed country such as Australia earned Shell huge Brownie points.
    Still, the long-term risk remains that PetroChina will learn to develop even difficult oil and gas fields with the aid of technology-rich service companies such as Schlumberger and Halliburton, then kiss Shell goodbye. Even though Shell has been clever in leveraging its position, you cant ignore the fact: You are now partnered up with the guy who doesnt want to be partnered with you long-term, says a former executive. CNPC is not in this to be a partner with Shell. They want to be Shell. They want to replace you. Thats the thing about the energy game in China: Sooner or later, someone has to lose.

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