State of Chinese Oil and Gas Industry

As the Chinese economy continues to decline, an already depressed global oil and gas industry could see crude prices driven even lower by the continued devaluation of the yuan. Naturally, any devaluation of the yuan – particularly against the US dollar – would lead to capital outflow from China, thereby weakening domestic demand for crude oil. National companies such as CNOOC, PetroChina, and Sinopec thrive on lower breakeven costs with the assistance of government subsidies. A devalued national currency coupled with the current drop in global oil demand is expected to drop Chinese national production by 5%-6% in 2016.[1]

China has evolved into the second largest consumer of crude oil and the world’s fifth largest producer. The three large national oil companies dominate the domestic oil and gas market, accounting for over 75% of Chinese production[2]. However, the expected drop in production in 2016 as mentioned previously, and the subsequent rise in imports has created a niche market for the small, private refiners known as teapot refineries. Beginning in late 2015, the Chinese government allowed teapot refineries to purchase crude oil with the specific purpose of exporting refined products to stimulate the economy. In fact, teapots are expected to purchase up to 20% of Chinese crude imports in 2016.[3]

Many experts – the Chinese government included – expected this new market for imports to increase the price of crude oil and drive production globally, with some estimating the price would be driven as high as $80 per barrel.[4] However, the teapot refiners had the opposite effect. Private refineries thrive on cheap oil prices, and according to Morgan Stanley the average profits increase by 20% in 2015 while global oil prices dropped by 35%.[5] The large-scale increase in refined exports from China found few new markets, and was forced to turn to the domestic demand they were never meant to supply. International companies supply the Chinese domestic market, and with decreased market share from the teapot refineries, global oil prices were driven further downward.

Going forward in 2016, the continued slump in oil prices and over supplied market will continue to adversely affect the Chinese producers and the global market as a whole. Sinopec, the primary onshore production company has been most strongly affected, having been recently overtaken by CNOOC as the second largest oil and gas company in China. Unsurprisingly, CNOOC is the country’s primary offshore exploration company. The offshore space is generally more insulated from global oil cycles. Additionally, until the government curtails teapot production, the slump in Chinese demand will keep crude prices low, and decrease domestic production through the next few years.

Wilson Deming

MBA Candidate 2016