ENERGY SECTOR DEVELOPMENT AND REFORM IN PRC With Special Reference to the Oil Industry Presented by Dr. Cherng-Shin Ouyang Research Fellow Chung-Hua Institution.

ENERGY SECTOR DEVELOPMENT AND

REFORM IN PRCWith Special Reference to the Oil Industry

Presented by Dr. Cherng-Shin Ouyang

Research FellowChung-Hua Institution for Economic Research

75, Chang-Hsin St.,Taipei, Taiwan29th September 2008

at Economic Department of Moscow State University

2

Part 1: Overview of China’s Energy Sector Development

Part 2: Reform and Market Opening

3

Chart 1 International Comparison of Energy Consumption Efficiency, 2006 (toe/10,000 US$GDP)

8.77

1.87

1.28 1.19 1.12 1.08 1.02

2.50

0

3

6

9

China U.S. France Germany Japan Italy U.K. World

source: The Industrial Map of China Energy, 2006

toe: ton oil equivalent

4

Chart 2 Energy Consumption / GDP of PRC (tce/10,000 RMB), 1980~2005

2.68

4.02

2.58

2.382.22

2.08

2

1.93 1.75

1.56

1.46

1.41.33 1.3 1.36 1.43 1.43

1

2

3

4

5

1980 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

source: Chart 1

tce: ton coal equivalent

5

Table 1 Structure of Primary Energy Consumption – Selected Countries, 2005

Energy in

Country kind

Oil NaturalGas

NuclearPower

Coal HydroPower

Total

USA 40.4 24.4 8.0 24.6 2.6 100

Japan 46.6 13.9 12.6 23.1 3.8 100

Germany 37.5 23.9 11.4 25.3 1.9 100

UK 36.6 37.4 8.1 17.2 0.7 100

France 35.4 15.5 5.1 39.1 4.9 100

China 21.1 2.7 0.8 69.6 5.8 100

Source ： BP(2006), Statistical Review of World Energy, http://www.bp.com. 。

%

6

Chart 3 Strategic Oil Reserve (days) – Selected Countries, 2005

169

158

127

9690

8374,5

60

44

30

0

50

100

150

200

Japan US Germany France EU UK Korea Taiwan Singapore China*source: various* Author estimate

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Chart 4 Primary Energy Production and Consumption of PRC, 1989~2005

10.2 10.4 10.5 10.711.6

12.313.1

13.9 13.813.2 13.0 13.0 13.5

14.8

16.8

20.3

22.2

9.7 9.910.4 10.7 11.1

11.912.9 13.3 13.2

12.4

10.9 10.7

12.1

13.9

16.0

18.5

20.6

8

12

16

20

24

1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

能源消費總量 能源生產總量Domestic energy consumption

Domestic energy production

100 million tce

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Table 2 Economic Growth and Energy Consumption of PRC, 1981~2005*

Real GDPa (ann. ave.) Growth Rate, %

Growth of Primary Energy Consumption (ann. ave.)b , %

6th FYP 7.8 6.1

7th FYP 8.0 5.2

8th FYP 12.3 5.8

9th FYP 8.6 1.1

10th FYP 9.5 10.1

*arithmetic ave.notes a) 1993~2004: revised GDP by SSB b) 1999~2004: revised energy consumption by SSB

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-0.52

0.72

0.96

1.701.64

0.46

0.65 0.62

-0.09

0.17

0.44 0.45

-1.00

0.00

1.00

2.00

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Chart 5 Energy Consumption Elasticity (e) of PRC, 1994~2005

Asian Financial Crisis

Notes: 1999~2005: revised figuresnormal: 1>e>0 (rest)abnormal: e<0 (1998)abnormal (inefficient): e>1 (2003,2004)

Source ： Chinese Statistics Bulletin, Chinese Energy Statistics Bulletin, DRC State Council

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Table 3 Primary Energy Structure Forecast – PRC, 2005~2050

2005 2020 2050

Total Energy Consumption(standard tce/per person per year)

1.0 2.0 3.0

Installed Power Generation Capacity

(1,000 w/per person)0.3 0.7 1.5

Primary Energy Structure, %

Coal 69.3 55.0 40.0

Oil 21.1 22.0 23.0

Natural Gas 2.7 8.0 12.0

Hydro & Nuclear Power 6.6 8.0 10.0

Renewable Energy － 7.0 15.0

Total 100.0 100.0 100.0

Source： Chinese Academy of Sciences

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Table 5 Energy Consumption Forecast – PRC, 2000~2020

ERI (forecast) DOE(U.S.) IEA

Baseline SustainableGrowth

GreenGDP

High Medium Low 2002 2004

2010(mill standard tce) 2,150 2,080 1,870 2,090 1,970 1,840 1,950 2,480

2020(mill standard tce)

3,300 2,900 2,470 3,220 2,790 2,430 2,560 3,170

Annual Ave., %

2000~2010 5.2 4.8 3.7 4.9 4.2 3.5 4.1 6.4

2010~2020 4.4 3.4 2.8 4.4 3.5 2.8 2.8 4.6

2000~2020 4.8 4.1 3.3 4.6 3.9 3.2 3.5 4.6

source：World Bank & DRC (2007)

sources

consumption

Projection Projection

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Table 6 Energy Final Consumption According to Sectors and Energy Types, 2000/2020

2000 2020 2000 2020

mtce % mtce % mtce % mtce %

Agriculture 48.2 5.4 59~80 3.1~3.2 Coal 381.8 42.8 559~836 33.7~29.3

Industry 497.7 55.8 998~1345 53.4~54.2 Oil 297.0 33.3 605~827 19.6~22.8

Transport 137.4 15.4 385~503 20.2~20.2 NaturalGas

27.7 3.1 159~157 8.4~6.3

Residents &Commerce

208.7 23.4 463~555 22.2~24.4 Electricity 147.2 16.5 434~487 19.6~22.8

Other 38.3 4.3 148~177 7.8~7.1

Total 892.0 100.0 1905~2484 100.0 Toal 892.0 100.0 1905~2484 100.0

Source: ERI: Energy Consumption Forecast- Baseline and Green GDP Scenarios

year

Sector

yearEnergy Type

Table 7 Oil and Natural Gas Production & Consumption – PRC, 1995~2006

1995 2000 2001 2002 2003 2004 2005 2006

Oil

Domestic Output(1,000 barrel/day)

2,989 3,252 3,306 3,346 3,401 3,481 3,627 3,684

Annual growth rate (%) － 1.2 1.7 1.2 1.6 2.4 4.2 1.6

Domestic Consumption(1,000 barrel/day)

3,395 4,772 4,872 5,288 5,803 6,772 6,984 7,445

Annual growth rate (%) － 6.6 2.1 8.5 9.7 16.7 3.1 6.6

Balance (1,000 barrel/ day) -406 -1,520 -1,566 -1,942 -2,402 -3,291 -3,247 -3,761

Natural Gas

Domestic Output(100 million cm)

179 272 303 327 350 410 500 586

Annual growth rate (%) － 7.9 11.4 7.9 7.0 17.1 22.0 17.2

Domestic Consumption(100 million cm)

174 238 268 286 332 390 470 556

Annual growth rate (%) － 13.9 12.6 6.7 16.1 17.5 20.5 18.3

Balance(100 million cm) +5 +34 +35 +41 +18 +20 +30 +30

years

Source: BP (2007), Statistical Review of World Energy, 2007

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Chart 6 Imported Oil Dependence – PRC, 1965~2005, %

44.7

27.3

7.0

1.2

-22.6

-39.1

-24.1

-12.8

-8.7

-2.8

-50

0

50

1965 1970 1975 1980 1985 1990 1993 1995 2000 2005

Source: Chart 1

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Table 8 Area/Country Concentration Ratio of Crude Oil Import – PRC, 2005/2006Area 2005 2006 Countries/ Top 10 2005 2006

Middle East 47.2 45.2 Saudi Arabia 17.5 16.4

Africa 30.3 31.5 Angola 13.7 16.2

Europe & Central Asia 11.5 13.1 Iran 11.2 11.6

Asian Pacific 7.6 6.6 Russia 10.1 11.0

Western Hemisphere 3.4 3.6 Oman 8.5 9.1

Yemen 5.5 3.1

Sudan 5.2 3.3

Congo 4.4 3.7

Indonesia 3.2

Equatorial Guinea 3.0 3.6

Venezuela 2.9

Total 100.0 100.0 Total 82.3 80.9

Source: China Custom Statistics, 2006/07

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Future Prospect

Domestic oil consumption continue to riseImported oil reaching 50% of domestic consumptionGas consumption expected to increase at two digitEnergy/oil security a serious policy concernFuture growth likely to be impinged by “resources” and “environment” constraints

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Major Strategy Responses

Drafting “Energy Act” (to be promulgated end of 2007)Unifying energy governing body: plan to reinstate Energy Ministry (abolished in 1992)To develop renewable and alternative energy resourcesTo enhance energy conservation while emphasizing clean energy: End of 11 FYP to reduce unit output energy consumption by 20%Global oil hunt coupled with increased international cooperation

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To initiate Three-Phase Program in building strategic/commercial oil reserve (Target: 60 days of annual consumption)

Undertaking comprehensive market-directed energy sector reform

Overhauling energy (oil) administration structure

Major Strategy Responses (cont.)

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Evolution of China’s Oil Market –Four Phases

I. Pre-reform period (before 1981)Incorporated within national economic plan, resources allocation based on overall balanceState intervention: at various levels of the oil sector /governmentSelf-sufficient in oil consumption: have surplus for export until 1993

II. Reform Period (after 1981)1. Plan & market coordination (1981~1994)

Adopting production responsibility System (PRS)Dual pricing allowed: above-target crude (exceeding 100 mt) and allocated input quota conserved be freely disposed at market priceEmergence of social entities in oil business Oil futures market set up in Beijing & Shanghai (1996)

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Evolution of China’s Oil Market –Four Phases (cont.)

2. State Domination (1994~1998)Oil sector reform

Production/import: subject to state allocation plan

Abolishing dual pricing

Closure of oil futures trading

3. Reform and Opening (1998~)Building international linkage

Price mechanism adjustment

Import liberalization

Access to wholesale & retail oil products market

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Main Feature of the Pre-reform Oil Industry Management System

- An Integral Part of the Traditional Planned Economy Ownership, management, and control entrusted to the state

The governing body and the governed-state enterprises- are intermingled, both represent administrative units at different levels of the oil industry complex

Despite incessant administrative restructuring the oil business management system remained largely intact

Production based on quota within a vertically integrated command system; resources allocation and intra-industry coordination followed bureaucratic rules

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Oil Industry management System Reform – Three Phases

Phase 1 (1982~1998)Bureaucratic organs divorced from Enterprises

Phase 2 (1998~2003)Restructuring and enhancing professional management competence of the three state oil groups: CNPC, Sinopec and CNOOC

Phases 3 (2003~)Market oriented reform taking place

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Brief History of the Three State Oil Groups

General Oil Administrative Bureau of State Fuel Industry Ministry

1950, 4

Oil Industry Ministry

1955, 4

State Fuel-Chemical Industry Ministry

1975

Oil Industry Ministry

1978

China National Petroleum Corporation / 中國石油天然氣總公司

1988, 9

China National Petroleum Corporation / 中國石油天然氣集團公司 (CNPC)

1998, 7

China National Off-Shore Oil Corporation - CNOOC

1982, 2

China Petroleum and Chemical Corporation- Sinopec

1983, 7

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Increasing Flexibility in Domestic Oil Pricing

Formation of domestic oil price (particularly oil product prices) ： traditionally fixed and regulated by the government to safeguard the livelihood of peopleHowever, oil as a strategic commodity withstood pressure of liberalization until the late 1990sGrowing import of crude and spiraling world oil price enabled the authority to adopt more flexible approach in the shaping of oil pricesSince 1998, government-sponsored adjustments in the mechanism of oil price formation has undergone five stages

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Major Policy Responses

A. 1st Stage (1998,7~2000,5): Reform Agenda of the Crude and Oil Product PricesPricing Formula: lagged floating (by one month)Measures:

Crude benchmark: taking monthly average of “Singapore, London and Rotterdam” quotations as the baseOil products pricing: crude benchmark + premium (floating band: 5%~8%)Oil products retail prices: based on import prices + circulation charges

Main drawbacks: encourage inventory speculation due to predicable (home and foreign) price differentials

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Major Policy Responses (cont.)

B. 2nd Stage (2000,6~2001,10): Price Setting Mechanism ReformPricing Formula: lagged floating (by one month)

Measures:Crude benchmark: reverting instead to Singapore monthly average price of oil products as the base for official price adjustment

High frequency in price adjustment: 17 times in total

Main drawbacks: ditto

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Major Policy Responses (cont.)C. 3rd Stage (2001,11~2005): based on “Notification of

the State Planning Commission for tying to International Price and for Oil Products Price Adjustment”Pricing Formula: lagged floating (by one month) combined with partial enterprise pricing autonomyTargeting instead to the monthly (weighted) average oil products price of “Singapore, New York and Rotterdam” according to the weights: 60%, 20% and 20%Asymmetrical targeting: lifting domestic prices when weighted average goes up but resisting downward adjustment the other way roundEnterprises granted some flexibility in retail trade at self-made pricesMain drawbacks:

Oil product prices trend upward but remain sluggish compared to crude price risesLagged floating distorts resource allocation and consumption behaviorPrice gaps encourage export thus aggravate shortages at home

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Major Policy Responses (cont.)D. 4th State (2006~ ): Continue to raise domestic

prices accompanied by the implementation of loss-compensating policy packages and compulsory profit tax on crude producersAbolishing “direct” linkage with foreign benchmark prices; resorting to “indirect” linkagesIntroduce four compensating measures

Establishing inter-industry redistributing mechanism in realigning “profits and losses” of up- and down- stream enterprises, i.e. between crude and oil product suppliersEstablishing horizontal price-coordinating mechanism to even out the negative impacts of distorted price spectrumEstablishing mechanism for subsidizing agriculture, utilities of public interest and socially weak groupsIntroducing (redistribution) financial mechanism in taxing windfall gains (threshold for ultra profit tax: 40US$/b)

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Major Policy Responses (cont.)

E. 5th State (2007,1~ ): Begin to implement <Measures for Regulating Oil Market> and <Measures for Regulating Oil Products Market>Suppressing time gap arising from delayed foreign market targeting; aim at synchronizing price setting

Targeting “oil futures” and shifting to three anchors: “Brent, Dubai and Minas”

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Dilemma in Official Pricing Policies—Objectives

In principle, gradually tying domestic oil price to international benchmark is the right step because it may

Rationalize allocation of resources,

Ensure that industries delivering tradable and non-tradable stand on equal footing, and

Obviate suboptimal resources diversion abroad

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Dilemma in Official Pricing Policies—Consequences

Price Perversion ( 價格倒掛 ): yet due to disproportionate and retarded price movements of oil products, crude distributors (upstream on the intra-industry chain) benefit from rises in international oil prices and able to reap huge profit, while refineries and oil products distributors suffer both from the controlled floating band and the delayed “cost-plus” transfer to final consumers

Efficiency v.s. Egalitarianism: Current price – setting mechanism evokes contradiction in macroeconomic goal-fulfillment. There is an inherent, textbook-type trade-off between the pursuit of “efficiency” in energy use and ad hoc “egalitarianism” (including control of inflation). Upon the inception of the 5-stage price adjustments, the above-mentioned drawbacks remain, though less conspicuous than it would otherwise have been

32

Dilemma in Official Pricing Policies—Consequences (cont.)

Heated debate over both the “speed” and “dimension” of continued price reform (liberalization) is going on all the time in China (predominantly at the academic level)

Socialism with Chinese characteristics implies that “gradualism” still outweighs “radicalism” in seeking to converge to international practice in the pricing policy of oil business.

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Market Opening in Sphere of Circulation

Meet WTO market opening time frame: transient phase expires on December 11, 2006 for domestic and foreign oil products distributors/retailers.

Trade liberalization: curtailing import tariff combined with loosening of quota limitations

Period Measures

Jan. 1,2004

A. Import Tariff Reduction

Crude Oil 0%

Gasoline 9%→5%

Lubricant 9%→6%

Kerosene, Diesel, Fuels

6% (unchanged)

Jan. 1,2004

B. Lift Import Quota

Crude Oil Import quota of non-state enterprises raised from 9.52 mill ton in 2003 to 10.95 mill ton

Oil Products Import quota of non-state enterprises raised from 5.30 mill ton in 2003 to 6.10 mill ton

C. Trade Services

No later than Dec. 11,2004

-Oil Products Retailing -Gas station: each foreign enterprise may own and operate up to 30 gas station; foreign entities are allowed to expand their business only as minority stake holder in a Chinese-owned enterprise

No later thanDec. 11,2006

-Wholesale Trade -Wholesale trading rights in crude and oil products opened to foreign investors

Jan. 1, 2004 D. Transport, Warehousing & Social Services

-Chinese entities deprived of the right in maintaining controlling interest in piers which are opened to all carriers;-Foreign investors are encouraged to undertake construction of habour infrastructure, oil and gas pipeline, reservoir, as well as pier terminals

Table 9: Time Schedule of Oil Market Opening

Source: Dan Shi (2006), Report on Market-Oriented Reform of china’s Energy Industry, pp.224-225.

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Summary and Evaluation

In 2005, China’s energy self-sufficiency stands at 92.2%, a noticeable improvement over the year 2000 (78.5%), notwithstanding the deteriorating trend persists since the breakeven year—1992. China’s energy efficiency raised by a factor of 2.8 in the last 25 years; energy consumption elasticity remains “volatile” on annual basis which contradicts the FYP configurations (real GDP growth surpasses growth of primary energy consumption by a wide margin, except for the 10th FYP which is negative – Table 8) Aggregate primary energy imbalance would have been worse by now if the authority failed to carry out reform and to push for investment in the energy sector.

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Summary and Evaluation (cont.)Domestic energy supply-gap has many origins: structural, institutional, administrative, etc.; “price, quantity and quality” represent the three dimensions to which the various causes of supply-gap reduce - given the vigorous growth – induced demand for energy; among them “quality” is a hybrid notion.Statistical aberrations: the observed low energy efficiency of China after the new millennium may be exaggerated (due to currency undervaluation) much as the unusually low “e” prior to the new millennium (energy consumption figures yet to be revised). According to ERI forecast, there are three growth scenarios up to the year 2010 and 2020: “baseline, sustainable growth, and green GDP”; based on the “11 FYP” projection, unit output energy consumption be reduced by 20% while per capita GDP doubled in year-2010 (base year, 2000).

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Summary and Evaluation (cont.)According to ERI projection, the share of transport in energy consumption pattern will expand from 15.4%(2000) to 20.2%(2020); on the sources of energy use, both coal and oil are projected to decline by around 10%, while natural gas, electricity and others (renewable + alternative) to increase substantially over the same period (Table 6). Both projections appear to be realistic and theoretically attainable in view of the record of Chinese leadership’s competence on target-fulfillment.Oil faces serious supply bottleneck more than any other energy sources largely because domestic production of oil is stagnating for years, its import dependence is growing and, worse still, international oil prices are skyrocketing beyond imagination. Dating from the early 1980s, the oil sector has undergone three-phase system reform involving “administration, market structure, company management and the price mechanism”.

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Summary and Evaluation (cont.)Generally speaking, system reform of the oil sector is on the right track, but there are still formidable obstacles lying ahead.State-enterprises: CNPC, Sinopec and CNOOC, radically transformed and listed on the Hong Kong and New York Stock Exchange by now; CNPC and Sinopec face perpetual conflicts of interest between (a) the government and the oil industry they represent, (b) themselves as holding companies and the many subsidiaries / branches they control, and (c) their crude producing units and the down-stream refining/distributing chains they sit on.Incomplete Reform: Perfection of the oil pricing system and market opening partly alleviate the supply shortage and the potential negative impact on the economy but they are inadequate. More thoroughgoing system reform and coordinating measures aimed at correcting the primary energy imbalance are called for in the future.