China’s path toward becoming the world’s largest economic power has been filled with potholes. The country does not have the natural resources to guarantee itself a sufficient supply of petroleum, a factor that threatens to limit the country’s future growth. To solve that problem, China has gone overseas, checkbook in hand, to acquire the largest possible volume of oil reserves. Deals such as the acquisition of Canada’s Addax Petroleum by Chinese-government owned Sinopec, and the interest shown by China National Petroleum and the China National Offshore Oil Corporation (CNOOC) to take over YPF, the Argentine subsidiary of Repsol, demonstrate the strategy that Chinese oil companies have been pursuing recently.

What is behind the sudden surge in this activity? According to Mauro Guillén, director of the Joseph H. Lauder Institute of Management and International Studies at Wharton, “All of the integrated oil companies, not just the Chinese ones, need to have access to deposits because their market capitalization and future viability depend on having proven reserves. In China, there is very little petroleum to serve the country’s high level of needs, so companies need to go elsewhere in search of deposits.” Juan Carlos Martínez-Lázaro, professor of economics at the IE Business School, agrees: “Although China is the fifth-largest producer of crude oil in the world, with almost 3.8 million barrels a day, last year China consumed 8 million barrels a day, so it needs to go elsewhere to guarantee its supply.”

With a population of 1.5 billion, the People’s Republic of China is the world’s most populous country and the second-largest consumer of petroleum behind only the United States. In addition, forecasters say that its demand for oil will grow by 150% by 2020, an annual growth of about 7.5%. One simple piece of data helps to illustrate the rise in petroleum consumption among Chinese consumers: The number of cars in the country has multiplied ninety-fold between 1990 and 2010.

“The Chinese have given up going by bicycle, and are getting into cars,” says Mike Rosenberg, general manager of strategy at the IESE Business School. “The Chinese economy is growing a lot, and that means enormous energy consumption. But to reach the same levels [of consumption] as a Western power, they still have to triple their energy consumption. So, if consumption is going to triple, they are going to have to look at where they are going to get the resources they need.” The answer? China is going to make the acquisitions it needs in order to guarantee its supply, he says.

Well-funded Advantage

As experts point out, China needs to guarantee itself as much control as possible within the global energy landscape, and it is still exposed to all the ups and downs in the price of a barrel of crude oil. Despite the fact that petroleum prices have stabilized in recent weeks, below US$70 a barrel in the case of Brent crude, any possible return to their historic peaks of 2008, when the price reached US$150 a barrel, would erode the balance sheets of the great Chinese industrial firms.

That’s why Sinopec, the Chinese state-owned oil company, eagerly paid US$7.2 billion to acquire Addax Petroleum last June. That sum of money surpassed even the purchase price for Norway’s Awilco Offshore paid by China Oilfield Services, a subsidiary of state-owned China National Offshore Oil Corp., in July 2008. That deal had been the largest acquisition by a Chinese oil company in history. “These companies are targeting all of the independent companies and, since they have money to spend, they don’t mind if they pay a premium for those companies,” notes Martínez-Lázaro.

Chinese oil companies can count on strong economic support for carrying out the expansion plans they have been involved in. One example is the US$30 billion loan that state-owned PetroChina recently obtained from China Development Bank, the investment arm of the Beijing government, with the implicit goal that it be spent on the globalization of that oil company.

Those funds could be used for the acquisition of YPF, owned by the Argentine oil company Repsol, in a deal that would cost China National Petroleum and CNOOC US$17 billion, according to speculators. Although such a deal has yet to be made, it could be appealing for both parties. For the Chinese, it would be attractive because of Repsol’s position in Argentina. This kind of market access is something that is hard to achieve in other countries like Saudi Arabia, the United Arab Emirates, Russia and Venezuela, where flagship oil companies are controlled by their governments and are, therefore, out of reach. For Repsol, on the other hand, this sale would mean an important and necessary injection of liquidity.

As Rosenberg notes, “Repsol has a historic debt and its earnings have been deceptive. If, ultimately, Repsol takes in US$17 billion for getting rid of YPF, it would entirely clean up its financial condition. At the very least, this kind of offer is tempting [for Repsol].” In addition, notes Guillén, “Repsol is having quite a lot of success when it comes to finding deposits in other places [around the world], which means that YPF is not as necessary as it once was [for Repsol]. Don’t forget that when acquisition of the Argentine company [YPF] took place [by Repsol] at the end of the 1990s, it was above all a defensive measure [for Repsol]; that is to say, it was about growing in order to avoid being bought. After the Argentine crisis of 2001 and [a period of] political instability, Repsol no longer has such a need for YPF. In this context, if the Spanish company [Repsol] wants to sell it, the Chinese will take advantage of the opportunity.”

Even before the YPF opportunity appeared, Chinese oil companies already had their eyes trained on Repsol. At the beginning of this year, the troubled financial situation of Sacyr Vallehermoso, the construction and real estate company that owns 20% of Repsol, led many investors around the world to consider the possible purchase of that company’s stake in Repsol. Sinopec was one of the companies that the press identified as interested in the deal, but Sacyr Vallehermoso’s high expectations about the price for such a deal put an end to any agreement.

Although there might ultimately have been an agreement about the price, everything points to the fact the Chinese oil companies would have found it very hard to take control of Repsol. Along these lines, Miguel Sebastián, Spain’s minister of industry, tourism and trade, guaranteed a few weeks ago in Beijing that the Spanish government would only be interested in “financial, not strategic” investments on the part of Chinese companies in Spanish companies in sensitive sectors. “If the Chinese companies show interest in strategic Spanish companies, we would be delighted that there is such ownership, so long as it has a financial character, not a strategic one,” said Sebastián.

This is one of the great problems Chinese oil companies are facing in their international expansion efforts. It is hard for countries like the United States and Russia to agree to a Chinese company controlling an asset of strategic importance. Four years ago, CNOOC tried doing that when it presented an offer for U.S.-based Unocal. But Chevron wound up taking over Unocal for a price that was US$1 billion below the amount that CNOOC was willing to pay for Unocal. “Situations like this have happened several times in the United States, but I doubt that in Argentina people will raise any objections” to a sale of YPF to the Chinese, says Guillén.

Strategic Agreements

Along with writing the checks to acquire oil companies, the Chinese government is speeding up its efforts to close agreements with those countries that are major oil producers. China has signed an alliance with Venezuela for the exploitation of resources in the Orinoco River oil belt, which contains what may be the world’s largest reserves. This will require investments of some US$16 billion through 2012. The agreement, through which Chinese oil companies will form a joint venture with the state-owned Petroleos de Venezuela (PDVSA), will increase crude oil production in that Latin American country by 450,000 barrels a day.

This year, China and Brazil signed an agreement along the same lines. In May, China Development Bank committed itself to granting a ten-year loan of $10 billion to Petrobras, the Brazilian government-owned oil company. In exchange, Petrobras will supply Sinopec an average of 150,000 barrels a day during the first year, and 200,000 barrels a day during the nine remaining years. Until now, Petrobras has been selling China about 60,000 barrels of crude a day.

Less than a year ago, China reached a similar agreement with Russia. China Development Bank granted a loan of up to US$30 billion to Russia in exchange for guarantees that China will annually import two billion barrels of Russian oil over the following twenty years. Given the lack of opportunities for China to make acquisitions in state-owned oil companies, these kinds of alliances are a good strategy, some experts say. As Martínez-Lázaro points out, “China can only hope to acquire midsize, independent oil companies because the global giants are state-owned enterprises.”

One of the markets that interests Chinese companies the most is Africa. There, the Chinese are competing to obtain large-scale contracts for exploration and development. “China is investing fortunes in Africa,” says Rosenberg, “because it needs every sort of raw material, whether it is petroleum, aluminum, [iron ore for] steel… and this continent offers all of those. In addition, they can do that [in Africa] without asking [the Chinese] too many questions about human rights.”

Nigeria is one example of a country that the Chinese have moved into in full force. In that country, 16 out of the 18 petroleum licenses are close to being renewed. State-owned CNOOC has taken the strongest position about committing to this strategy, and it has initiated formalities to obtain contracts that would permit it to produce six billion barrels of oil, or 16% of Nigeria’s total reserves.

CNOOC’s competitors for these awards include major Western oil companies such as Total, Chevron and Shell. These companies all complain about the difficulty of competing against Chinese companies. Chinese energy companies take more risks when it comes to winning contracts, something that has enabled them, for example, to be the first to drill in Iraq despite the primacy of the United States in the region. Not to mention the fact that Chinese companies have an economic advantage.

As Rosenberg comments, “China relies on having the largest dollar reserves in the world. In addition, it is financing the ability of the United States to maintain its consumer society, in which consumption patterns are also directed to a great extent toward acquiring Chinese products. This liquidity permits [Chinese] companies to make bids that have a premium price, since they think about the long-term. The reasoning is this: If you estimate that China is going to multiply its oil consumption ten-fold by 2020, and a barrel [of oil] is now worth [only] half of what it was a year ago; and then you figure they have the cash they need to go shopping — then it’s logical to think that Chinese oil companies are going to make a lot of news.”