China hangs its future on oil, but foreign companies have doubts

This week the official Chinese news agency released a jaunty statement predicting large production of oil before the end of the decade. While oil-bearing areas have been located and oil-producing wells sunk, some foreign operators bearing the cost and risk of China's exploration program are having difficulty matching such unrestrained optimism.

Chinese officials are fond of estimating China's offshore oil reserves as being between 75 and 150 billion barrels. The highest foreign estimate made public is 30 billion.

''You just can't make a firm estimate until you've done some drilling,'' says the chief of Esso's China operations, Murray Hudson. Esso expects to begin wildcatting early in 1984. ''We've made an aggressive proposal and our costs will be great. Obviously we're aiming at being successful but we are realistic enough to realize that we may never recover a cent,'' he adds.

Although competition to win exploration rights has been intense since last year, many foreign operators are treading cautiously.

The tough terms demanded by China - despite last year's slump in world oil prices, attempts to exclude foreign firms from the oil support industry, and the recent sinking of the drill ship, the Glomar Java Sea - point up potential pitfalls that foreign consortiums face before costs can be recovered.

Arco, Total, Elf, and Japan National Oil corporations have been drilling off China in agreements with the Chinese made before the recent international bidding. Of 18 contracts signed with foreign companies so far this year, only the BHP-BP consortium has begun wildcatting in the South China Sea.

One operator, who asked not to be named, said that the hard bargain driven by the Chinese may require renegotiating contracts, if and when oil is discovered.

No details of the 18 contracts signed this year between the China National Offshore Oil Corporation (CNOOC) and foreign companies have been released, but a model contract upon which all were based was published last year.

Foreign operators are to bear all exploration costs. CNOOC has a 51 percent option to participate in the development and production phases. A 17.5 percent royalty levied on gross production will be split into recovery of operating and investment costs. Any production in excess of this becomes profit oil and is taxable at an effective rate of 70 percent.

The main negotiating factor - the ''x factor'' - is the division of profit oil at various levels of production. Crude oil purchasing and pricing was also covered by the contract and CNOOC retains the right to veto export destinations.

The French oil company, Total, which has been operating in the Gulf of Tonkin since 1981, has already reached the appraisal stage.

The company closed down its operations for the typhoon season to evaluate the results of the 14 wells it has sunk. Although it is believed to have found oil in four of the wells, it has not yet resumed operations. Several industry sources have said that the company may be reluctant to go ahead with the next stage under their present contract.

''Their seeming reluctance to get back into action could mean two things,'' one industry source said. ''Either the results weren't good enough. Or they weren't viable under the terms of their contract, and Total needs to get some concessions out of the Chinese before they can go ahead.''

Officially Total has denied that it is biding time, but they are being closely watched by 27 companies poised to spend a total $2 billion in the next three years on oil exploration in China.

Originally there were some fears that the ups and downs in Chinese-United States relations may encourage China to limit the number of exploration contracts awarded to American companies, who made up half of the 102 bids received by the Chinese.

But last year, the Reagan administration is believed to have made a number of contacts to try to ensure that diplomatic strains would not disadvantage US firms.

Although a non-American consortium, led by British Petroleum, was awarded the first and prize contract areas in the Pearl River basin of the South China Sea in May of this year, American companies are well represented in the contracts awarded since then.

The sinking of the Glomar Java Sea off the coast of Hainan Island in the South China Sea, and the loss of the 81 crew members, has also caused some re-thinking by foreign oil companies. The incident, and the handling of it by the Chinese rescue services, have raised doubts about the ability of China's resources to cope with such a disaster.

There is also increasing concern that China may be moving to exclude any totally foreign-owned company from providing equipment and services to oil companies, in hopes of building up local industries.

China's new restrictions also raise the question of foreign companies' vulnerability in a country that has had highly unstable politics and demonstrated the willingness to cancel large foreign contracts with little hesitation or warning.

And there is some concern among oil companies that China may attempt eventually to nationalize the industry or simply alter the terms of the contracts if oil is discovered and ready to come on stream.

''Oil companies are largely powerless to defend contract changes, and host governments are essentially free to make changes, as long as such actions do not scare off substantial foreign investment in the future,'' said Thomas Emmons, vice-president for energy at Citibank, during a recent conference in Canton. ''Operators can only hope that their host governments exercise their powers reasonably.''

Mr. Emmons concluded, however, that the highly detailed contracts already signed by foreign companies and China's desperate need to keep attracting foreign investment would probably prevent any drastic moves by the Chinese government.

''The chances are very small that significant injury to foreign oil company investment will occur in China. China's model contract has been carefully drafted. Its terms have anticipated the situations in the past that have precipitated unilateral changes,'' he said.

As to the uncertainty of China's political future, most operators appear remarkably fatalistic. But they are prepared to wait for the chance of sharing in one of the last, largely untapped oil reserves in the world.

Certainly China's current leaders are anxious to keep China's door open to foreign investment and reassure foreign companies that such a policy will continue into the long-term future.

What remains to be seen is whether Chinese leader Deng Xiaoping, who is largely responsible for the opening of China's door, will be able to ensure a smooth succession. Deng is working against time to eradicate the extreme-leftist and anti-foreign factions in the Chinese leadership.

''Our corporate outlook is that China looks stable for the next 20 years,'' Esso's Mr. Hudson said, indicating that Esso may know something that Deng does not.

Provided that there is continuation of China's pragmatic economic policies beyond Deng's reign, it would be unlikely that Chinese authorities would significantly alter the agreements made with foreign oil companies this year.

China is anxious to develop its offshore oil reserves as existing onshore sources of oil dwindle. Static production has meant that some oil refineries are working well below capacity, which peaked at 102-106 million tons in 1976.

An adequate supply of energy is vital to China's plans of economic growth. At present China's consumption of standard coal - its major energy source - at 600 million tons a year nearly equals Japan's. Yet China's economy is not even a third of its neighbor's.

Although China has massive coal reserves, if it is to reach anywhere the stated aim of quadrupling the value of its industrial and agricultural production by the turn of the century, it needs both the foreign exchange from oil exports and the oil itself.

The projected timing of production from the offshore wells is likely to coincide with a decline in worldwide sources of oil and an increase in demand.

According to economist Herman Franssen of the Paris-based International Energy Agency, China's oil should come on stream just as oil markets tighten and production begins to decrease in developed countries and the Soviet Union.

''By the end of the decade, when China's offshore oil production is likely to increase significantly, the current surplus in the world oil market will probably vanish, leaving excellent prospects for the newly found oil,'' he said.

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