China Braces for Energy Changes

China's government is readying rules for private investment in the energy sector, but analysts expect only a partial easing of state controls.

On May 22, an unnamed official of the National Development and Reform Commission (NDRC) said the government will soon issue "specific guidelines" to draw private capital into state-controlled sectors.

The rules to be released by June 30 will cover investment in state-dominated industries including electricity, oil and natural gas, the official Xinhua news agency said.

The move follows ministry guidelines issued in April for private investment in transport, railway and health industries.

In February, the State Council ordered rules to be published in the first half of the year for sectors that have been largely closed, including municipal administration, finance, energy, telecommunications and education, Xinhua said.

The rule-making is the latest sign that the government is scrambling to launch long-term changes before new leaders take power after the Communist Party Congress next March.

The initiative is also aimed at spurring investment in the near term, as the government worries that slowing growth rates could continue to slide into an economic downturn.

"Allowing private firms to pour money into the railways, banking, energy and healthcare sectors will give a boost to the world's second-largest economy as the government shuns fresh fiscal stimulus," a Reuters report said.

Monopolized

But experts say that oil and gas present special problems of inertia, entrenched interest and economic impact in an industry that has been monopolized by state giants since the government restructured the sector fourteen years ago.

Analysts expect something less than a "big bang" of reforms that would transform the three-legged structure, based on state interests in China National Petroleum Corp.
(CNPC), China Petroleum & Chemical Corp. (Sinopec) and China National Offshore Oil Corp. (CNOOC).

"I think it's going to be very difficult," said Philip Andrews-Speed, a China energy expert at the German Marshall Fund of the United States.

"To create competition in energy where you've got very powerful state-owned energy companies that actually have stronger market power than they did in 1998 is going to be extremely difficult," he told RFA.

Andrews-Speed compared the challenge to that in Great Britain, where it took years to foster real competition after the industry was privatized in the 1980s.

Just releasing guidelines for private investment may do little unless the government loosens the hold of state companies over infrastructure, imports and resource assets, he said.

"It's almost going to do nothing because the entry barriers in the sector are high for private sector companies if you've got very powerful incumbents," said Andrews-Speed.

China's consumers may care only if private investment leads to lower prices through competition and increased supplies. So far, the government has been slow to change its price-setting controls for fuels, power and gas.

Although a big bang is still possible, time is running out for the present government to implement a sweeping reform package including industry restructuring, full market competition and decontrolled pricing.

But without major reforms, private investment may stall.

Across the board

The question is whether the new government will take on the entire task of creating competition across the board.

"This is going to be a big fight not only to do the restructuring but to see that the momentum of the reforms continues," Andrews-Speed said.

Analysts also draw a distinction between investment opportunities that are likely in the "upstream" of the petroleum industry, or exploration and production, and the "downstream," which includes refining, distribution and retail sales.

"I would tend to doubt that this is about allowing private investment in the upstream oil and gas industry,"
said Mikkal Herberg, research director for energy security at the Seattle-based National Bureau of Asian Research.

China already has structured arrangements for partnering in joint ventures with the big three oil companies that are similar to international practice, said Herberg.

Private investment in the downstream, particularly in retail sales and distribution, seems more likely. The government could set rules to encourage more distribution of gas, for example.

"The pipeline system for natural gas is so underdeveloped.

CNPC's and Sinopec's monopoly is slowing down the development of bigger markets for natural gas," Herberg said. Investment in sales of liquid petroleum gas is also possible.

Major projects

Broader participation of private investors may also speed major projects with the state-owned companies.

Last week, CNPC signed a framework agreement for a joint venture to develop China's third West-East gas pipeline, stretching some 5,000 kilometers (3,100 miles) from Xinjiang to Fujian province in the southeast, Xinhua said.

Partners in the 116-billion ($18.2-billion) project include Baosteel Group, the National Council for Social Security Fund (NCSSF) and the Urban Infrastructure Construction Investment Fund (UICIF).

The NCSSF manages China's social security funds, while the UICIF represents private investment interests in the infrastructure sector, China's central television CCTV said.

But a major question is whether more private investors will stake capital on the promise of competition without changes in state price controls.

"It would imply that at the same time you would be creating more flexible pricing arrangements," said Herberg.
"It should be enough for the investor to have some sense of security that pricing will justify the investment."

The government has been reluctant to scrap price controls on fuels for fear of stirring social unrest when market costs rise.

Price controls

While struggles with the state giants may be a challenge, the government's willingness to loosen its own price controls will be a major test.

Herberg expects decontrol to be gradual, perhaps with pilot programs, comparing the process to "feeling the stones while crossing the stream."

One problem is that private investors would probably be unwilling to accept the losses on fuel and power sales that state companies have absorbed under government controls in return for monopoly rights or subsidy payments later on.

"It's a very complicated bargain that takes place," said Herberg, including trade-offs over employment levels, management and policies.

"That's one of the things that makes transition toward a more market-oriented energy structure that much more difficult because you have to unwind pieces of these bargains that operate between the government and the big national oil companies," Herberg said.

Sinopec, for example, reported losses last year of 37.6 billion yuan ($5.9 billion) on refining operations due to state-controlled fuel prices and the high cost of crude oil, according to Xinhua.

Refining losses at CNPC's PetroChina unit were even larger, reaching 60.1 billion yuan, Reuters said.

Even if the government and private investors decide to leap into competitive markets at the same time, there are questions whether the financial sector will open simultaneously.

Andrews-Speed said China's banks have shown reluctance to finance the private sector.

"Unless you deal with that problem, Chinese companies are not going to be able to raise a lot of money to enter the game," he said.