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Interview

with Chen Wei Dong, Chief Energy Economist, China National Offshore Oil Company Limited. (CNOOC Ltd.)

23.03.2012 / Energyboardroom

Mr. Chen, CNOOC implemented a strategy of technological innovation as one of its core strategies in 2004. Today, its technological innovation platform consists of CNOOC Engineering Technology Center, key laboratories of CNOOC, national technology centers and postdoctoral stations. As head of research, can you begin by expounding on how CNOOC has refined its approach to R&D over your years with the organization?

CNOOC is quite different, in many ways, from its two ‘big bothers’—China’s other two major national oil companies. This difference is visible, for example, in the organization’s approach to innovation.

CNOOC was built, from the beginning, as a special vehicle for cooperation with foreign oil players. At the time that this company was founded in the early ‘80s, the Chinese did not yet know how to work with IOCs. China had just opened up, and CNOOC was a model, in the offshore oil sector, for cooperation and joint venture with international partners. In contrast, a company like CNPC did everything it could to grow on its own.

CNOOC offered its hand to the foreign oil industry, and said, “We need your capital; we need your technologies.” In turn, the international oil industry was interested in China’s resource potential: they believed that perhaps another Persian Gulf or Gulf of Mexico could be found offshore in China.

This was the starting point: our foreign partners transferred technology to our organization; they brought cutting-edge equipment into the country; they even offered training: I was myself quite extensively trained by Exxon. Likewise, many of my CNOOC colleagues were trained either by the Exxon organization or other majors like Shell and BP.

CNOOC is the first Chinese company that learned how foreign oil enterprises work. We learned the international definition and understanding of operatorship, services, etc. We also began to learn how to conduct R&D in this field.

You mentioned our research institute. One segment of this institute is in Beijing, and is concerned with upstream: exploration, development, and production—“routine” works; not much innovation is involved in the their efforts.

On the other hand, I was in charge of our service subsidiary COSL’s research department for three years. The principal part of innovative work within CNOOC is geared towards the service sector. We have innovated in logging and drilling. This is also a matter of our history: for instance, we began our research programs in logging in the early 80s—we have accumulated a wealth of knowledge in this field.

In terms of drilling, we have developed our first deepwater platform and are now readying for our first deepwater well. But from my perspective, this is not innovation: this is assembly.

Ever since CNOOC Ltd. and COSL were publically listed in Hong Kong, we have steadily increased our R&D budget. We are struggling with a bit of a philosophical question: should we, as CNOOC, focus solely on our own business, or conduct R&D for the greater sake of the country? If we look at the evolution of the IOCs, their growth has been driven by very much focusing on their own interests: when they develop some technology or equipment that is valuable on the market, they guard it very closely.

I remember, for example, some training I received from Exxon circa 1986. At the time, each of the IOCs had developed proprietary computer systems, and they were extremely secretive about their technology. I needed very high security clearance to even enter the room that housed the workstations. When the technology became widely available, they immediately cut their programs and moved on to something new.

Today, it is the services companies that put more emphasis on physical innovation—in logging, seismic, drilling, or what have you. It is no more the oil companies that lead in R&D. Oil companies focus on the long term, and the big picture: the broader set of technology, rather than focusing on single technological niches like logging. They look at how to integrate, and how to meet the challenges of the future.

Chinese oil companies, given this reality, are in a disadvantaged position. If we look around the world, major import countries almost always have either public, or privately owned, oil companies. This is because such companies are on the lookout for additional buying channels and opportunities for securing oil and gas. On the other hand, most of the major oil producer countries have NOCs that are totally state-owned—because, for them, income from their oil industries is paramount within their economy and state budget.

Before 1993, China was a pure oil exporter. Today, it is a major importer—over 56% of our oil consumption, last year, can be attributed to imports. And yet, our oil companies are state-owned. Furthermore, they are integrated: E&P, services, equipment manufacturing, trading, and etc. are all part of single organizations. Within this kind of diversified model, R&D needs to be carefully budgeted across the business. This means that upstream oil companies are managing the budget of service companies. As I mentioned earlier, innovation in our field usually comes from the service companies; hence, Chinese service companies’ ability to innovate is limited. Simply put, this is not the right way to work.

For IOCs, the trend is very clear. They are becoming more and more focused on upstream; some IOC majors are cutting or downgrading, for example, their activities in refining or retail. The national oil companies in producer and export countries, on the other hand, prefer more local content. They seem to be taking on the Chinese model. But the Chinese model is not right for China now a day, as an importer country. Will China go the way of the IOCs? It is not clear yet.

Some Chinese managers, and government officials, tend to think that integration is the strength of our NOCs. From my point of view, integration is our greatest weakness. I recently heard a keynote address from one of CNPC’s leaders. The moderator remarked that this man was at the head of 1.6Mn employees! That is roughly the entire population of Qatar! This is no way to move quickly, or to foster innovation.

The Chinese oil industry is fourth in the world in terms of barrels produced per day—we generate approximately 4Mn BPD. And yet, there is almost no technology invented by the Chinese that is currently applied globally. If we take all of China’s national oil companies together, their investment into R&D is likely beyond that of the IOCs. Why is it that we have not created any leading technology in this industry? I am not proud of this. You echoed this opinion in a recent interview with the business magazine Caijing: you stated that the monopolistic approach that China takes to oil & gas development is hampering the growth of critical emergent energy sectors. You pointed out that in the U.S., there are about 8000 operational oil & gas companies—by way of contrast, in China, there are only a handful of organizations with licenses for hydrocarbon exploration. You also pointed out that the high number of competitors in the U.S. creates a healthy environment for innovation.

Indeed, this is precisely why America is undergoing its shale gas revolution! I have written several articles on this point. What is driving this revolution? First, free competition in the market. Second, entrepreneurial spirit. Third, the services market in America is very mature. Fourth, there are very strong capital markets.

It would seem that China is not lacking, at least, in capital.

That is correct. In fact, we potentially have the right conditions here, in general, for a shale revolution of our own—but the spirit is different. Many people still believe in a ‘United China.’ They believe in the entire country working together to make a breakthrough on some single point. This line of thinking is no longer effective; it is no longer efficient.

In this line, you mentioned earlier that CNOOC is not sure whether it should conduct research for the sake of its own business or for the sake of advancing the country at large. Does this mean you believe that CNOOC should, indeed, be more self-interested as an enterprise?

Yes. I do believe that.

With these structural and attitudinal challenges, do you believe that China will be able to replicate the shale gas revolution of North America?

I participate very deeply in this discussion. I was recently participant on a report on how to develop China’s shale resources, which has been sent to the desk of top leaders. And the outlook is positive: I think China is on the verge of releasing a breakthrough policy on shale gas quite soon. Officials will significantly open up the industry—which is what we need to succeed.

We must develop the domestic market, or face significant difficulties. Look to the figures: China produces 4Mn BPD of oil, but consumes 9Mn BPD. That is a gap of 5Mn. Chinese companies have acquired a wealth of resources from outside of the country, but the fact is that the largest share of our imports comes from trading. Only a small percentage of the oil that reaches China from abroad is secured by our NOCs. Company growth, and energy supply security, are not the same. These are two trends on different tracks. And yet, ten years ago—and even now—many people think that the Chinese are venturing to international markets to secure supply for the domestic market. This is not true!

The figures certainly show that shipping the equity barrels back home is not the NOCs’ principal aim in foreign markets. Many believe that a stronger reason for Chinese NOCs to go abroad is learn more about international E&P approaches. For example, CNOOC’s Chesapeake deal is one of the most iconic overseas acquisitions made by a Chinese NOC in recent memory. It is a particularly poignant instance of the maturation and development of China’s national companies, especially in juxtaposition to the failed bid for Unocal just a few years ago in 2005. In addition to adding value for the organization as an asset, the Eagle Ford shale play should teach CNOOC much about the international community’s approach to shale development. Would you agree?

Actually, I disagree with this viewpoint. This is a proliferation of this ‘United China’ thinking, that we as business people are moving away from. Shale gas extraction technology is invented, operated, and managed by service companies—as we have mentioned—not by the oil company. Chesapeake, for example, is an oil company, not a service company. On the contrary, it employs service companies to do the cutting-edge work. Why buy a part of Chesapeake’s shale asset to learn about the technologies in use there? We can spend much less money, and take on much less risk, to hire the services company to come and provide the same work here. We went to Eagle Ford—and, to speak of larger trends, Chinese NOCs are going outside China—in order to grow our business. We found that Chesapeake could benefit from our investment, and, because of the mature approach in the North American market, our profit margins could be higher. It is a matter of pure business! It is not a matter of bringing knowledge back to the country.

The evolution of Chinese businesses interestingly mirrors the recent history of the world. After World War I, a ‘winner is king’ approach was adopted, wherein the winners of the war felt they had the innate right to persecute the losers, to take their land, to impose large penalties, etc. World War II, subsequently, began in large part because Germany—a loser in World War I—was not pleased with such an approach. And, after World War II, the order of the world was reorganized by national sovereignty: that is, country interests are the highest objects, and they should not be imposed upon by the loss of a war. This began the conception of ‘country is king’ rather than ‘winner is king.’ War penalties should be imposed only by one-on-one negotiations; winners have the duty to help losers, and losers retain their land.

Today, the trend has shifted again. Today, human rights—the rights of individuals—are higher than country rights. The Chinese have not yet developed this notion as completely as the West: but it will guide our future direction.

Oil & Gas ties into these concepts because before, we believed that if we hold on to our reserves, then we would be secure. This is no longer the case. For example, if we own reserves in Libya, can we move them to China in the midst of humanitarian crimes? Absolutely not; the world would not allow it. Mr. Chen, returning to the energy sector for a final question, we would like to discuss the future. China today is a net importer of all major kinds of energy—even coal, which many believed the country would never have to import. The country is also famously a major polluter. How do you believe China’s energy landscape will change over the next five-ten years, and what will be the role of CNOOC in helping to drive this change?

China is now the leading energy consumer in the world, and its status as such will remain for the long-term, foreseeable future. There is no doubt about that.

After the industrial period, energy consumption became directly related to quality of life. The more energy consumed, the better life a country could provide for its people. There is also no doubt about this. China is growing, and the Chinese want to improve their life standards. Energy use, therefore, will continue to grow.

However, the Chinese energy structure is the highest CO2-containing energy structure in the world, due to our 70% reliance on coal within our energy matrix. Worldwide average gas consumption is about 24%; in China, it is between 3-4%. We understand that gas is the cleanest major, reliable energy source available. For sure, our country will improve our gas ratio—but it is a difficult challenge.

Firstly, in terms of conventional gas reserves, China is not a rich country. Conversely, it is estimated that China has a huge unconventional base—but we are just starting exploration in this niche. For instance, we began our CBM activities more than 15 years ago, but many would say that this initial trial was a failure, despite favorable government policies. We need to do better this time.

CNOOC believes that gas will be increasingly important here, and that the gas industry has a bright future in China. We are the first in our country to say that, while oil & gas are of similar importance, we will emphasize gas. We said this over 20 years ago. In implementing our strategies in this respect, we began LNG importation; today, we are the major LNG importer in the country. 80% of LNG that comes into China arrives through our channels. We are also an active participant in shale gas exploration. We have discussed Chesapeake—this is just one indication that we believe shale gas is the future.

What is your final message to the international readers of Oil & Gas Financial Journal?

Do not be afraid of Chinese oil companies’ overseas investment. This trend is something that can elevate the entire industry. Our participation in the international oil business will increase the whole world’s supply. Chinese NOCs do not, and cannot, bring what they produce overseas back to China directly. This means that our participation in international projects will directly benefit local markets. Global supply grows more secure with our involvement; indeed, because of energy geopolitics, no single country can be secure unless the whole world is secure.

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