China Oil and Gas Report Q4 2012

BMI View: While China is increasingly dependent on energy imports – particularly gas – owing to rapidgrowth in energy demand, there is considerable upside potential from its unconventional gas resources.A more open environment to foreign investment is needed in order to meet the ambitious productiontargets set by the state, especially if its vast unconventional gas resources are to be maximised. In themeantime, oil and gas demand could surprise to the downside if economic expansion comes underpressure.

The main trends and developments we highlight for China’s oil and gas sector are:

Much of the country’s upside production potential will come from increased production from fieldsyet to reach its peak capacity such as Tarim. Enhanced oil recovery (EOR) measures will also help tomaintain production levels at older fields such as PetroChina's Daqing and Sinopec's Shengli. Weexpect Chinese production to rise over the next few years, peaking at 4.48mn b/d in 2016 beforedeclining to 4.36mn b/d in 2021.

A slowdown in economic growth makes it unlikely for a reform in China's fuel price mechanism inthe short-term, as it could bring up domestic fuel prices and run counter to the government's aim tostimulate economic growth. This could decrease refiners' willingness to expand China's refiningcapacity, given the loss they are incurring from their downstream operations – a result of buyingcrude feedstock at high international prices and selling refined products at low state-mandated rates.

Hence, we forecast a slow rise in China’s refining capacity, from 10.4mn b/d in 2012 to 11.5mn b/dby 2016.

As a weak global economy and troubles in its export markets contribute to slower economic growth inChina, the rate of oil consumption growth is likely to decelerate as well. BMI forecasts that Chineseoil demand should reach 11.5mn b/d by 2016, a lower estimate than the 12.5mn b/d we had initiallyexpected. Consumption should grow to 13.3mn b/d by 2021.

A report by China's Ministry of Land and Resources has estimated China's technically recoverableshale reserves at 25.1trn cubic metres (tcm). This is significantly lower than the 36.1tcm estimatemade by the US Energy Information Administration (EIA) in April 2011. The discrepancy reflects thelimitations of resource estimations at such an early stage of appraisal. Further changes in reservesestimates are therefore likely as operators' understanding of China's various shale basins improves.

The ministry's report considered a number of barriers to realising this vast shale gas potential. Inparticular, it highlighted China's complicated geology and lack of domestic technological expertise. Inview of these challenges, we expect shale gas production to only slowly make its impact felt by 2018.Gas production will continue to grow, based on conventional and deepwater production, from anestimate of 110.8bn cubic metres (bcm) in 2012 to 133.40bcm in 2016.

Gas consumption is set to grow by the combination of economic growth, increasing use of gas ascleaner energy alternative and government policies tailored to encourage gas usage in industry andhouseholds. It could grow from an estimate of 145.9bcm in 2012 to 227.5bcm in 2016, rising furtherstill to 346.8bcm as cheap prices accelerate the use of domestic gas in households and industry.

Oil imports are expected to cost China some US$228.80bn in 2012, which could climb toUS$237.45bn in 2016. Net gas imports are expected to rise to 94.1bcm in 2016, costing someUS$43.7bn, using BMI base case assumptions. This suggests a total oil and gas import bill ofUS$281.10bn by 2016. At the time of writing we assume an OPEC basket oil price for 2012 ofUS$107.05/bbl, falling to US$99.10/bbl in 2013.