The Weekly Wrap — June 29, 2012 (Part II)

The four squabbling fiefdoms in China’s shale-led political transition

By Sophie Lu

The writer is a consultant with Regester Larkin Energy

For those tracking China’s factional politics in this year of momentous transition, a telling indicator will be a coming brawl over its apparently gargantuan shale gas resources. In the arena of political power, where China’s shale goes, so shall China.

Shale gas — locked into barely porous rock deep within the Earth, and released through a method called hydraulic fracturing, or fracking for short — has fundamentally disrupted the global energy balance, and changed geopolitics: American shale gas has undermined Moscow’s political influence in Europe by reducing the dominance of Russian natural gas, and reverberations in the Middle East and elsewhere are likely in coming years.

The shakeup appears especially likely to strike China, which has the world’s largest estimated reserves of shale gas. In August, the government will hold its second auction of shale reserves, and already we can make out the shape of a titanic struggle for them.

The shale brawl mirrors China’s larger political currents. In the Fall, China will undergo a once-in-a-decade transition of power in which seven out of nine members of the country’s top decision-making body, the Standing Committee, will be replaced. The struggle for who ends up on top pits two competing factions — the reformists against the statists. Who are they, and what makes them tick? And how will their destiny be reflected on China’s shale gas patch?

First, take a look at these two charts. The first juxtaposes the recent trajectory of U.S. shale gas production with China’s own plans — Beijing, as you see, hopes by 2020 to reach what the U.S. was producing four years ago.

This second chart details China’s year-by-year plans.

Go to the Jump for the rest of China’s shale brawl.

The reformists — technocrats led by President Hu Jintao and Prime Minister Wen Jiabao — want further economic reforms, including a stronger private sector, liberalized market prices, and minor democratization of lower-level elections. Yet this promotion of reform reflects not ideology, but power politics: The more the reformists diversify the country’s economic players, the more they solidify their own position against rival centers of power.

In contrast, the statists — by and large local and provincial leaders — seek to preserve the status quo. They support a military-police-state complex that controls civil society, a central government that sticks to fiscal and monetary policy, and provincial governments that have relative authority to run themselves. All in all: a continued comfortable perch atop the economic food chain.

Beneath that factional overlay, the battle becomes fragmented. It pits four bastions of power within the Communist Party leadership against one another (see list below). The faction that wins will dominate both shale and politics.

As of now, the reformists appear to be on the ascent with a platform of liberalizing the energy market, creating competition, and driving down retail natural gas prices. In January, they won a major victory when China’s State Council categorized shale gas as an “independent resource.” This powerful political gesture signaled that, as far as Beijing is concerned, shale gas falls outside the purview of the traditional oil and gas sector, and is therefore open game, even for private actors. The battle has begun.

Here is a map for understanding the four shale politics power centers:

The National Oil Companies: China’s national oil and gas companies — CNOOC, PetroChina and Sinopec — are the political heavyweights in the battle over its shale future. In addition to their colossal income and economic importance to Beijing, they control national pipeline networks. In other words, they decide who can and cannot ship oil and gas across the country. Yet their influence has decreased recently with a rise in gasoline prices. China’s energy producers have long struggled with market incongruence — they are able to spend and earn what they want exploring for and extracting oil and gas, but the state strictly limits the retail price for the resulting gasoline and other products. Earlier this year, the companies won a major victory when Beijing agreed to a staged 11 percent increase in gasoline prices. But the cheering was short-lived: The higher prices at the pump triggered a backlash from the public and from populist government factions.

Provincial Level Governments: Contrary to popular perception, it only seems that Beijing and the national oil companies are all-powerful. A large majority of China’s shale fields are situated in traditionally powerful provinces that — already wielding decisive influence over how infrastructure projects are allocated and funded — have significant leverage and interest in gaining stakes in shale gas development. Those with the most to gain — and lose — are north-central and -eastern provinces including Hebei, Shaanxi, Shandong and Shanxi, all of which have large and growing urban populations and energy-hungry industries. They are the venues for shale gas basins that may soon get much more attention, so write these down: Bohai, North China, Ordos and Songliao.

Another set of provinces, Sichuan and Chongqing, have an interest in controlling stakes in the promising Sichuan Basin. But recent politics has undermined their influence, namely the sensational fall of Chongqing party boss Bo Xilai, a prominent leader of the statist faction. Bo’s fall has shifted the balance of power in favor of energy-hungry and traditionally reformist southeastern provinces such as Guangdong and Shanghai.  

Coal Companies, utilities, and regional oil and gas producers: Beijing’s reformers, by opening up the field, have gained latitude to trade shale resources for the support of the powerful heads of state-owned coal companies, utilities, and second-tier oil and gas companies, all of which hold voting seats in the National People’s Congress. However, up to 75 percent of China’s shale gas resources are on land already under license by Sinopec and PetroChina. In addition, some shale gas basins overlap with significant coal beds owned by mining giants such as Datang, Fushun Mining, Huadian, Huaneng and Shenhua, which are bound to put up a fight for shale gas development rights.

Another category of shale-gas contenders are regional or smaller national state-owned petrochemical companies such as Sinochem, Henan Coal Seam and Shaanxi Yanchang. Although second-tier companies, they still enjoy significant political clout.

Central Government Factions: The reformists seem to currently hold the advantage, but that is a shifting dynamic. Even if the reformists succeed in opening up the field to new players, they still could face resistance by the other forces. For example, how will smaller, private actors championed by the reformists get their gas to market when the big incumbent oil companies control the national pipelines? The pipeline access issue is likely to grow in importance as shale gas production starts scaling up in the next five years. This is no academic question — in recent years, China’s independent wind-power developers have found themselves stranded from consumers by territorial powerful state-owned grid companies.

WHAT WILL CHINA’S SHALE FUTURE LOOK LIKE?

The outlines of the brawl are already visible. So far, auction organizers say that between 30 and 200 companies have registered to bid. But they have indicated that none of the three majors — CNOOC, PetroChina and Sinopec — has yet registered. If that is true, then reform faction leaders may have arrived at a quiet arrangement allowing the national oil companies to keep their existing shale gas fields. As evidence, Petro-China has targeted production of 1 billion cubic meters per year of shale gas by 2015, while Sinopec is looking to produce 1 to 2 billion cubic meters, which in combination is about half of China’s national shale gas production target for the year. Beijing’s reformists are likely to use the rest of the resources to buy the loyalty of key Party leaders in politically strategic provinces and enterprises. As for the private companies, it is not clear how they will make out. If the reported figures are accurate, then only about 1 percent of the registered bidders are private, and the winners are likely to be those with strong political connections. Companies to watch: Fortune Oil and Kunlun Energy, both of which are backed by have large state-owned shareholders (in the case of Kunlun, the champion is PetroChina).