China's biggest oil company has sold a half-interest in its Central Asia gas pipelines for a fraction of its cost, raising questions about its finances and the government's energy reform plans.
On Nov. 25, PetroChina, the listed arm of state-owned China National Petroleum Corp. (CNPC), announced the decision to sell 50 percent of its Trans-Asia Gas Pipeline Co. subsidiary for 15-15.5 billion yuan (U.S. $2.3-2.4 billion).
The sale was one of two PetroChina deals, including a share sale in the country's West-East gas pipelines last week. Both appeared aimed primarily at raising cash.
The Trans-Asia sale to a unit of China Reform Holdings Corp., a state-owned asset management firm, was first reported as a step in the right direction for CNPC and the government-controlled energy sector, which have been urged to demonopolize, restructure, and open up to investment for years.
"Most major integrated oil and gas companies do not own pipeline networks. Neither should PetroChina," said Sanford C. Bernstein & Co. analyst Neil Beveridge, as cited by Bloomberg News.
Despite the questionable implications of shifting assets from one state pocket to another, many comments focused on the benefit for PetroChina's finances, which have suffered from the global plunge in energy prices over the past year.
In the first nine months, PetroChina earnings fell 68.1 percent from a year earlier to 30.6 billion yuan (U.S. $4.7 billion), while the company's return on net assets dropped to a negative 5.6 percent.
But there has been less focus on the Trans-Asia Gas Pipeline assets themselves and the apparent beating that CNPC has taken on building the 1,830-kilometer (1,140-mile) cross- border connections to import gas from Central Asia.
Rising costs
While there appear to be no complete estimates for the three-stranded system from Turkmenistan through Uzbekistan and Kazakhstan to Xinjiang, a sampling of figures suggests that project costs have far exceeded the valuation of U.S. $4.8-billion (31 billion yuan) implied by the November sale.
Reports during construction from 2007 through 2009 put the cost of the first strand at U.S. $7.3 billion (47.1 billion yuan). Investment in subsequent strands have added billions more.
In 2010, a report from Uzbekistan on the second line estimated project costs through that country at U.S. $3 billion (19.3 billion yuan).
In the same year, Interfax cited a cost of U.S. $4 billion (25.8 billion yuan) for a branch linking cities in southern Kazakhstan.
In 2011, the Uzbek section of a third line was estimated at U.S. $2.2 billion (14.2 billion yuan), Interfax reported.
A fourth planned project through Kyrgyzstan and Tajikistan, known as "Line D," will cost U.S. $6.7 billion (43.3 billion yuan), the official Xinhua news agency said last year, although pipelines "under construction" are not included in the current sale, according to Moody's Investors Service.
In a research note, Moody's said the sale would be "credit positive" for CNPC, since it would "partially offset the negative impact from low crude oil and natural gas prices and help preserve its financial profile during the current industry downturn."
But CNPC also stands to lose half of the long-term profits it might earn from the Central Asia pipelines, which would typically be expected to have a long payback period with "thin profit margins," Moody's said.
Changed prospects
The sale, coming just six years after the Central Asia network opened, is a sign of the changed prospects for such projects, which are normally designed to last 30 or 40 years.
The dramatic drop in oil and gas prices, along with the cooling of China's economy, may be forcing CNPC to sell assets far below cost and long before costs can be recovered.
In the case of the Trans-Asia system, CNPC has never been in a position to earn profits from its investment, since it has been forced to supply imported gas to the domestic market at state-controlled rates.
"I suspect the reason it looks to be so cheaply valued is that it's a big money-losing operation," said Mikkal Herberg, energy security research director for the Seattle-based National Bureau of Asian Research.
In effect, there is no payback period for the Trans-Asia pipelines, because CNPC has been losing heavily on the gas import business from the start.
In 2011, for example, PetroChina lost 21 billion yuan (U.S. $3.2 billion) on imported gas sales, the official English-language China Daily said.
In the first half of 2015, losses reached 10.6 billion yuan (U.S. $1.6 billion), including sales of both pipeline and liquefied natural gas (LNG).
As a state-owned company, CNPC has been made to absorb costs of pipeline development and gas sales in the national interest of promoting energy security and the switch to cleaner fuels to reduce China's reliance on coal.
In some years, gas losses have been offset by profits from the monopoly's privileged position in the oil industry and domestic gas development. But with the decline in world oil and gas prices, PetroChina faces pressure on all sides.
Government regulation
Government regulation of gas prices has not helped.
After years of robust gas demand in coastal cities drove up LNG import prices, the high costs and weakening economy slowed growth to just 2.1 percent in the first half of this year.
The government responded last month with a sharp 28- percent cut in wholesale gas prices for nonresidential use to ease industry's burdens of complying with anti-smog efforts. But the move has left suppliers like PetroChina holding the bag with further losses on sales.
The announcement of the pipeline sale just five days later suggests the decision was motivated mainly by finances rather than energy sector reform.
"They're selling it to another arm of the state, which is telling you something about what kind of deal it is. It's finding a way to shore up CNPC's balance sheet," said Herberg.
Financial pressures also appear to be the main force behind the partial sale of the West-East gas system announced last week.
Under the deal, PetroChina is consolidating its three West-East pipelines into a single PetroChina Pipelines entity, in which it would retain 72.26 percent, the Financial Times said.
The remaining interest would be sold to a group including Baosteel, financial institutions and investors that acquired shares in an earlier 20-billion yuan (U.S. $3-billion) financing deal in 2013.
The entire West-East system is valued at 281.4 billion yuan (U.S. $43.4 billion), somewhat less than reported two weeks before.
State control
From an operational standpoint, the sales may not make much difference, since one state-owned company or another will likely remain in control of the pipelines due to agreements with transit countries and energy security concerns.
But more significant moves toward reform are possible if CNPC sells larger shares and eventually cedes control of the network.
The company's 20,500 kilometers (12,738 miles) of domestic pipelines carry 80 billion cubic meters (2.8 trillion cubic feet) of gas per year, or 45 percent of China's consumption, Reuters said.
Like the Trans-Asia deal, a larger domestic pipeline sale could recapitalize PetroChina and help to pay down debt, but it could also be a step toward setting up a separate pipeline management entity.
That would be a more meaningful reform that would open up pipeline access for independent producers and shale gas development, Herberg said.
Reuters said the government is expected to introduce "a sweeping reform package" for the energy sector within weeks, aimed at increasing efficiency and attracting private investment.
The government has been trying for over a year to promote a "mixed ownership" initiative to draw private capital into state-owned enterprises (SOEs). But the response has been poor because the investment opportunities fall far short of privatization as long as the state stays in control.
That could change if the government reform package clears the way for more asset sales, competition and comprehensive market pricing, but past decontrol measures have been limited to avoid social risks.
Even if the government is ready to take big steps, the outlook for low energy prices is likely to offer poor prospects for profits, so that losses may have to be buried or subsidized in the pipeline system for years.