Internationalization strategies Of Chinese National Oil Companies
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Introduction 7
Chapter I. Literature review 9
1.1 Literature review 9
1.1.1 Studies on the theory of internationalization 9
1.1.2 Studies on state capitalism and the specific features
of Chinese internationalization strategy 12
1.1.3 Studies on internationalization of Chinese NOCs 14
1.1.4 Summary and research gap 16
1.2 Research question and objectives 17
1.2.1 Research strategy and the structure of the study 18
1.3 Summary of Chapter I 19
Chapter II. Methodology and theoretical study
of Chinese NOCs’ internationalization strategy 20
2.1 Determining the object of the study 20
2.2 Multiple-case study methodology justification 22
2.3 Validity and reliability of the research 24
2.4 Limitations of the research strategy 25
2.5 Summary of Chapter II 25
Chapter III. Empirical study 27
How to read the cases 27
Case 1. Strategic alliance with China Development Bank (Sinopec Group and CNPC) 28
Middle East 30
Case 2. Yadavaran field deal in Iran (Sinopec Group) 30
Case 3. Saudi Aramco and Sinopec
JV YASREF refinery in Yanbu city, Saudi Arabia (Sinopec Group) 34
The Americas 36
Case 4. Repsol Sinopec Brazil in Santos Basin, Brazil (Sinopec Group) 36
Case 5. Devon Energy, USA (Sinopec Group) 39
Africa 41
Case 6. Acquisition of Addax Petroleum (Sinopec Group) 41
China 44
Case 7. Exxon Mobile, Saudi Aramco, and Sinopec
JV refinery in Fujian Province (Sinopec Limited) 44
Case 8. Royal Dutch Shell in China (Sinopec Limited) 47
Executive summary 49
Findings and discussion 52
List of references 56
Appendix
Chapter I. Literature review 9
1.1 Literature review 9
1.1.1 Studies on the theory of internationalization 9
1.1.2 Studies on state capitalism and the specific features
of Chinese internationalization strategy 12
1.1.3 Studies on internationalization of Chinese NOCs 14
1.1.4 Summary and research gap 16
1.2 Research question and objectives 17
1.2.1 Research strategy and the structure of the study 18
1.3 Summary of Chapter I 19
Chapter II. Methodology and theoretical study
of Chinese NOCs’ internationalization strategy 20
2.1 Determining the object of the study 20
2.2 Multiple-case study methodology justification 22
2.3 Validity and reliability of the research 24
2.4 Limitations of the research strategy 25
2.5 Summary of Chapter II 25
Chapter III. Empirical study 27
How to read the cases 27
Case 1. Strategic alliance with China Development Bank (Sinopec Group and CNPC) 28
Middle East 30
Case 2. Yadavaran field deal in Iran (Sinopec Group) 30
Case 3. Saudi Aramco and Sinopec
JV YASREF refinery in Yanbu city, Saudi Arabia (Sinopec Group) 34
The Americas 36
Case 4. Repsol Sinopec Brazil in Santos Basin, Brazil (Sinopec Group) 36
Case 5. Devon Energy, USA (Sinopec Group) 39
Africa 41
Case 6. Acquisition of Addax Petroleum (Sinopec Group) 41
China 44
Case 7. Exxon Mobile, Saudi Aramco, and Sinopec
JV refinery in Fujian Province (Sinopec Limited) 44
Case 8. Royal Dutch Shell in China (Sinopec Limited) 47
Executive summary 49
Findings and discussion 52
List of references 56
Appendix
Beginning of the 21st century was the time when some major changes in the world’s economy took place. Developing countries started their impressive rise to world leadership, while gaining economic power and international influence. This process has been fuelled by different factors in Russia and China, that both belong to the largest developing economies in the world. In Russia, the progress was largely driven by its national oil companies, following the rise in oil prices. In China, foreign investment and manufacturing helped to boost the economy. However, these two countries share a lot of very important characteristics and trends.
First of all, both Russia and China share a socialist past and have a strong state, i.e. their governments exercise a very high degree of influence over many areas of the economy and own a lot of different enterprises within the so-called pillar industries. Second, both countries have established special umbrella organizations that united largest state-owned companies in various strategic industries to manage them more effectively. Also, a series of market reforms has been conducted to change the old-fashioned non-efficient state-owned enterprise (SOE) model and allow the companies be driven by market forces. One of the organizations established to boost the profitability of SOEs was China’s State-owned Assets Supervision and Administration Commission of the State Council (SASAC). It was created in 2003 and originally managed over 200 large holding companies and about 150,000 small enterprises. By 2013, the number of SASAC-controlled entities shrank to 117, partly due to sell-off and partly because some large- scale mergers took place. The list of the companies is not finalized yet and is expected to drop under 100 in the coming years. However, the largest portion of revenue, profit and assets is generated by only a handful of companies, among which national oil companies (NOCs) play the most prominent role. There are only two major NOCs in China, and the industry is very centralized. They are also the most actively internationalizing Chinese companies, just as their peers in Russia.
Today, oil accounts for almost 50% of energy consumed worldwide and it is the main source of revenue for many countries across all continents. Generally, oil companies can be divided into two categories: those owned by national governments (NOCs), and those owned by private investors (international-owned companies, IOCs, such as Shell, ConocoPhillips, etc.). National-owned companies posses 90% of world’s oil & gas reserves and account for 75% of production. Private international oil companies have 10% of worldwide reserves, but account for 25% of total output.
The role of NOCs has been growing over the last two decades. The composition of worldwide oil reserves ownership has been changing accordingly. Some of the largest NOCs by oil reserves, output and revenue are Chinese companies owned by the government. One of them is China Petrochemical Corporation (Sinopec Group) with its publicly traded subsidiary China Petroleum and Chemical Corporation Limited (Sinopec Limited). Sinopec Limited is the largest oil company in China by revenue ($440 billion in 2014) and one of the most active players in the fields of international alliances and M&A (Sinopec Annual Report 2014). While mostly owned by the government, it pursues a market-driven strategy trying to increase margins, secure higher profits and diversify risks. However, state support remains an invaluable resource for the company to attain its goals and grow further. The company has historically focused on the downstream sector of oil production and started to actively internationalize earlier than other major Chinese NOCs. In the mid-2000s the company had a greater need to go overseas in order to level its downstream operations with inputs, i.e. to have more crude oil to process. Although the company operates on its own, one should be able to see the State behind it and understand that Sinopec is a member of a large, SASAC-managed family, with other major NOCs belonging to it as well.
The other major oil company in China is China National Petroleum Corporation (CNPC) with $425 billion revenue in 2014 and its traded arm PetroChina. Sinopec, being the largest NOC out of two in terms of revenue, and the most actively internationalizing one, is the most representative company to study. Its operations and strategy is similar to and aligned with that of CNPC, and by focusing on Sinopec, we will be able to make generalizations for the whole industry.
First of all, both Russia and China share a socialist past and have a strong state, i.e. their governments exercise a very high degree of influence over many areas of the economy and own a lot of different enterprises within the so-called pillar industries. Second, both countries have established special umbrella organizations that united largest state-owned companies in various strategic industries to manage them more effectively. Also, a series of market reforms has been conducted to change the old-fashioned non-efficient state-owned enterprise (SOE) model and allow the companies be driven by market forces. One of the organizations established to boost the profitability of SOEs was China’s State-owned Assets Supervision and Administration Commission of the State Council (SASAC). It was created in 2003 and originally managed over 200 large holding companies and about 150,000 small enterprises. By 2013, the number of SASAC-controlled entities shrank to 117, partly due to sell-off and partly because some large- scale mergers took place. The list of the companies is not finalized yet and is expected to drop under 100 in the coming years. However, the largest portion of revenue, profit and assets is generated by only a handful of companies, among which national oil companies (NOCs) play the most prominent role. There are only two major NOCs in China, and the industry is very centralized. They are also the most actively internationalizing Chinese companies, just as their peers in Russia.
Today, oil accounts for almost 50% of energy consumed worldwide and it is the main source of revenue for many countries across all continents. Generally, oil companies can be divided into two categories: those owned by national governments (NOCs), and those owned by private investors (international-owned companies, IOCs, such as Shell, ConocoPhillips, etc.). National-owned companies posses 90% of world’s oil & gas reserves and account for 75% of production. Private international oil companies have 10% of worldwide reserves, but account for 25% of total output.
The role of NOCs has been growing over the last two decades. The composition of worldwide oil reserves ownership has been changing accordingly. Some of the largest NOCs by oil reserves, output and revenue are Chinese companies owned by the government. One of them is China Petrochemical Corporation (Sinopec Group) with its publicly traded subsidiary China Petroleum and Chemical Corporation Limited (Sinopec Limited). Sinopec Limited is the largest oil company in China by revenue ($440 billion in 2014) and one of the most active players in the fields of international alliances and M&A (Sinopec Annual Report 2014). While mostly owned by the government, it pursues a market-driven strategy trying to increase margins, secure higher profits and diversify risks. However, state support remains an invaluable resource for the company to attain its goals and grow further. The company has historically focused on the downstream sector of oil production and started to actively internationalize earlier than other major Chinese NOCs. In the mid-2000s the company had a greater need to go overseas in order to level its downstream operations with inputs, i.e. to have more crude oil to process. Although the company operates on its own, one should be able to see the State behind it and understand that Sinopec is a member of a large, SASAC-managed family, with other major NOCs belonging to it as well.
The other major oil company in China is China National Petroleum Corporation (CNPC) with $425 billion revenue in 2014 and its traded arm PetroChina. Sinopec, being the largest NOC out of two in terms of revenue, and the most actively internationalizing one, is the most representative company to study. Its operations and strategy is similar to and aligned with that of CNPC, and by focusing on Sinopec, we will be able to make generalizations for the whole industry.
The researched has revealed the following:
1. Both domestic and international economic policies of the PRC are the ultimate drivers for Chinese NOCs’ internationalization activity. As a result, their internationalization strategies are not only tied to, but also facilitated and directed by the government. This relationship shapes the strict top-down hierarchical structure of the strategies and leads to their having a clear algorithmic nature.
2. Internationalization activity of Chinese NOCs can be split into support activities (shared HR, political facilitation, state financing and so on), which are applied to all projects, and primary activities. Primary activities of various business units differ in each case and depend on the nature of particular deals.
3. Support activities mentioned above are the key factors that shape the internationalization strategies and lead the NOCs to undertake particular projects at the business unit level. The current strategy of Sinopec Group, Sinopec Limited, CNPC, and PetroChina (major Chinese NOCs) is the expansion strategy.
4. The expansion strategy manifests itself differently in different types of deals. To describe particular modifications of the strategy, Igor Ansoffs product-market framework can be employed.
5. To attain the objectives of expansion strategy, the so-called functional project strategies are developed and implemented: production strategy, financial strategy, and some other strategies, which are not covered in this research.
• Financial strategy is shaped at the support activities level.
• Production strategy is shaped differently for every given type of project and includes several dimensions:
❖ What entity is engaged in the deal, i.e. a 100% state-owned NOC (Sinopec Group, CNPC) or its traded arm (Sinopec Limited PetroChina), depending on the risk level (the higher the risk the more likely a 100% state-owned entity is the actor)
❖ What kind of legal form does the activity take (JV with majority/minority of shares, WOS)
Detailed layout of the particular factors that are taken into consideration when the production strategy is being formed can be found in Table 1.
It becomes evident that the internationalization strategies of Chinese NOCs should be studied at two levels: the corporate level that covers support activities, and the project level that describes primary activities. This can attributed to their specific structure, i.e. a 100% state- owned entity passes down the directives it received from the government to its traded arm, after which internationalization ‘manuals’ tailored to each particular case are developed. This approach can be applied to all state-owned companies functioning within industries considered strategic by respective governments.
China’s policy of energy security in the 1990’ has pushed local NOCs to develop outside of China, while vast cash deposits facilitated their progress. Next step was taken in the 2000’, when NOCs established their traded arms (Sinopec Limited and PetroChina) to increase efficiency and monetize on the domestic market.
The analysis of cases has revealed that there is a strategic alliance between Chinese state- owned banks, national oil companies and their traded arms, with distinctive role assigned to each member. The alliance in general balances between political and commercial interests, with the former mostly pursued by the state-owned Sinopec Group and CNPC, and the latter driving Sinopec Limited and PetroChina.
Despite being different legal entities, all Chinese NOCs are controlled by the government through a special body that provides the ultimate agenda. This leads to their having a shared strategy that has been revealed in this study.
Oil industry can be roughly divided into the upstream and downstream sectors. The upstream sector covers exploration and extraction of oil as well as the related technology, while the downstream sector is centered on refining, marketing and distribution. It can be easily deducted that the upstream sector has more strategic significance, because oil can be used without a refinery (e.g. sold as crude or refined by small grassroots factories), but refineries cannot run without oil supply. Quite unfortunate for the Chinese NOCs, there were late entrants in the international energy market and faced the challenge of securing resources. This forced them to internationalize into the high-risk areas of the world such as some parts of the Middle East or Africa.
The combination of high strategic significance of the upstream sector and high risk of the available options define the first level of the internationalization strategy of Chinese NOCs: overseas expansion is almost exclusively conducted by 100% state-owned entities, namely Sinopec Group and CNPC. Their traded arms, Sinopec Limited and PetroChina, are mostly responsible for the less risky and well-controlled domestic operations.
Different motives for internationalization lead to a variety in geographical locations. Downstream sector implies resources as the primary motive, and leads to expansion into countries that allow large-scale extraction of strategic resources by foreign NOCs. It happens that such countries have weak institutions and high political risk (Nigeria, Cameroon, Sudan, Iraq, Iran, Russia). There, Chinese NOCs may partner up with local governments or local NOCs to establish joint ventures or even invest into a wholly owned subsidiary. The choice depends on whether the host state is strong enough to secure the majority of shares in the JV or at least not allow the Chinese to create a WOS.
Technology can also drive expansion into downstream, especially when it has to do with challenging oilfields. In this case, geography does not play a significant role, unlike the choice of partner. Major IOCs or technologically developed ‘niche’ and service firms possess the desired technology, and Chinese NOCs agree to hold minority stakes in JVs with such enterprises (Brazil, USA, Canada).
Apart from the upstream sector, downstream sector has also become increasingly important for Chinese NOCs. As a part of the expansion strategy, it allows them to diversify, i.e. refine crude oil and sell new products in new markets. The amount of resources and the market size define the choice of host country for the downstream internationalization activity (Nigeria, Saudi Arabia, Russia). Whenever possible, the NOC tries to establish a WOS or a JV with a majority stake, but the particular form depends on whether the local state is strong (Russia) or weak (Nigeria).
Domestic internationalization activity is primarily driven by technology-seeking motives. Chinese NOCs represented by their traded arms engage in low-risk joint ventures with international oil companies or service firms that can bring in the necessary know-how and transfer it to their Chinese counterparts. Another motive is the creation of a seller lock-in situation, when a major oil supplier invests into a large refinery in China and signs a long-term contract. As a result, the supplier becomes dependent on the Chinese market and takes up significant fixed costs. All JVs on China’s soil are controlled by local companies that motivate their partners by allowing access to the immense domestic market.
The summary of the strategic framework is presented in Table 1.
The framework may also help us make assumptions about potential deals in various locations, e.g. Russia, a country with significant resources and large population, but high political risk and weak institutions. Our strategic framework implies that since the deal is to take place overseas, a 100% state-owned company will participate. The potential deal would be driven by resource-seeking or market-seeking motives, but the political and economic vulnerability of Russia implies that most probably the resource-seeking motive would take over as the more profitable option, given the weak domestic demand and the government’s need for investment (see case 2 on Iran). The counterpart would be the Russian government or a local NOC, and the deal would be financed by Chinese state-owned banks, Sinopec’s own capital or CDB, very likely through a loan-for-oil contract. Sinopec Group would attempt to establish a WOS or have the majority stake in the JV, but since Russia does not allow foreign companies to operate strategic assets alone, the Chinese party would have to agree to a minority share. However, the vulnerability of the Russian counterpart and the political/financial leverage would help the Chinese get a significant stake in a JV they would consider important enough.
A good illustration to the explanatory and predictive power of the resulting framework can be observed in the recent deal between Rosneft and Sinopec Group over the Russkoye and Yurubcheno-Tokhomskoye oil fields in East Siberia. The Russian company was looking for a partner to co-develop the fields in order to decrease the operational risks, and as a result a joint venture between Rosneft and Sinopec Group was established, the latter holding a significant stake, but not the majority (49%).
The framework could be further employed by Russian companies to:
1) Asses and predict Chinese NOCs’ international behavior
2) Develop attractive investment projects for Chinese NOCs domestically and abroad
3) Develop more efficient internationalization strategies that would cover both primary and support activities and involve co-operation between state-owned banks, NOCs, and the government.
1. Both domestic and international economic policies of the PRC are the ultimate drivers for Chinese NOCs’ internationalization activity. As a result, their internationalization strategies are not only tied to, but also facilitated and directed by the government. This relationship shapes the strict top-down hierarchical structure of the strategies and leads to their having a clear algorithmic nature.
2. Internationalization activity of Chinese NOCs can be split into support activities (shared HR, political facilitation, state financing and so on), which are applied to all projects, and primary activities. Primary activities of various business units differ in each case and depend on the nature of particular deals.
3. Support activities mentioned above are the key factors that shape the internationalization strategies and lead the NOCs to undertake particular projects at the business unit level. The current strategy of Sinopec Group, Sinopec Limited, CNPC, and PetroChina (major Chinese NOCs) is the expansion strategy.
4. The expansion strategy manifests itself differently in different types of deals. To describe particular modifications of the strategy, Igor Ansoffs product-market framework can be employed.
5. To attain the objectives of expansion strategy, the so-called functional project strategies are developed and implemented: production strategy, financial strategy, and some other strategies, which are not covered in this research.
• Financial strategy is shaped at the support activities level.
• Production strategy is shaped differently for every given type of project and includes several dimensions:
❖ What entity is engaged in the deal, i.e. a 100% state-owned NOC (Sinopec Group, CNPC) or its traded arm (Sinopec Limited PetroChina), depending on the risk level (the higher the risk the more likely a 100% state-owned entity is the actor)
❖ What kind of legal form does the activity take (JV with majority/minority of shares, WOS)
Detailed layout of the particular factors that are taken into consideration when the production strategy is being formed can be found in Table 1.
It becomes evident that the internationalization strategies of Chinese NOCs should be studied at two levels: the corporate level that covers support activities, and the project level that describes primary activities. This can attributed to their specific structure, i.e. a 100% state- owned entity passes down the directives it received from the government to its traded arm, after which internationalization ‘manuals’ tailored to each particular case are developed. This approach can be applied to all state-owned companies functioning within industries considered strategic by respective governments.
China’s policy of energy security in the 1990’ has pushed local NOCs to develop outside of China, while vast cash deposits facilitated their progress. Next step was taken in the 2000’, when NOCs established their traded arms (Sinopec Limited and PetroChina) to increase efficiency and monetize on the domestic market.
The analysis of cases has revealed that there is a strategic alliance between Chinese state- owned banks, national oil companies and their traded arms, with distinctive role assigned to each member. The alliance in general balances between political and commercial interests, with the former mostly pursued by the state-owned Sinopec Group and CNPC, and the latter driving Sinopec Limited and PetroChina.
Despite being different legal entities, all Chinese NOCs are controlled by the government through a special body that provides the ultimate agenda. This leads to their having a shared strategy that has been revealed in this study.
Oil industry can be roughly divided into the upstream and downstream sectors. The upstream sector covers exploration and extraction of oil as well as the related technology, while the downstream sector is centered on refining, marketing and distribution. It can be easily deducted that the upstream sector has more strategic significance, because oil can be used without a refinery (e.g. sold as crude or refined by small grassroots factories), but refineries cannot run without oil supply. Quite unfortunate for the Chinese NOCs, there were late entrants in the international energy market and faced the challenge of securing resources. This forced them to internationalize into the high-risk areas of the world such as some parts of the Middle East or Africa.
The combination of high strategic significance of the upstream sector and high risk of the available options define the first level of the internationalization strategy of Chinese NOCs: overseas expansion is almost exclusively conducted by 100% state-owned entities, namely Sinopec Group and CNPC. Their traded arms, Sinopec Limited and PetroChina, are mostly responsible for the less risky and well-controlled domestic operations.
Different motives for internationalization lead to a variety in geographical locations. Downstream sector implies resources as the primary motive, and leads to expansion into countries that allow large-scale extraction of strategic resources by foreign NOCs. It happens that such countries have weak institutions and high political risk (Nigeria, Cameroon, Sudan, Iraq, Iran, Russia). There, Chinese NOCs may partner up with local governments or local NOCs to establish joint ventures or even invest into a wholly owned subsidiary. The choice depends on whether the host state is strong enough to secure the majority of shares in the JV or at least not allow the Chinese to create a WOS.
Technology can also drive expansion into downstream, especially when it has to do with challenging oilfields. In this case, geography does not play a significant role, unlike the choice of partner. Major IOCs or technologically developed ‘niche’ and service firms possess the desired technology, and Chinese NOCs agree to hold minority stakes in JVs with such enterprises (Brazil, USA, Canada).
Apart from the upstream sector, downstream sector has also become increasingly important for Chinese NOCs. As a part of the expansion strategy, it allows them to diversify, i.e. refine crude oil and sell new products in new markets. The amount of resources and the market size define the choice of host country for the downstream internationalization activity (Nigeria, Saudi Arabia, Russia). Whenever possible, the NOC tries to establish a WOS or a JV with a majority stake, but the particular form depends on whether the local state is strong (Russia) or weak (Nigeria).
Domestic internationalization activity is primarily driven by technology-seeking motives. Chinese NOCs represented by their traded arms engage in low-risk joint ventures with international oil companies or service firms that can bring in the necessary know-how and transfer it to their Chinese counterparts. Another motive is the creation of a seller lock-in situation, when a major oil supplier invests into a large refinery in China and signs a long-term contract. As a result, the supplier becomes dependent on the Chinese market and takes up significant fixed costs. All JVs on China’s soil are controlled by local companies that motivate their partners by allowing access to the immense domestic market.
The summary of the strategic framework is presented in Table 1.
The framework may also help us make assumptions about potential deals in various locations, e.g. Russia, a country with significant resources and large population, but high political risk and weak institutions. Our strategic framework implies that since the deal is to take place overseas, a 100% state-owned company will participate. The potential deal would be driven by resource-seeking or market-seeking motives, but the political and economic vulnerability of Russia implies that most probably the resource-seeking motive would take over as the more profitable option, given the weak domestic demand and the government’s need for investment (see case 2 on Iran). The counterpart would be the Russian government or a local NOC, and the deal would be financed by Chinese state-owned banks, Sinopec’s own capital or CDB, very likely through a loan-for-oil contract. Sinopec Group would attempt to establish a WOS or have the majority stake in the JV, but since Russia does not allow foreign companies to operate strategic assets alone, the Chinese party would have to agree to a minority share. However, the vulnerability of the Russian counterpart and the political/financial leverage would help the Chinese get a significant stake in a JV they would consider important enough.
A good illustration to the explanatory and predictive power of the resulting framework can be observed in the recent deal between Rosneft and Sinopec Group over the Russkoye and Yurubcheno-Tokhomskoye oil fields in East Siberia. The Russian company was looking for a partner to co-develop the fields in order to decrease the operational risks, and as a result a joint venture between Rosneft and Sinopec Group was established, the latter holding a significant stake, but not the majority (49%).
The framework could be further employed by Russian companies to:
1) Asses and predict Chinese NOCs’ international behavior
2) Develop attractive investment projects for Chinese NOCs domestically and abroad
3) Develop more efficient internationalization strategies that would cover both primary and support activities and involve co-operation between state-owned banks, NOCs, and the government.
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