Technical Tuesdays

How China Oil Inc. Profits from Conflict

How China Oil Inc. Profits from Conflict

Home to vast fishing areas, major shipping lanes and huge crude oil and natural gas reserves – it’s not difficult to understand why so many conflicts start in the South China Sea region.

China, the largest player in Asia has a lot at stake in the hotly contested region and it’s leveraging it’s huge state-owned enterprises (SOEs) to take over.

SOEs are companies that are under direct control of the government and traditionally focus on national priority sectors, such as natural resources, utilities, telecommunications and defense. Often they pursue public service before profit, which can hurt their bottom line.

State-owned oil companies, for example, have seen dwindling profits. Compared to other Chinese SOEs shown in the graph below, China National Offshore Oil Company (CNOOC) – the country’s leading oil producer – produces little profit.

The South China Sea’s vast oil reserves could be a convenient solution for CNOOC’s underperformance.

What’s wrong with CNOOC?

CNOOC is spoilt rotten.

The Chinese government showers CNOOC with state-owned privileges like exclusive energy rights, limited competition and access to political influence. In return for special treatment, SOEs like CNOOC have to work towards realizing the Chinese governments’ goals, which doesn’t always rhyme well with maximizing profits. CNOOC, for example, had to share the responsibility of maintaining a stable oil supply in China.

The government’s heavy hand has made the SOE inefficient, which has decreased output.

Lower output means lower revenue, which is exactly what CNOOC has seen quarter-after-quarter since 2014.

The solution to CNOOC’s revenue woes

Access to the South China Sea’s energy reserves could provide CNOOC with a revenue boost.

The CNOOC 981 oil rig (see above) was a first step towards unilateral deep-sea oil exploration in the disputed South China Sea. In recent years, the company has started to focus more on developing its deep-sea exploration skills to conform to the strategy of the Chinese government.

As local oil and gas demand rises, the CNOOC has already struck deals with energy companies South Korean SK Innovation Co and Canadian Husky in March and April 2017 respectively. These deals will help CNOOC develop much needed reserves.

These partnerships resulted in a net profit of CNY 16.25 billion (US$2.57 billion) in the first half of 2017, while they recorded a net loss of CNY 7.74 billion (US$1.22 billion) a year before.

The Chinese government’s territorial claims in the South China Sea will continue to enhance CNOOC’s position in the sea.  After all, the country wants to gain control of over 80 percent of the South China Sea area.

The coming years may show that public service can be profitable for CNOOC.