Filling Up The Chinese Tank

BMI View: China looks set to continue attempts to diversify its oil imports, with recent statements by the country's foreign minister highlighting the country's rising appetite for Latin American crude. However, while we believe that China's actions will pay off in the long-run, the poor business environment in Brazil and Venezuela suggest that rewards from an increased footprint in these countries could be delayed.

Recent statements by China's foreign minister further highlight the country's desire to increase its access to Latin American crude oil. However, while we see this as a way for China to diversify its natural resource base, and mitigate exposure to political instability in a number of its major Middle Eastern and African suppliers, Latin American crude comes with its own risks. While the countries flagged by China as potential partners have among the biggest below-ground potential in the region, they also have considerable above-ground risks.

China Continues To Diversify Supplies

Heading Higher Even On Slower Economic Growth
China - Crude Production, Consumption & Net Crude Imports

Filling Up The Chinese Tank

BMI View: China looks set to continue attempts to diversify its oil imports, with recent statements by the country's foreign minister highlighting the country's rising appetite for Latin American crude. However, while we believe that China's actions will pay off in the long-run, the poor business environment in Brazil and Venezuela suggest that rewards from an increased footprint in these countries could be delayed.

Recent statements by China's foreign minister further highlight the country's desire to increase its access to Latin American crude oil. However, while we see this as a way for China to diversify its natural resource base, and mitigate exposure to political instability in a number of its major Middle Eastern and African suppliers, Latin American crude comes with its own risks. While the countries flagged by China as potential partners have among the biggest below-ground potential in the region, they also have considerable above-ground risks.

China Continues To Diversify Supplies

In recent years, rising domestic demand in China coupled with political instability in a number of Middle Eastern and African producers has seen the country increasingly attempt to diversify its crude oil imports. We believe that weaker economic activity and a slowdown in downstream expansion will temper the extent of China's crude oil demand. Nonetheless, with domestic crude production growth stagnating and potentially falling towards the tail-end of our 10-year forecast period, we forecast net crude imports to rise from an estimated of 5.6mn b/d in 2013 to 7.7mn b/d by 2023.

Heading Higher Even On Slower Economic Growth
China - Crude Production, Consumption & Net Crude Imports

This has already prompted China to stake out a foothold in Latin America in an attempt to source crude imports. This trend looks set to continue, with Chinese Foreign Minister Wang Yi having recently indicated 'potential for further oil cooperation' in the region, specifically stating his country's interest in Brazil and Venezuela as potential partners.

…But Latin America Has Risks As Well As Rewards

That said, China's choice of countries with which to set up long-term oil cooperation partnerships - namely Brazil and Venezuela - suggests some risks. Venezuela is by far the more problematic of the two. Despite China having already pumped substantial funds into the Latin American country through its oil-for-loans programme, a misappropriation of these monies and red-tape has seen continued delays in bringing projects online, and crude oil production has failed to head higher in recent years ( see 'PdVSA Looking Increasingly Precarious', November 20). Despite having the largest proven oil reserves in the world, we continue to expect that a poor regulatory environment will temper Venezuela's output substantially, such that it remains well below state-owned PdVSA's ambitious target of 5.8mn b/d by 2018. This implies that China may not receive the full amount of crude that it hopes to source from Venezuela.

While Brazil is on an entirely different scale than Venezuela in terms of the extent of its operating environment difficulties, we note that the country's production has been delayed due to various above-ground factors, and we cannot rule out further such instances. This suggests that for China, and especially the two companies - China National Offshore Oil Corporation (CNC) and China National Petroleum Corporation (CNPC) - that took stakes in the Libra block during Brazil's first pre-salt licensing round, Brazil is no panacea. Aside from the poor licensing terms, Brazil also suffers from substantial red-tape, cumbersome local content requirements and a regulatory system which places a substantial financial burden on state-owned Petrobras and could slow oil development ( see 'Petrobras: Structural Weaknesses Prompt Cautious Stance', September 6, 2013).

In some ways, China is facing a vicious circle in its attempts to expand its presence in the Latin American oil and gas space. The very fact that these countries so eagerly embrace China's presence and funding is due to their poor business environment which has made it difficult to secure alternative financing or foreign partners. That said, these same factors suggest downside risk to the Latin American nations' ability to rapidly bring online their substantial below-ground resources. Thus, it would likely delay China's ability to access these crude supplies in a timely way.

Ultimately, we believe that in the long-term, a greater footprint in Latin America will benefit China. We anticipate crude production growth for both Venezuela and Brazil, and have previously highlighted that the region as a whole has substantial ability to be the upside surprise of the global upstream segment in the next decade. That said, in the short-to-medium term, China's gamble on Latin America will carry considerable risks.

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