A proposed new energy law signals a shift towards more market-orientated energy pricing in China. China Economy’s Hong Zhu looks at the impact of an end to government-set price controls on energy giant PetroChina

The government’s newly unveiled draft of an impending energy law states that energy prices will in future be set mainly by the market with only moderate government intervention. As a result, observers have predicted a more promising future for China National Petroleum Corporation, also known as PetroChina, one of China’s top two oil and gas companies.

It is generally accepted that the time of high oil prices has come and the days of cheap oil are fading fast. According to Feng Fei, head of the economic research department under China’s cabinet, aside from brief ups and downs, oil prices have been rising since the 1990s and the pace has quickened after 2001 against the backdrop of oil shortages worldwide.

Wang Jing, chief oil industry analyst at Oriental Securities, said oil shortages would continue to prevail as global oil prices hit new record highs. In China, there is room for the prices of oil products to rise. With authorities stepping up efforts to curb pollution and emissions, price rises could be an effective tool.

Zhang Guojun, an analyst with Ping An Securities, argued that recent oil price hikes were not due to short-term speculative factors but rather due to the lack of money going back into the developing the global oil industry. Over the past five years, global demand for oil grew 2% on average each year while growth in refining productivity was just half that.

It is a different situation than in the 1970s when oil price hikes were caused largely by geopolitical upheaval. Today, the world has entered a period in which oil prices are unlikely to ever reverse.

As China’s largest oil and gas explorer and producer, PetroChina’s technological advances and its merger and acquisition activities overseas will enlarge its pool of oil and gas reserves. The company had 11.26 billion barrels of crude oil and 1.514 trillion cubic meters of natural gas in reserve as of the end of 2006, accounting for 70.8% and 85.5% of China’s total reserves.

PetroChina’s oil and gas exploration has advanced a great deal in recent years. From 2004 to 2006, 1.07 billion tons of proven geological oil and 563.32 billion cubic meters of natural gas were discovered by PetroChina, accounting for 65% of newly discovered reserves. It is expected to be China’s most important oil and gas explorer in the near future.

PetroChina’s discovery of the Nanbao oil fields resulted from improvement in exploration technology rather than mere luck. This was just a start; a promising future lies ahead.

From a macro perspective, oil price hikes and calls for energy conservation and environmental protection will lead to higher costs for refiners. Some small refineries with no competitive advantages are doomed to closure, bringing new opportunities for larger firms like PetroChina.

As China’s largest natural gas distributor and provider, PetroChina owns 21,000 kilometers of gas pipelines across the country, accounting for 80% of China’s total. Its half-year revenues from the natural gas business reached US$2.71 billion (RMB20.03 billion) this year and its half-year net profit surged 33.59% year-on-year to US$824.49 million (RMB6.1 billion).

According to the 2007 Report on Energy Development in China, China’s demand for natural gas will grow exponentially over the next 15 years. Demand was projected to reach 100 billion cubic meters by 2010. PetroChina’s natural gas output climbed 16.8% year-on-year to 1.18 trillion cubic feet in the first ten months of this year. The growth is expected to be up to 20% in the years to come as new gas fields keep turning up.

Li Mingxia, an analyst with Qunyi Securities, said the second phase of the “western gas for the east” project will help grow PetroChina’s natural gas sales and transport volumes, enhancing its competitive advantages in this area. The government-set price for natural gas in China is equivalent to between US$5 and US$6 every million joules, compared to real market prices of US$8 to US$10 every million joules. Obviously price hikes are around the corner.

The pricing mechanism set in 2005 allows companies to charge a maximum of 8% either side of the government-set price every year. If natural gas output grew 20% annually, PetroChina would rake in an extra US$540.65 million (RMB4 billion). PetroChina’s profit from its natural gas business is forecast to jump 40% year-on-year to US$1.70 billion (RMB12.58 billion) by the end of this year.

Industrial analysts predict PetroChina can expect a period of steady growth for at least a decade, and said its status as China’s cornerstone state-owned enterprise is irreplaceable.

This article was originally published in Chinese in China Economy on December 5, 2007. The China Perspective takes no responsibility for the accuracy of the original article