South America has been a special part of my life for four decades. I have lived many years in Brasil and Peru. I am married to an incredible lady from Argentina. I want to share South America with you.
Ecuadorian Vice President Jorge Glas announced July 6 that one of China's state-owned oil companies, China National Petroleum Corp., will take a 30 percent stake in Ecuador's $12.5 billion Refinery of the Pacific, which will have a refining capacity of 300,000 barrels per day. The announcement is the most recent manifestation of a trend that has slowly unfolded over the past decade. China's originally simple relationship with Ecuador and Venezuela, primarily involving oil-for-loan agreements, has morphed into much more complex relationships involving investments throughout the energy production process, from financing to production to refining. Because these deals satisfy Beijing's overseas energy strategy, as well as Quito's and Caracas' own strategic imperatives, this already close cooperation is likely to expand in the years to come.
China has become a major importer of oil, and with its domestic oil consumption doubling over the past decade, it is highly exposed to fluctuations in the global energy trade. To mitigate the effects of these changes, the Chinese government, operating through its state-owned oil companies -- primarily China National Petroleum Corp. and China Petroleum & Chemical Corp. (often referred to as Sinopec) -- has taken a number of opportunistic measures to guarantee that domestic demand is satisfied in a way that ensures at least a modicum of control and stability.
Chinese companies have invested in many of the Western Hemisphere's major oil-exporting countries, from Canada to Colombia, but their involvement is most robust in Ecuador and Venezuela. As a result of those countries' interventionist economic policies, they have been downgraded in international capital markets and pay a premium to borrow. Due to perceived risk, they have also fallen out of favor with many companies looking to invest overseas. As investment dried up, production stagnated and fell. As these countries searched for capital, China filled the void, taking advantage of opportunities not present in more crowded, reputable markets.
While its involvement in each country is unique, China uses similar tactics in both countries. These tactics shed light on China's strategy and the future development of the relationships.
China's foray into both Venezuela and Ecuador began with commodity-backed loans. China essentially bartered financial liquidity for guaranteed supplies of oil. Though other financiers were wary, China hedged the risk by denominating repayment not in fiat currency, such as the dollar or the bolivar, but in a raw commodity in which these countries are well-endowed and whose price is set by market forces and not by bureaucrats. Moreover, it made these loans relatively small and short-term, with renewal predicated on fulfilling the terms of the earlier tranche. So if either of these countries violated the terms, the downside risk to China was limited.
Both Venezuela and Ecuador have responded favorably to this mechanism. Since 2008, China has extended nearly $36 billion in oil-backed loans to Venezuela. In exchange, Venezuela has increased its shipments of oil and fuel oil to China tenfold, from around 50,000 barrels per day in 2005 to around 500,000 bpd in 2012. Since 2009, China has lent Ecuador around $8 billion. In exchange, Ecuador has begun sending oil to China. While in 2012 Ecuador sold only 5 percent of its exports to China, the loans are beginning to accumulate, and Ecuador will need to send record amounts of oil to Chinese firms. Indeed, according to Ecuadorian daily newspaper Hoy, by late 2012 more than 70 percent of Ecuador's future oil exports had been committed to China. This reported figure is likely a bit of a stretch, but it reflects the magnitude of the loan agreements.
While both countries can continue to reallocate oil shipments away from the United States to expand exports to China in the short term, this tactic is inherently limited if declining or stagnating production levels are not addressed. If production continues to fall while consumption rises, exports will fall and each country will have limited ability to take on additional loans.
In addition to its commodity-backed loan portfolio, China has also recently begun purchasing stakes in upstream exploration and production projects. Its main motivation for doing this is to hedge against increasing imports and price fluctuations by owning a stake on the production side. Another likely reason is to bolster oil production in countries to which it has loaned. Additionally, China's oil companies, particularly China National Petroleum Corp., have a lot of experience and expertise in heavy oil extraction and can leverage those skills to economically extract oil in Ecuador's and Venezuela's more challenging fields.
China's activities in Venezuela's and Ecuador's energy sectors began to expand noticeably in 2007, when China National Petroleum Corp. and Petroleos de Venezuela began to form a number of joint venture companies to produce oil in the Orinoco Belt. Currently, they have four joint ventures -- Petrolera Sino-Venezolana (formed November 2006), Petrozumano (formed November 2007), Sinovensa (formed February 2008) and Petrourica (formed December 2010). The latter two operate throughout the Orinoco Belt, in the Carabobo and Junin divisions, respectively. Since 2008, China National Petroleum Corp. has increased production at Sinovensa from zero to around 140,000 bpd, and it now intends to increase it to 330,000 bpd by 2016. Additionally, the Petrourica joint venture is still in the exploration phase and could begin producing oil in the coming decade.
Similarly, in Ecuador in 2006, China National Petroleum Corp. and Sinopec created a joint venture called the Andes Petroleum Co., and through its subsidiary PetroOriental, began operating three blocks -- the Tarapoa block and blocks 14 and 17. Together, these three fields produce roughly 50,000 bpd. The joint venture also holds a 36.26 percent share in the country's second-largest pipeline, the Heavy Crude Pipeline.
As oil-for-loan deals and upstream production have increased, China has entered into deals with each country to build up refining capacity, both at home and in the region. China currently has a limited ability to refine more than a few hundred thousand barrels per day of Latin American crude, an amount that is quickly becoming insufficient. Moreover, much of this refining capacity is provided by smaller independent refineries, which Beijing is attempting to close or consolidate.
In May 2012, China broke ground on the400,000-bpd Guangdong refinery, which is a joint venture between China National Petroleum Corp. and Petroleos de Venezuela and will likely provide the financing to finally guarantee the future of the 300,000-bpd Refinery of the Pacific. With a 60 percent stake in the former and a 30 percent stake in the latter, China will have much more bandwidth to increase the oil trade with Ecuador and Venezuela, signaling that cooperation is likely on the upswing. But given that these two projects are still in their infancy, it will likely be at least several years before these refineries come online.
What began as a lucrative business opportunity for Beijing is now becoming a much more robust strategy. Not only will China continue to get guaranteed supplies of oil on favorable terms, it will also get a slice of the profits from the production and refining of that oil.
This involvement also has enabled the governments in Caracas and Quito to achieve their own strategic imperatives. With a steady flow of liquidity, these governments can maintain high levels of social spending without having to increase fiscal revenue. This arrangement will also help these countries increase oil production and refining capacity -- an issue of great national import.