THE GUARDIAN

Terry Macalister
Friday October 14, 2005

BP is in talks with Sinopec of China on a wide-ranging joint venture that could put Britain's biggest company at the centre of the world's fastest-developing energy market.

Lord Browne, the BP chief executive, is hoping to pull off the kind of coup he achieved in Russia when he stole a march on ExxonMobil and other rivals by tying up a ground-breaking deal with local group, TNK.

The London-based oil group is refusing to comment publicly on the talks, but a spokesman admitted "you don't have to be a rocket scientist" to realise China is a vital market. Well-placed sources confirmed Lord Browne had put forward various proposals to China's biggest producer of refined oil products and state officials about a tie-up.

Critical to any future deal is the attitude of the Beijing government, which still controls 80% of Sinopec through its parent group, China Petroleum and Chemical Corporation. The remaining 20% is listed in New York, Shanghai and Hong Kong. BP took a 2% stake at Sinopec's partial privatisation in 2000 but sold out last year to take profits.

BP, awash with cash from high oil prices, has been active in China for 30 years and has been slowly forming joint ventures on specific projects. It already has a joint venture with Sinopec to build acetic acid plants in Chongqing and Nanjing as well as a petrochemical operation in Shanghai. The British group also runs a network of 500 petrol stations jointly with Sinopec in the eastern province of Zhejiang.

ExxonMobil, Shell and other oil majors have all established footholds in China but Lord Browne has been anxious to win first-mover advantage with a decisive move, preferably through a major equity stake.

It will not be easy. The Reuters news agency reported that an early BP proposal to take a "very substantial stake" by swapping oil and gas fields for a Sinopec holding had already been knocked back. But China is desperate to win access to more oil reserves, greater refining expertise and petrol retailing and logistics skills, while BP wants new customers. China is not just the world's most populous nation, it is also going through a transport revolution that is promising to turn a country of cyclists into one of gas-guzzling motorists. Car sales were up around 55% in 2002 and 80% in 2003, although they dipped to 10% in 2004 as the government cracked down on credit facilities for car buyers.

Still every expectation is that car sales will grow by 10% - 20% a year for the foreseeable future, triggering a rush by major western car manufacturers to set up plants there. With 5m cars sold last year, China is the third largest car market behind the US and Japan but is expected to become the biggest after 2010.

The tarmac road network is already being massively expanded. It has been increased by 50% since 1990 to 34,000 kilometres but the government wants to double this number again by 2020.

The growth in car-buying reflects the increasing affluence of the country and has been helped by the emergence of consumer credit, better-paid private sector jobs and the appearance of cheaper foreign models. Around 60% of the country's 1.3 billion people live in rural areas on $1 a day but a growing middle class is emerging in the cities where nearly all car ownership is concentrated.

A cap on petrol prices in China keeping them below international levels has helped the roads become increasingly clogged but has led to plunging refining margins over the last 12 months for Sinopec. The company is struggling to build new refineries with its more limited cashflow, leaving China with a potential political problem of how to fuel the next stage of industrialisation.

Lord Browne has shown himself to be a deft political animal, continually avoiding the kind of environmental and other criticisms that rival Exxon has faced. He has close relations with Tony Blair and has managed to avoid tangling with more prickly foreign characters such as the Russian president Vladimir Putin. Energy analysts suggest that if anyone is going to sweet-talk Chinese president Hu Jintao, it is more likely to be the low-key Lord Browne than the more brusque Texan, Lee Raymond of Exxon.

Jason Kenney, top oil analyst at ING Barings, believed a potential tie-up between the two sides made sense. "I can only see this as a big positive for BP if for no other reason than allowing it to keep a close eye on the key developing demand centre on the planet," he said. But Citigroup analysts considered a huge deal too risky. "We doubt that BP would be willing to enter a joint venture on the scale of TNK-BP," it argued in a note.

Lord Browne has a clear template to work from should he eventually win an equity stake in Sinopec, as he did with TNK. His drive into Russia through the purchase of 50% of TNK in 2003 was seen as daring and possibly dangerous, but is paying off handsomely. ExxonMobil tried to follow suit by negotiating to acquire a sizeable chunk of another major Russian player, Lukoil, only to find the Kremlin firmly stepping in and slamming the door closed on the Americans.

Since then the position for foreign oil majors trying to win a greater holding of Russian businesses has only become worse. Vladimir Putin is talking about tightening up the rules governing foreign participation in oil and gas licensing while encouraging state-owned Gazprom to move into oil by buying Roman Abramovich's Sibneft group.

TNK-BP is now a main driver of BP production growth when others such as Shell are struggling to halt falling output. The City deemed the £8bn takeover of TNK expensive at the time but that was when global crude prices were rattling along at $25 per barrel. Yesterday they were at $64, with gas values following in their wake, transforming the economics of Russian hydrocarbon production and encouraging a rash of new gas fields to be looked at.

Taking an equity stake in Sinopec with its $35bn market capitalisation and profits of $7.2bn a year would hold few regulatory problems. But it would touch on sensitive political nerves in a nationalist country still under communist rule despite its liberal economic approach.

But BP is now breathing down the neck of Exxon, vying for the title of the world's biggest oil and gas producer. A bold move into China could deliver up all the consumers it needs in what promises to be the ultimate motoring market.

Other ventures

While some question whether BP is wise to head into a highly politicised Chinese market, no one will ask whether the company has the financial clout to make things happen, as it demonstrated yesterday.

A series of announcements underlined the scale and breadth of the oil company's investment programme and its willingness to spend some of its growing mountain of cash that could reach $40bn (£23bn) by the end of this year.

BP signed a letter of intent with India's state-run Hindustan Petroleum to form a joint venture covering refining and marketing in India. A $3bn refinery is to be built in Bhatinda, northern Punjab, while a network of petrol stations is planned.

Separately it is planning to invest $2.2bn to double production at its Wamsutter gas field in the Rocky Mountains of the United States.

BP has just announced plans to sell off its chemicals division for $9.5bn and is expected to record annual profits for 2005 of up to $24bn.

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