Analysis: CNOOC needs to double down on drilling and deals in carbon-cutting gas pivot

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SINGAPORE/BEIJING (Reuters) – A rapid rise in offshore drilling and deepwater gas extraction may seem an unlikely path to lower emissions, but are central planks of Chinese energy major CNOOC (NYSE:CEO) Ltd’s plan to help hit Beijing’s climate goals.

While global peers like BP (NYSE:BP), Royal Dutch Shell (LON:RDSa) have announced cuts in hydrocarbon output and huge renewable energy investments to cut emissions, China’s third-largest oil and gas producer plans an ambitious gas-heavy overhaul of its production mix by 2035 as its way of helping meet carbon-cutting goals.

Beijing views natural gas as a vital ‘bridge fuel’ to displace dirtier coal. The country aims to cap carbon dioxide emissions by 2030 and become “carbon neutral” by 2060.

While many western economies are looking to abandon fossil fuels altogether to fight climate change, China must first take an intermediate step of switching out coal for cleaner-burning gas. Twenty times more electricity was generated from coal than from gas in China in 2019, despite a 200% rise in gas-powered electricity since 2010, according to BP.

CNOOC plans to help close that gap by having gas make up half its output portfolio by 2035, up from 21% currently.

Chief Executive Xu Keqiang last month laid out the firm’s multi-pronged gas strategy, which includes ramping up deepsea drilling in the South China Sea and Bohai Bay areas, development of onshore unconventional gas resources, and “actively scouting for premium global assets”.

The firm produced 20 bcm of gas in 2019 – equivalent to 6% of China’s total consumption – including 11 bcm from domestic fields and the rest from operations in North America, Australia and Europe.

Readul Islam, analyst at Rystad Energy, said CNOOC will need to more than double gas output to about 45 billion cubic metres (bcm) to meet its 2035 goal, which would put CNOOC on par with global gas majors like Brazil’s Petrobras and Norway’s Equinor provided these two make no major acquisitions between now and 2035.

But experts say the firm, which has never operated a deepwater project on its own, faces challenges to meet its target and may be better served by acquiring gas assets from abroad.

“CNOOC needs different types of projects to achieve that goal, but the easiest way could be acquisitions of liquefied natural gas (LNG)-linked assets,” said Bernstein Research’s Neil Beveridge, referring to upstream gas investments tied to long-term LNG supply deals.

DIGGING DEEP

CNOOC told Reuters that it will focus over the near term on developing discoveries such as deepwater Lingshui 17-2 in the South China Sea, where first production is due by late June, and large shallower water condensate fields like Bozhong 19-6 in Bohai Bay which is due online in the third quarter.

Coalbed seam gas projects in north China’s Qinshui and Ordos basin will contribute an additional 3.5 billion cubic metres of output in 2021, the company added.

“With a better grasp of geological knowledge and advances in drilling technology in recent years, the company will accelerate building a ‘mega gas zone’ with a trillion cubic meters (of reserves) in the South China Sea,” said a CNOOC representative.

“CNOOC has also identified an inventory of exploratory targets to underpin mid-to-long term production growth.”

GOING SOLO

Analysts say that actually extracting gas profitably from such an array of deposits is much easier said than done.

Developing fields like Lingshui 17-2, 1,500 meters below the water’s surface, as its first fully-owned and solo-operated deepsea project will be a major test of CNOOC’s operational capabilities.

CNOOC has previously tied up with Total in deepwater Nigeria and with Exxon (NYSE:XOM) in Brazil, but only as a stakeholder.

And with seasoned global deepwater players focusing more on lucrative LNG projects elsewhere, it may be hard for CNOOC to draw new partners for its endeavors in China, said Beveridge and Islam.

Zhang Xianhui, analyst at Wood Mackenzie, expects CNOOC to make more discoveries in Bohai Bay, a traditional oil-rich zone, after recent large finds Bozhong 19-6 and Bozhong 13-2, located some 5,200 meters below the seabed, “massively upgraded” the region’s gas potential.

But with capital also required to build large infrastructure needed to operate at these offshore sites, such as the 120-meter tall, 53,000-tonne Deepsea-1 floating production facility recently delivered to the Lingshui project, CNOOC may need to balance between domestic drilling and investing in lower-cost overseas projects.

“Given our forecast of CNOOC’s organic portfolio, it seems clear the one-half gas goal will require gas-weighted acquisitions, and perhaps also disposal of mature oil assets,” said Rystad’s Islam, adding that CNOOC could only grow output by one third to about 27 bcm by 2035 based on current discoveries.

Projects in Australia, East Africa’s Mozambique and Russia’s Arctic could be on CNOOC’s shopping list, analysts said.

China’s share of global gas use may climb even higher if toughening standards on methane emissions – often from leaky pipelines – accelerate cuts to gas use and speedier uptake of renewables in markets like the United States and Canada.