Less-informed elements in the US media continue to extrapolate global trends from statistics related to domestic oil demand, but serious energy investors realize that rising consumption in emerging markets has driven the price of crude over the past decade.

The Asia-Pacific region, in particular, has accounted for much of the upsurge in total oil demand, offsetting stable to slightly declining consumption in developed economies.

Source: BP Statistical Review of World Energy 2012

Within Asia and Australasia, the world’s quintessential emerging economy, China, has accounted for much of this growth. Since the turn of the millennium, the Mainland’s annual oil consumption has more than doubled, growing to 11.08 percent of global demand from 6.22 percent.

Source: BP Statistical Review of World Energy 2012

However, this robust growth in Mainland China’s oil consumption hasn’t been matched by a corresponding increase in domestic production, which has grown only haltingly.

Source: BP Statistical Review of World Energy 2012

Accordingly, China’s three major state-run oil companies–China National Petroleum Corp (PetroChina), China Petroleum & Chemical Corp (Sinopec) and China National Offshore Oil Corp–have pursued overseas acquisition programs to meet rising domestic demand, diversify their supply base and gain experience in deepwater and unconventional onshore plays.

The national oil companies also have a strong financial incentive to pursuing this strategy: International expansion is critical to reducing the losses suffered by their downstream (refining and marketing) operations, which must pay elevated prices for imported oil and sell the resulting products at rates fixed by the central government.

Over the past five years, China’s national oil companies and their publicly traded arms have completed 45 international acquisitions and announced seven pending deals. These 52 transactions amount to USD78.74 billion, almost 78 percent of which targeted upstream assets (exploration and production).

Source: Bloomberg

North American investors should be keenly aware of this phenomenon: China’s state-owned oil companies have spent USD40.25 billion over the past five years on mergers and acquisitions targeting Canadian assets.

Several factors have made Canada a prime destination for China’s national oil companies, including a stable political environment, reserves of “heavy” oil (a price-advantaged feedstock) and a regulatory regime that welcomes foreign investment.

Despite the occasional political disagreement, the economic ties between China and Canada have tightened significantly since June 2010, when the two governments set the goal of doubling trade within five years, to USD60 billion. In November 2011, China allowed direct trading of the renminbi with the Canadian dollar in an effort to facilitate trade between the nations.

Not surprisingly, the two blockbuster deals announced by Sinopec (Hong Kong: 0386, NYSE: SNP) and CNOOC Ltd (Hong Kong: 0883, NYSE: CEO), the publicly traded arm of China National Offshore Oil Corp, involved Canada-based companies.

Sinopec acquired a 49 percent stake in Talisman Energy’s (TSX: TLM, NYSE: TLM) business in the North Sea, a segment that includes interests in 46 operated and non-operated fields, 11 offshore installations and one onshore terminal. The USD1.5 billion transaction, which is expected to close by the end of 2012, will bolster Talisman Energy’s balance sheet and enable the company to expand its planned capital expenditures. Meanwhile, Sinopec will gain further experience in exploiting offshore reserves and grow its oil output.

This headline-grabbing deal was overshadowed by CNOOC Ltd’s USD15.1 offer for Nexen (TSX: NXY, NYSE: NXY), an exploration and production firm that generates about 28 percent of its annual output in Canada and also holds blocks offshore Nigeria and in the North Sea and the Gulf of Mexico. CNOOC Ltd’s takeover offer represents a roughly 60 percent premium to the stock’s closing price during the last trading session prior to the bid.

If regulatory officials approve the national oil company’s acquisition of Nexen, the transaction would go down as the largest international acquisition by a Chinese company.

The day after Sinopec and CNOOC Ltd announced their latest deals, China’s National Development and Reform Commission (NDRC) released an updated state plan that calls for increased investment in overseas energy assets and other vital commodities to ensure long-term access to these resources at a reasonable price.

All the focus on the state-owned oil companies’ efforts to grow production and gain expertise through international acquisitions has overshadowed the recent upsurge in foreign interest and investment in China’s shale gas resources.

Unconventional Plans

The US Energy Information Administration estimates China’s technically recoverable shale gas at 1,275 trillion cubic feet–roughly 25 percent more than its approximation of US resources.

China’s Ministry of Land and Resources (MLR)–the government entity responsible for overseeing the utilization of land, marine and mineral resources–has published similar estimates.

After conducting an initial appraisal of 1.5 million square kilometers (579,153 square miles) across Chongqing, Hubei, Inner Mongolia, Shanxi, Shaanxi, Sichuan, and Xinjiang, the MLR estimates that shale formations in these provinces contain about 31 trillion cubic meters (1,094 trillion cubic feet) of natural gas.

Although this resource potential has international oil companies salivating, expected growth in China’s demand for natural gas makes the long-term opportunity even more enticing.

The Chinese government’s long-term plans call for natural gas to account for 10 percent of the country’s energy mix, about one-third of which will be imported via pipelines or as liquefied natural gas (LNG). In ExxonMobil Corp’s (NYSE: XOM) Outlook for Energy: A View to 2040, the integrated energy giant forecasts that China’s natural gas demand will grow at a faster rate than any other nation in the world.

Natural gas has been growing in popularity in China, particularly in power-generation facilities located near major cities. Concerns about air quality mean that many of the high-rise residences constructed during China’s recent housing boom are equipped for piped gas. Further migration to urban areas will only increase consumption.

To satisfy rising demand for natural gas, the NDRC on March 13, 2012, issued its long-awaited National Shale Gas Development Plan for 2011-15. The document calls for a preliminary, two-year survey of China’s shale formations, with the goal of identifying between 50 and 80 blocks for exploration. This process will involve drilling roughly 200 wells to map the distribution of these resources and determine which areas are prospective for development. A related study will focus on the resource potential of 12 specific basins.

The NDRC’s shale gas plan also outlined some ambitious appraisal and production goals, including the identification of 600 billion cubic meters (about 21 trillion cubic feet) of shale gas resources. According to the plan, China aims to produce 6.5 billion cubic meters (229 billion cubic feet) of shale gas by 2015 and between 60 and 100 billion cubic meters (2.1 and 3.5 trillion cubic feet) by 2020.

Although China’s first shale gas licensing round, held in June 2012, awarded only two of the available exploration blocks, the MLR and NDRC learned their lesson from this disappointment.

Whereas authorities limited participation in the auction to only six companies that had experience with exploration and production and downsized the licensing round four blocks, the second licensing round is open to local entities with at least RMB300 million (USD47 million) in registered capital. Participants must also have a license to explore for oil and natural gas.

Meanwhile, Reuters and other news outlets have reported that this auction, which is expected to take place within the next several weeks, will include about 20 blocks that have been identified by local governments. However, acreage in Sichuan Province, the region that likely contains the most shale gas reserves won’t be included in the licensing round.

To this point, Western oil companies seeking exposure to China’s shale gas industry have primarily worked with the major national oil companies.

Royal Dutch Shell (LSE: RDSA, NYSE: RDS A, RDS B) remains the most active Western operator in China’s unconventional plays. The London-based international oil company on March 20, 2012, announced that the firm had inked a production-sharing contract (PSC) with close partner PetroChina. The deal covers the 3,500-square kilometer (1,351-square mile) Fushun-Yongchuan Block and marks the first PSC between a Western oil company and a China-based operator.

Royal Dutch Shell and PetroCHina first signed a joint evaluation agreement for this acreage in 2009; two years later, the international oil company spent USD400 million drilling 15 shale gas wells in China. Most of the between 20 and 25 shale wells that Royal Dutch Shell plans to sink in 2012 will be in the Fushun-Yongchuan block. The PSC suggests that CNPC expects output from this block to contribute significantly to management’s stated goal of achieving 1 billion cubic meters (35.3 billion cubic feet) of annual shale gas production by 2015.

More recently, Royal Dutch Shell signed a joint-study agreement with China National Offshore Oil Corp to evaluate shale gas resources in an unspecified exploration block in Anhui Province.

With this next licensing round likely to expand the number of players involved in developing China’s unconventional oil and gas fields, Western oil and gas companies are reportedly eager to partner with or invest in these smaller firms.

We’ve already seen this trend in the oil services sector, with Schlumberger (NYSE: SLB) acquiring a 20.1 percent equity interest in China-based Anton Oilfield Services (Hong Kong: 3337). The deal, which builds upon a strategic cooperation agreement signed in 2010, provides Schlumberger with exposure to a key growth market and Anton Oilfield Services with invaluable experience in shale gas production.

CEO Paal Kibsgaard explained the rationale behind this move during a recent conference call to discuss second-quarter results:

I think in the high-volume markets, the key high-volume markets around the world, there is often a benefit of owning or having interests in local companies, mainly because they know the local conditions and, in some cases, they have technologies that are more custom made for the local environment.

Schlumberger and other Western oil services companies have struggled to gain a foothold in China’s burgeoning upstream industry, as the national oil companies often engage their own subsidiaries to perform this work.

Inundated with work in China’s natural-gas plays, Anton Oilfield Services has expanded its headcount by 23 percent over the past year and recently announced contracts with Sinopec and PetroChina to perform hydraulic fracturing and directional drilling in the Erdos Basin. Management also reported that the number of wells services by the firm increased sequentially by 151 percent.

In the wake of Schlumberger’s investment in Anton Oilfield Services, Honghua Group (Hong Kong: 0196), a leading producer of onshore drilling rigs, disclosed that the firm was in advanced talks regarding a joint venture with a leading Western oil services firm. Such an agreement would help the firm gain experience in hydraulic fracturing and other critical services. Honghua’s management team has indicated that the firm also plans to take minority stakes in companies that participate in the upcoming shale gas licensing round.

Around the Portfolios

Second-quarter earnings season is under way. Here are the reporting dates for our Portfolio holdings.

Growth Portfolio

BG Group (LSE: BG/, OTC: BRGYY)–07/26/12
Cameron International (NYSE: CAM)–07/26/12
Chesapeake Granite Wash Trust (NYSE: CHKR)–08/15/12
Dresser-Rand Group (NYSE: DRC)–08/03/12
Eagle Rock Energy Partners LP (NSDQ: EROC)–08/01/12
EOG Resources (NYSE: EOG)–08/03/12
Linn Energy LLC (NSDQ: LINE)–07/26/12
Mid-Con Energy Partners LP (NSDQ: MCEP)–08/07/12
Nordic American Tanker Shipping (NYSE: NAT)–08/07/12
Occidental Petroleum Corp (NYSE: OXY)–07/26/12
World Fuel Services Corp (NYSE: INT)–08/01/12

Conservative Portfolio

Chevron Corp (NYSE: CVX)–07/27/12
Eni (Milan: ENI, NYSE: E)–08/01/12
Enterprise Products Partners LP (NYSE: EPD)–08/01/12
Natural Resource Partners LP (NYSE: NRP)–08/03/12
NuStar Energy LP (NYSE: NS)–08/01/12
Sunoco Logistics Partners LP (NYSE: SXL)–08/02/12
Total (NYSE: TOT)–07/27/12
Western Gas Partners LP (NYSE: WES)–08/01/12

Aggressive Portfolio

Afren (LSE: AFR)–08/21/12
Alliance Holdings GP LP NSDQ: AHGP)–07/27/12
Macmahon Holdings (ASX: MAH, OTC: MCHHF)–08/20/12
Oasis Petroleum (NYSE: OAS)–08/06/12
Oil Search (ASX: OSH, OTC: OISHF)–08/21/12
Petroleum Geo-Services (Oslo: PGS, OTC: PGSVY)–07/27/12
SeaDrill (NYSE: SDRL)–08/31/12
Tenaris (NYSE: TS)–08/01/12
US Silica (NYSE: SLCA)–07/31/12