By David Winning
Of DOW JONES NEWSWIRES
BEIJING (Dow Jones)--The Chinese government confirmed Tuesday that it will work with Saudi Arabia on developing China's strategic oil reserves as part of efforts to deepen energy ties between the two countries.
"China and Saudi Arabia are going to have further cooperation on oil...including oil reserve facilities," Jiang Yu, spokeswoman at the Foreign Ministry, said at a press briefing in response to a question from Dow Jones Newswires.
Her comments came after sources in China and the Gulf region said both nations were actively discussing a deal to import oil from Saudi Arabia to fill China's strategic reserves.
A deal would see large volumes of Saudi crude imported by China, although the first shipments would be unlikely to take place before the end of this year, a senior Chinese industry official told Dow Jones Newswires.
A Gulf source confirmed that Saudi Arabia and China were discussing details of a possible agreement under which the kingdom would supply oil for China's strategic petroleum reserves.
But this source, who is close to the negotiations, declined to comment on how much Saudi crude oil China may take, and at what price.
According to the Chinese official, foundations for the current negotiations were laid in April when Chinese president Hu Jintao met made a three-day visit to Saudi Arabia.
He added that negotiations over the terms of the deal are being led by the National Development and Reform Commission - the central government planning body responsible for China's energy planning.
The Chinese industry official, who asked not to be identified, said he was unaware of specific volumes, other than that large amounts would be involved, and said the total value of the contract had not been finalized.
However, deliveries were not imminent, he added.
"China is unlikely to begin importing the oil by the end of this year - largely because the facilities for storing the reserves aren't ready yet," he said.
This was partly because a safety review of the storage areas still needed to be completed, he said.
He declined to disclose the names of the Saudi organizations or agencies involved in the deal, but said, "The talks with Saudi Arabia have been going on in a good spirit."
The oil will be sold at a discount to the average market price as China has promised the oil imports will only be used as strategic reserves and will not be sold to the market, the Chinese official said.
But this was contradicted by the Gulf source who said the oil would not be discounted under the terms of the current talks.
Earlier this month, Saudi Oil Minister Ali Naimi said the kingdom's oil output had dropped in recent months, falling to 9.1 million b/d in April, due to a lack of demand.
But he ruled out the idea of Saudi Arabia discounting its oil to sell more barrels. "We will not leave money on the table" for others, he said in an interview with the Wall Street Journal on June 5.
Already A Major Supplier To China
Separately, an official at Sinopec, which is China's second-largest oil producer, on condition of anonymity, said supplies to the strategic oil reserves were being secured and Saudi Arabia was possibly one supplier.
Saudi Arabia accounted for 17.5% of China's imports of crude in 2005, delivering 22.18 million tons of crude, or 445,401 b/d - up 28.6% on the previous year.
According to the official, the Saudi oil for the reserves will be medium-quality crude and will need to be desulfurized once it arrives in China.
Gao Shixian, director of the Energy Research Institute under the NDRC, acknowledged on the sidelines of a Beijing oil conference last week that China "has been in talks with several countries" about oil supplies.
However, a decision on whether to import oil to fill the reserves "would depend on changes in the oil market," he said.
Asked if China had selected Saudi Arabia as a supplier for its oil reserves, Gao could not confirm this, saying he was not best-placed to comment.
Gao added that "it is still hard to say" when China may start filling its reserve tanks.
Separately, an NDRC official in charge of strategic reserves declined to comment on what, if any, arrangements for filling the reserves had been made with Saudi Arabia.
Another official at the Energy Research Institute - Zhou Fengqi - said last week that China would obtain oil for the reserves "from two sources that aren't very affected by international market (prices): domestic production (by state-owned oil companies) and some overseas fields where Chinese oil companies have stakes".
Storage Facilities Being Readied
China is building four oil reserve facilities. Xu Dingming, director of NDRC's energy bureau, was cited by state media as saying Friday that China will in August complete the first facility, which is in Zhenhai, a port city about 160 kilometers south of Shanghai.
NDRC head Ma Kai said in March that filling the facilities is expected to start by the end of this year.
The Zhenhai base comprises 55 tanks with each expected to store 100,000 cubic meters of petroleum, said the industry source who had cited Saudi as a supplier for China's strategic reserves.
Based on the current term prices of benchmark Arab Medium crude supplied to Asia by Saudi Arabian Oil Co. (SOI.YY), filling just one of the Zhenhai tanks would cost around $38 million, and filling all 55 would cost nearly $2.1 billion.
The official said the construction of another reserve facility in Qingdao, Shandong province, is likely to be completed by the end of this year, while the two remaining sites at Dalian in Liaoning province and Zhoushan in Zhejiang province are likely to be delayed.
Once construction of any of the facilities is finished, they must undergo "a strict review on safety issues" and any problems could push back plans to bring them into use, he said.
So far the quality of Zhenhai facility looks quite good, he added.
Apart from on-the-ground facilities, China is also investigating whether underground reserve tanks can be built as a second phase, he said.
As soon as a survey is completed, the government will start to select the sites and design the underground facilities, the official said.
Some say the only reason China hasn't started filling its reserves already is current high oil prices and limited government funds.
"The government initially formulated the budget for the oil reserves projects at an oil price of around $20 per barrel in 2004," but soaring oil prices have meant the government is finding it hard to fund the project, said an official from PetroChina Co. (PTR) in May.
-By David Winning, Dow Jones Newswires; 8610 6588-5848; david.winning@dowjones.com
(Spencer Swartz in London contributed to this story)
-Edited by Simon Hall and Ryan Woo
(END) Dow Jones Newswires
June 20, 2006 04:24 ET (08:24 GMT)
Copyright Dow Jones Newswires 2006
