Canada's oilfield manufacturers face a huge challenger

By Mike Byfield

[Figure 1] In China, the traditional dragon symbolizes good fortune. Westerners, in contrast, have always seen the flying fire breathers as threats. In the case of oil and gas manufacturing, both views happen to be appropriate. China's expanding exports of drilling rigs, pumpjacks, and other petroleum technology are generating foreign revenue and influence. Never before have North America's onshore equipment makers faced a challenger of this strength. Chinese firms offer a comprehensive range of exploration and production components at prices perhaps 20-30 per cent below their Canadian and American competitors.

Luke Lu manages North American marketing for Pemsco Ltd., the Calgary-based subsidiary of China Petroleum Technology & Development Corporation. CPTDC in turn is the technology-trading arm of the state-controlled China National Petroleum Corporation. "We have submitted a business case for opening a facility in Alberta. This centre would handle quality testing, parts inventories, repairs, and training. In future, it might also fabricate components that are too large to ship from China, mainly for the oilsands," Lu says. "No decision has been made by our head office yet, but I am optimistic that we will proceed within a year."

CPTDC's export sales were as strong in 2009 as 2008, running at about US$2.3 billion annually. The company supplies customers in 66 countries from 35 overseas offices, four warehouses, and seven maintenance centres throughout the world. Its parent firm is the world's largest oil and gas operator in terms of personnel, with more than one million employees in the upstream, pipeline, downstream, and petrochemical sectors.

Pemsco is planning its Canadian expansion despite a large annual sales drop in this country, from about $10 million in good years to a mere $250,000 in 2009. "The Canadian market has suffered more than the United States, where demand started picking up in September," Lu notes. "However, our senior management in China takes a long-term approach to investment and CPTDC believes in the future of the Canadian industry. Our customers can count on us to be here for the long run."

Another Chinese manager says his nation's presence is already strong in the western Canadian oilpatch. (This individual, who's not authorized by his employer to comment publicly, goes by the pseudonym Pang Zi, Mandarin for Tubby.) "A few fully assembled drilling rigs have been sold in the U.S., but so far none in Canada. Instead, a lot of rig components come here from China," he reports. "Although very few rigs are being built this year, I think a new made-in-Canada rig consists of up to 80 per cent Chinese parts."

[Figure 2]

Duane Mather, president of Nabors Canada, says his company assembles its drilling rigs here but buys "the right pieces" from China. "We've purchased pumps, some drawworks, masts, virtually some of everything except our AC drives, which are always designed and built in house," the Calgarian says. "We must buy in China or our capital equipment costs would not remain competitive."

Initially, the Calgary-based drilling contractor found it essential to closely supervise the manufacture of parts in China. "Their skills and quality control were not equivalent to North American standards. We went there solely because prices were 50-60 per cent lower," Mather says. "Chinese manufacturing costs have risen pretty quickly over the past two or three years, but they're still significantly less than here. Meanwhile, the quality has gotten much better. We still test every component and we do get a surprise once in a while but the improvement is very noticeable."

Roger Soucy, president of the Petroleum Services Association of Canada, acknowledges that Chinese oilfield suppliers are formidable rivals. "Their primary advantage is well understood-labour costs there are a small fraction of ours," he comments. "Canadian companies must counter that factor with research and development, where this country still leads China. But the competition is going to be difficult; there's no way of getting around that fact."

Pang Zi agrees that North America still has a big lead in research and development capability. "In China, patents cannot be enforced, so R&D investment often cannot be recovered. Even the government cannot protect its R&D results. As a result, our manufacturing goals focus on making equipment that's simple and very durable. We also work with foreign companies who have technology."

The president of a Canadian pump manufacturing firm, speaking on a not-for-attribution basis, says his firm has developed patent-protected technology that lowers the full-cycle cost of its pumps over the operating life of the equipment. "Unfortunately, the initial purchase price of our products is higher than Chinese pumps. Convincing a producer to accept a higher price tag is difficult, even if that initial investment will pay off later. Even when times were good, a higher first cost was a hard sell, and it's worse now," he says.

Until now, onshore technology remained firmly rooted on this continent despite the fact that petroleum has long been produced outside North America-for well over a century in Russia, Iran, Indonesia, and Mexico, for instance. Even the Soviet Union, although scientifically advanced in some industries, used strikingly primitive upstream equipment. So how did the People's Republic of China forge itself into an oil and gas manufacturing juggernaut?

The nation achieved its first significant petroleum production during the 1960s, when a giant oilfield was found in its northeastern region. Production developed around the city of Daqing, initially with Soviet-style equipment. Lu's own life and career help illustrate his country's forward momentum. "Thirty years ago, a working family like mine received three or four ounces of pork a month, and just two ounces of cooking oil. The annual clothing allowance was just as poor," he recalls.

In 1980, China's Communist regime introduced market-oriented reforms. A professional engineer, Lu advanced to chief of quality control in the factory that makes drilling rigs for China National Petroleum Corporation (CNPC). "In 1997, I was earning a little less than US$200 per month plus housing and other benefits, which was a good salary," says the marketing manager, who has lived on this side of the Pacific Ocean for the past 12 years. "Today, that position is worth US$700-US$800 a month. Our labour costs are rising, but the economy continues to make great progress." [Figure 3]

Lu uses mud pumps as an example of how Chinese engineers acquired modern manufacturing skills. "During the 1980s, CNPC purchased more than 500 mud pumps from an American company. As part of that deal, we received the drawings and personnel training-it was a complete technology transfer," he recounts. "Since that time, CNPC has manufactured many thousands of mud pumps, including 700 for Precision Drilling."

To date, the Daqing field has produced more than 10 billion barrels of crude. Its pumpjacks have been made by a CNPC subsidiary based in the city. "The population is the same size as Calgary, about one million, and making pumpjacks is the main manufacturing industry there," says Pang Zi, a Chinese-trained engineer who now lives in North America. "The central factory complex has a footprint of about six million square feet."

Annual manufacturing capacity is estimated at 6,000 to 8,000 pumpjacks, depending on unit size. There's no lack of customers, and the Chinese government is in the process of doubling capacity over five years. The country now has smaller pumpjack makers as well, privately held firms that have spun off from the government-owned operation. "In the early days, we could not get good machine tools, and materials were also deficient," Pang Zi says. "Now the equipment used by our factories is global quality and so are the steels and other materials."

Chinese steel has become a contentious trade issue. The people's republic has been sanctioned in the United States, Europe, and Canada, on the grounds that the price of exported oil country tubular goods (OCTG) in export markets has been set below what they would sell for in the country's domestic markets. In November, the Canada Border Services Agency ruled that China is dumping and subsidizing certain OCTGs in this country. Federal duties ranging up to 182 per cent have been imposed.

Chinese seamless casing with an outside diameter up to 11 ¾ inches was already subject to a finding in 2008 by the Canadian International Trade Tribunal. The CITT is also investigating alleged dumping of well casing and tubing in other categories. That inquiry was triggered by a joint complaint from Canada's principal steelmakers, Tenaris Canada, Evraz Inc. NA Canada, and Lakeside Steel Corporation.

Ron Bedard, president and COO of Ontario-based Lakeside, says the Ontario-based company is "committed to ensuring imports into the Canadian market are fairly traded." The petroleum industry is considered a crucial market by American and Canadian steel firms. Lu responds that the import duties levied against China will raise tubular prices for western Canadian oil and gas producers. "The main benefit of those duties will go to foreign-owned companies who are China's competitors here," the Pemsco engineer argues. [Figure 4]

In making the steel that goes into oilfield pipe and equipment, China has no obvious competitive advantage. Labour does not constitute a large percentage of steel cost, and the country imports iron ore. Yet documentation provided to federal agencies by Canadian-based tubular producers portrays China as fiercely aggressive in the industry. Its government sector-at the national, state, and municipal levels-has made large investments over the past five years, boosting China's share of global steelmaking to 50 per cent from 20 per cent. Over the same period, the country's internal demand has increased from 20 per cent to about 25 per cent of the world total.

Canada's steel industry, mostly foreign-owned but based here, argues that China has violated investment regulations laid down by the World Trade Organization. One Canadian executive, speaking on a not-for-attribution basis, sums it up: "China overshot the world market with its steel investments and is dumping its surplus. That trading strategy is aimed primarily at protecting jobs. To Chinese governments, employment and political stability are more important than profitability. Fortunately, the Canadian steel industry is positioned to bear the considerable expense required to fight this type of trade case. I'm not sure other oilfield manufacturers are as well organized."

Beyond tubulars, labour expense is definitely a key factor in most oilfield manufacturing. Pang Zi notes that Chinese technicians are now as well-trained as their North American counterparts, and in his opinion they're often more motivated. "A Chinese team can accomplish in a single day what I sometimes see being done here by the same number of workers in three or four days," the engineer says. "Right now, China is a train that can't be stopped."

But perhaps that train should be slowed down a little. Andy Wright, founder of Torque Control Systems Ltd., has done business in China. "Our company makes oilwell components in Edmonton. We pay our skilled workers $30 per hour, and the comparable wage rate in China is $0.20," Wright says. "Everyone recognizes the benefits of trade. Still, when North Americans are competing against countries with very low wage rates, I believe it would be reasonable to charge an import duty that reflects at least a percentage of that difference."