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A Beautiful Mistake

Whiskey & Gunpowder
August 5th, 2005
by Byron W. KingPittsburgh, Pennsylvania

"In a script that could have been written in Titusville of old, the lure of striking it rich with an oil well began to attract investors. To the local Chinese, the smell of oil was captivating.

"In a story reminiscent of the heydays of the Pennsylvania oil boom of the 1860s, the government's offer of ownership of the mineral rights caused people to catch oil fever. By the thousands, they pooled their funds and invested in oil-drilling ventures."

"THE TOTAL INVESTMENT was $84,000, a princely sum in northern Shaanxi province, a hardscrabble moonscape of dusty, yellow-earth hills at the edge of the Gobi Desert. But it seemed worth it when the black crude began to flow."

So writes Howard French, a reporter for The New York Times , in an article about a man named Mr. Gao, entitled "Whose Oil Is It? Property Rights at Issue in China" (July 18, 2005).

According to the article, the roots of the matter go back to 1994. Back then, the government of the People's Republic of China, through its Ministry of Oil and in cooperation with the state-owned China National Petroleum Corp., decided to spur investment in China's domestic petroleum industry. What ensued was a series of laws and agreements that allowed private citizens to drill for and produce oil in a region of northern Shaanxi, a few hundred miles west of Beijing.

In a script that could have been written in Titusville of old, the lure of striking it rich with an oil well began to attract investors. To the local Chinese, the smell of oil was captivating.

In a story reminiscent of the heydays of the Pennsylvania oil boom of the 1860s, the government's offer of ownership of the mineral rights caused people to catch oil fever. By the thousands, they pooled their funds and invested in oil-drilling ventures.

Ambitious prospectors in that part of China pooled their savings; approached family and friends for additional capital; and talked their way into the heads, if not the purses, of any other investors who would listen. And then they drilled their wells.

When it comes to finding oil, you need people who can dream. You need people who can (whether they truly understand the physics or not) envision a rock formation at depth, charged with an energetic liquid that will flow from its place of geological rest into an open well bore.

Then, among this group of dreamers, you need people who can talk their dreams. Not to be trite, but those dreams of the oil patch flow from somewhere between peoples' hearts and minds. Without this ability, you can forget it. You will never find a drop of oil, and you might as well be living in the Stone Age. Come to think of it, if humanity loses this ability to dream and envision the oil in the rock, everybody who is left probably will be living back in the Stone Age. Go rent the movie Mad Max , but I digress.

And when it comes to finding oil, people talk a lot. People talk about prospecting for oil and the economics of the substance. They discuss things like taking magnetic surveys and measuring gravity anomalies. They discourse upon thematic mapping, spectral analysis, and seismic refraction. People make geologic maps and envision their cross sections. People dissect issues along the lines of "what is the probability of finding what quantity of oil in what place." They look at discounted cash flows and calculate the return on capital. This is all well and good. This is all part and parcel of how to do it right.

But when it comes down to the essence of the effort, the hard and dirty job of making dark liquid flow from a hole, the only way to turn a dream into oil and the only way to lift that oil out of the ground is by drilling a well. Dream you must. Talk until you have had your say. But your final exam is when you aim that drill bit towards those ancient rock beds. And Mother Nature is a hard grader.

Whether you are in the dusty outback of China or the remote woodlands of northwest Pennsylvania or even floating 8,000 feet above the sea floor in the Gulf of Mexico, it all goes back to making a hole in the ground. That is what Col. Drake pioneered, and that is what still has to happen. Things are different today only in the type of technology, not in the basic mission of creating a channel between the surface of the Earth and its ofttimes fickle subsurface. But let's get back to China.

Taking the Chinese government at its word (well, at its former word, which we will address), according to The New York Times , Mr. Gao "collected his savings and contributions from every friend and relative he could, and drilled a well." After driving a hole almost half a mile into the Earth, Mr. Gao struck something. He completed his well, and then, we are told, "he camped there," at his well site, "following the hypnotic nod of his derrick and worrying about losing everything."

But as luck would have it, and as the old saying goes, Mr. Gao "conquered the rock." According to article, "Two days after he turned his pump on, oil began to gush in a rich flow that amounted to 21 tons a day." Putting this number into a measurement that might be more familiar to those who are reading this article, Mr. Gao had drilled a well that was producing about 180 barrels of oil per day. This is a very respectable rate of production and should gladden the heart of any old hand in the oil patch.

According to Mr. Gao, recalling the moment when his oil well came in, "I screamed, I washed my hands in the oil, and I drank all night, but I couldn't get drunk," he said. "I was too happy."

Whether he knows it or not, China's Mr. Gao has become one of the fraternity. He is a member of the somewhat informal, but certainly exclusive, brotherhood (and sisterhood, to be sure) of oil finders. Welcome aboard, Mr. Gao.

But within a few months of Mr. Gao's good fortune in making his well, the central government in Beijing rescinded the right of private parties to prospect for oil. According to one Chinese commentator, "Local governments actually encouraged investors to drill more oil wells between January and November 2000 and signed lots of long-term investment contracts." Chinese investors and drillers apparently put down over 2,000 wells in the area over the next three years.

In 2003, the provincial government seized control of the privately owned oil wells. Although the government offered compensation to the affected property holders, many investors said that the amounts would cover only about a third of their investment outlays, let alone make up for the lost future profits of lifting and selling the oil into the booming Chinese market. Some Chinese well operators accused local officials of conflicts of interest and profiteering from the government takeover. [Greg's note: Really? In China? Can you imagine that?]

In late 2003 and early 2004, a number of dispossessed oil investors commenced a class action and sued the Chinese government in the Chinese equivalent of a court of claims. In terms of monetary value, the suit could possibly prove actual damages in the many billions of dollars. This lawsuit is estimated to be the largest court action ever brought against the Chinese government. In that the subject matter also involves ownership of mineral rights to petroleum, a matter of some pressing concern worldwide, there is a great deal of interest in the outcome from both domestic and foreign observers.

No one acting on behalf of the Chinese leadership in Beijing has said anything publicly about the dispute. However, according to The New York Times , in May 2005, the mayor of one oil-rich town in northern Shaanxi told reporters that allowing the private investments had been "a beautiful mistake." Asked what this meant, Liu Xuming, another city official, said: "At first, our government was too poor to produce oil, and that's why private investment was sought. But that decision is not in the same spirit as central and provincial government policy now."

"A beautiful mistake"? And "that decision is not in the same spirit"? Reading these words, one can only imagine an elaborate "bait-and-switch" scheme on the part of a government impoverished in both the monetary as well as the moral sense.

That is, the governing authorities offered the investing public the so-called "right" to exploit the mineral wealth of the nation. The government, in essence, asked people to take the risk of drilling oil wells and, in return, promised that the investors could profit by their labors. Was this not part and parcel of that famous Chinese slogan, "Let's all get rich together"? Where is the "togetherness" in all of this?

Then, when the oil wells were drilled and producing, these same authorities seized the wells in the name of their own state power. It is, of course, a disaster for the investors, who have lost everything. But it is also a disaster to the future economic development of China. Not to put too fine a point on it, but China has ruined the dreams of its oil finders. Who will be foolish enough to believe the government's promises the next time around?

This kind of highhanded property seizure might work once and enrich a few government offices, if not the temporary occupants of those offices. But it is not in the long-term best interests of development in China. It is like Mark Twain once said about a cat that sits on a hot stove: That cat will never again sit on a hot stove, nor sit on a cold one, either.

The fundamental legal claim of the dispossessed private parties in this matter is their demand for more compensation from the government for the seizure of the oil wells that they drilled in good faith, relying on the assurances and written promises of their government. There is no evidence that the government ever promised to compensate the investors if they drilled dry holes. It is a classic case of flipping a coin, with the result, "heads, the government wins; tails, the people lose."

The larger issue, and one that will reflect well or ill upon the future of basic freedoms in China, concerns the fundamental legal processes that are involved. Is China on the road to becoming a land where the government respects the property rights of its citizens and its citizens enjoy equal protection under the law?

Or is China still a land and culture in which arbitrary decisions can be imposed by edict, based upon the whim or caprice of distant mandarin bureaucrats and without recourse or appeal to the affected party?

In a manner that reflects a throwback to an earlier era, many of the plaintiffs in the class action against the state have been detained by government authorities at the local, regional, and national levels. Some of the detainees have been charged, conveniently, under laws against illegal assembly or accused of the catchall offense of "disturbing the public order." The plaintiffs' lawyers have been forbidden to speak with members of the press. And according to The New York Times , the plaintiffs' lead counsel, Zhu Jiuhu, is under arrest.

The same Chinese government that has sanctioned the seizure of the oil wells of private parties and arrested their lawyers also owns 70% of China National Offshore Oil Corp. (CNOOC), the entity that is making an attempt to purchase the American oil company Unocal.

CNOOC has gone out of its way to reassure Western investors and their governments that it is a good corporate citizen, interested only in competing fairly in the marketplaces of the world's economy. CNOOC tells us that its effort to acquire Unocal is part of China's evolution into a modern participant in the arena of global trade and peaceful cooperation between the peoples of the world.

But now we have learned about the "beautiful mistake," in which the government of China prompted its own citizens to make the effort to drill and find oil at the bottom of a well. And then that same government just reached out and took what it wanted from its citizens, simply because the government coveted the property.

Chinese authorities are fond of chastising foreign critics for what they call "interfering in the internal affairs of China." But that is not what I am doing in this article. No Chinese bureaucrat took any of my oil wells. I am not suing the Chinese government. And I am not "interfering," just observing. The Chinese government has demonstrated that it will do whatever it wants.

All that I am doing in this article is noting what has gone on, and offering to others the opportunity to draw their own conclusions.

Until we meet again...

Byron W. King

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