China National Offshore Oil Corp (CNOOC) faces tough domestic competition in its drive to build a $2-billion refinery and realise a decade-old ambition to become a fully-integrated oil firm, industry officials say.

With little in the way of infrastructure to support sales and with China facing a surplus of oil products as new capacity grows faster than demand, officials say CNOOC's best chance of success may be to join forces with top refiner Sinopec.

The firms are not strangers. They recently announced they were both buying separate stakes in the North Caspian Sea oil project in Kazakhstan from Britain's BG.

"CNOOC's biggest weakness is the lack of a distribution network, but that could be resolved through a possible tie-up with Sinopec," said an official at China International Engineering Consulting Company (CIECC) in Beijing.

CIECC, linked to China's macro-economic planner, the State Development and Planning Commission (SDPC), approved in February CNOOC's plan to build a 12 million tonne-per-year (246,000 barrel per day) refinery in south China's Guangdong province.

The project, due on stream by about 2006, awaits final government approval. CNOOC is the smallest of China's three state oil firms and is largely an upstream exploration and production company.

Its ambition to follow rivals Sinopec and PetroChina and enter the downstream refining sector was fuelled by the oil discovery PL19-3, China's largest offshore oilfield.

Located in the Bohai Sea, PL19-3 pumped its first oil in December and is estimated to hold 2.6 billion barrels of crude. It is forecast to hit peak output of 15 million tonnes in 2005-2006.

"CNOOC wants to build a world-class refinery with state-of-the-art technology to process crude from its huge oil find. Refining is a blank sheet for CNOOC, but the plant will move us in that direction," said a CNOOC official in Beijing.

Guangdong is China's biggest regional oil market and depends on supplies from outside the province for nearly half its annual consumption of about 15 million tonnes.

Industry officials said CNOOC's investment would probably be higher than similar-sized plants run by Sinopec and PetroChina as the refinery would have to be able to treat PL19-3 crude, which is highly acidic.

"The location makes it competitive. But it has three big problems: CNOOC has no crude terminal, no distribution network and it's an expensive investment," said a senior Sinopec official.

In addition, the planned start-up date comes around the same time as Sinopec and PetroChina are due to bring onstream some 35 million tpy of new capacity, which is aimed at supplying the south and east China market.

"CNOOC will compete with top refiners like Sinopec's Zhenhai or PetroChina's Dalian. And getting together a sales network will come at a high cost," said the Sinopec official. China already has surpluses of gasoline and gas oil with Sinopec and PetroChina running their plants at about 80 per cent of capacity.