China’s petroleum predicament

If China’s rise is one of the most important stories of this century, China’s growing appetite for energy is one of its most striking subplots.

China’s energy consumption more than doubled between 2000 and 2009, and the country is now the world’s top energy consumer. While coal remains China’s dominant energy source, oil poses a unique challenge for the country: China remains far more dependent on the outside world for oil than for any other energy source. China imported less than 4 per cent of its natural gas in 2009, but 53 per cent of its oil. By 2035, according to the International Energy Agency (IEA), China may import as much as 12.8 million barrels per day (bpd), or 84 per cent of its supply, notwithstanding its energetic efforts to control its growing demand.

It is against this backdrop that China has adopted a variety of supply-side policies to ensure its access to oil supplies over the next several decades. Thus far, however, these policies have ranged from largely ineffective to insufficiently developed. For more than a decade, for example, the Chinese government has encouraged its national oil companies (NOCs) and other state-owned enterprises to ‘go out’ — to invest overseas and gain greater access to resources abroad. By the first quarter of 2010, the NOCs’ overseas equity shares had reached 1.36 million bpd — nearly one-third of China’s net imports for 2009. Yet it is unclear that this has enhanced China’s energy security. The NOCs do not necessarily send the oil they produce overseas back to China. Nor is it reasonable to assume that oil produced by the NOCs would somehow be cheaper or more available to China in a supply crisis.

Physical disruptions that impede the flow of oil to China will affect foreign and Chinese firms alike, and the NOCs have shown little inclination to grant Chinese customers a discount when prices are high.

China is also diversifying the sources of its oil imports away from Middle Eastern suppliers, and its ‘loans for oil’ deals in recent years have facilitated long-term contracts with a range of oil-producing countries in other parts of the world — including Russia, Brazil and Venezuela. Yet the volume involved in these deals is not large enough to greatly reduce China’s reliance on the Persian Gulf. Moreover, Russia’s reliability as an energy supplier remains open to question, as some Chinese analysts recognise, and it remains unclear how much oil will be shipped from the Americas to China given the distance involved.

China is also investing in new naval capabilities that could help it to patrol the sea lines of communication through which its oil shipments flow. It is debatable whether a much stronger navy would actually be a worthwhile investment for China, as far as energy security is concerned. A robust force that would allow China to challenge the United States for sea control would provide the country with the means to counter an American-led oil blockade. Such capabilities would take a long time to develop, however, and they would be quite costly as well. Nor is it clear that the US would ever attempt such a blockade, for both economic and military reasons. A less robust force, in contrast, might actually prove more appropriate, particularly if it focused on multinational anti-piracy missions of the sort currently underway off the coast of Somalia.

Lastly, China is actively building its own Strategic Petroleum Reserve (SPR) to bolster its energy security. When completed in 2020, China’s SPR will hold approximately 500 million barrels — enough to cover 63 days of imports at levels projected for 2020. To prove effective, the SPR will need to be coordinated with the reserve systems of other countries. In the event of future supply crises, Beijing is likely to find itself drawing on its own reserves at the same time that other major importers are drawing on theirs, since supply disruptions are far more likely to affect many countries at once than just China alone. Should China’s actions fail to be coordinated with those of other countries, or should China’s response be insufficiently transparent, oil traders are more likely to be confused than reassured, and instability in the markets will persist.

This raises a broader issue concerning how China pursues energy security. China has thus far emphasised unilateral and bilateral measures to reduce its vulnerability to oil-supply shocks. Pursuing greater coordination with other oil importers through the IEA would allow China to develop the multilateral side of its approach to energy security. In the short term, China could deepen its level of consultation with the IEA and make its energy sector more transparent. In the longer term, China could seek membership in the organisation. Such multilateral engagement would provide Beijing with more information and greater influence in the event of future supply shocks — a danger that appears all too real in light of recent instability in the Middle East. Greater multilateral engagement would also demonstrate that Beijing is looking for ways to cooperate with the international community as the story of China’s rise continues to unfold. Author: Andrew Kennedy, ANU from East Asia Forum
Dr Andrew Kennedy is Assistant Professor at the Crawford School of Economics and Government, the Australian National University. This is a digest of an article by the same name that originally appeared in Rising China: Global Challenges and Opportunities.