Friday, February 10, 2012

China’s upstream energy dealings: the Persian problem

This year presents a new set of challenges for Chinese energy endeavours, and nowhere more so than in oil.

Despite analysts bemoaning China’s ‘cavalier’ approach to risk as it strikes upstream deals in exotic locations, Beijing always knew it would have to cash in some of its chips when geopolitical cards were put on the table. And while some of the bigger cards will be called this year, other options will open up for China — and not where most people would commonly think.

Beijing’s biggest problem for 2012 is Iran. US and EU pressure is mounting via sanctions as rapidly as the Iranian bluster over the Strait of Hormuz is pushing benchmark prices higher. The structural hedge currently being played out in Tehran is the fight for nuclear enrichment against the threat of a major oil price spike.

The game will keep being played until someone makes a wrong — or rash — move. Forget Beijing buckling to Western pressure over sanctions — what matters here is the regional dynamics of the Middle East. Unless China can convince the bulk of Middle Eastern producers that its close ties with Iran can help constrain Tehran’s nuclear ambitions, China’s core suppliers in the Gulf will call time on Iran and expect Beijing to comply accordingly. If Iran thinks Saudi Arabia is already tightening the screw by covering prospective Persian supply gaps, it will be turned even harder when the Saudis withhold oil from global markets to force assertive international action on Iran. As painful as this reality is for China, it knows that Arab output will always trump Persian production; of China’s 5.5mb/d of imports in 2011, 2.3mb/d were source from Saudi Arabia, Iraq, the UAE and Kuwait, with Iran only accounting for 550,000b/d. ‘Chirabia’ rather than ‘Chiran’ is the key relationship Beijing needs to get right.

Uncertainties surrounding Iraq also feed into the regional dynamics. Baghdad has little political glue to hold the country together following the US withdrawal. Oil has been at the epicentre of secessionist Kurdish claims. And Sunni–Shia schisms remain ingrained as Baghdad’s core weakness — and these schisms will continue to grow as external power vacuums unfold. The upshot is that regional players will use Iraq to advance their own ambitions, which in turn points toward the real interest for Iran. Disrupting Iraq to buy more nuclear time would do far more harm to the US’s international credibility — and presidential election campaigns — than short-term blockages from the Strait of Hormuz.

This is all bad news for China. Beijing’s overriding energy interests are to secure and maintain steady energy supplies to fuel the Chinese economy and to keep benchmark prices within a ‘stable range’. Even if suspicion over Iranian nuclear weapons had not been raised and uncertainties surrounding Iraq’s future were not a concern, the Arab Spring and prospective ‘Eurasian and African Summers’ pose major questions as to whether China is prepared to do the heavy lifting required to keep global hydrocarbon provisions online. Beijing needs to get its strategy right so that its political risks abroad do not translate into political instability at home.

At the very least, Beijing should start reflecting upon which energy policies to keep and which to trade in at ‘reasonable energy prices’. This logic should not only apply to key producers like Iran, but also to more marginal players in Central and Eastern Africa, not to mention the Gulf of Guinea reserves. China cannot fill all these geopolitical gaps overnight, which means the global power transition from West to East will be intrinsically fraught for energy.

But it will not be all bad news for Beijing in 2012. Political risk — or rather a lack thereof — holds the key for China’s bright future; despite endless hype over US energy independence, China’s energy aces will be found in the Americas this year (most notably Canada, the US and Latin America), and the reason for this is simple.

American markets like the colour of Beijing’s money and have the infrastructure in place to harness reserves and investment to ramp up production. True, issues of ‘resource nationalism’, ‘tax hikes’ and ‘fiscal fiddles’ will flare up from time to time in these more mature markets, but they will not be in the same ballpark as problems in the Middle East, West Africa or Central Asia. The prospect of state implosion (or explosion) in these regions will clearly have dramatic implications for global energy provision.

China’s strategic play should therefore see Beijing hedging its stakes in the global energy system by buying into the Americas. Beijing is well aware that it needs to invest geopolitically to secure supplies from some of the world’s key energy producers — and that this will remain a long-term project. Investing in the Americas now, will come in handy for China later, when the truly serious energy bets are cashed in — namely, the US ceding ground in the Middle East in return for Chinese concessions handed back in the Americas. As this ‘neat’ division of hydrocarbon labour plays out, China must be ready to take up the security slack. The year 2012 will thus provide some painful, but very valuable, lessons for China as to how an Asian hydrocarbon century will pan out.

By Matthew Hulbert Lead Analyst at the European Energy Review, Amsterdam. East Asia Forum

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