China’s Quest for Oil

Chinas Quest for Oil
The passport on Yang Hua’s desk is stamped with visas that would alarm immigration clerks around the world. He showed up in Indonesia two days after the Bali nightclub bombings in 2002. He’s logged trips on a moment’s notice to Iran, Yemen and Qatar, as well as to the U.S., Australia, Canada, England and Brazil. But Yang doesn’t try to hide the substances contained in little glass vials that he brings home from his travels. They’re lined up on the windowsill of his Beijing office, affixed with labels such as “Saudi sweet.” As senior vice president of China National Offshore Oil Corp. , Yang is responsible for the state-owned company’s efforts to secure oil and gas supplies all over the globe. The samples of crude are souvenirs that testify how far he must roam in his search. “I’d like it if there was oil under Paris,” he says, “but I spend my time in less comfortable places.”

Yang isn’t the only one made uncomfortable by his globetrotting. CNOOC’s aggressive efforts to secure reliable supplies of oil and natural gas around the world reflect just how strong China’s thirst for fossil fuels has become. Motorists bemoaning high prices at the pumpsoil rose to a record $55 a barrel on Oct. 15, up 65% this yearcan with some justification point an accusatory finger toward the mainland. Its booming economy and burgeoning appetite for cars and other modern conveniences have caused energy demand to soar. China’s oil imports doubled over the past five years and surged nearly 40% in the first half of 2004 alone. These increases vaulted the mainland ahead of Japan and into second place among the world’s biggest oil consumers, behind only the U.S.

Of course, there are numerous other factors driving the price of crude, among them supply hiccups caused by chaos in Iraq, political and economic turmoil in oil-producing nations such as Nigeria and Russia, hurricanes in the Gulf of Mexico, and fears of terrorism. “It is neither fair nor accurate to blame China for most of the rise in oil prices,” says Jeffrey Logan of the Paris-based International Energy Agency . But with oil in short supplycurrently, producers are pumping just 1 million barrels more than the 81 million barrels being consumed worldwide every daygrowing demand from China is clearly having an unwelcome impact. The country accounted for about one-third of the increase in world oil consumption this year, more than any other single nation.

While many of the factors that have caused the oil-price spike appear to be fleeting, there may be no respite from Chinese demand for the foreseeable future. The country’s industrial base is gobbling up vast amounts of petrochemicals to make everything from fertilizer to Barbie dolls. The number of cars on mainland roadsabout 20 millionis expected to increase by 2.5 million this year alone. Even if China’s blazing GDP growth of 9.4% this year moderates to 8% in 2005, as the Chinese Academy of Social Sciences predicts, the country is now a permanent major player in the global competition for oil. “More than a billion Chinese are joining the oil market,” says Bo Lin, an energy specialist at the Asian Development Bank. “How can prices go down?”

And just as oil is seen driving American foreign policy, so too are China’s geopolitical strategies increasingly influenced by the country’s inability to meet its energy needs solely through domestic production. Last week Russian President Vladimir Putin began a state visit to China, during which Chinese President Hu Jintao was expected to press for the swift approval of several proposed billion-dollar, oil-and-gas joint ventures between the two countries, including a pipeline to connect Russia’s oil fields with China’s main domestic distribution network.

China wasn’t always so heavily dependent upon imported oil. The discovery in 1959 of the Daqing oil fields under the Manchurian grasslands meant the once largely agrarian country was for decades able to produce more crude than it required, a happy circumstance that the government celebrated as a political victory. “Study Daqing!” chanted legions of Red Guards during the 1966-76 Cultural Revolution, when the country’s best-known “model worker” was Wang Jinxi, who was said to have plunged into a vat of Daqing oil during a freezing winter and stirred it with his body so it would continue flowing. Oil and gas discoveries in the South China Sea and Bohai Gulf, where drilling began in 1979, made China seem all the more invulnerable to oil shocks, and the country remained an oil exporter until 1993. Today, however, output from China’s top four oil fields is in decline. By some estimates, the country’s current proven reserves will be depleted in as few as 14 years. Meanwhile, largely untapped petroleum pools believed to lie beneath western China’s desolate Tarim Basin are uneconomic to drill, even with prices at $50 a barrel.

That doesn’t mean China’s robust economic engine is destined to grind to a halt. The country already suffers frequent power outages, but they occur because of insufficient electrical-generation capacity, not a lack of fuel. The mainland meets more than two-thirds of its energy needs with coal and boasts the world’s largest coal reserves. But to keep the increasingly oil-dependent economy racing aheadand to ease some of the pollution that comes from burning coal for powerChina’s leaders are forced to seek ever-greater supplies of petroleum from overseas. More than half of China’s oil imports currently come from the volatile Middle East, making oil security a pressing concern in Beijing. China has begun building up a strategic oil reserve that it hopes to fill with at least 30 days’ worth, and the country has several pipelines planned that would theoretically receive supplies from fields in Russia, Central Asia and Burma. But China’s state-controlled oil industry, comprising three major companiesCNOOC, Sino-pec and China Nation-al Petroleum Corp. as well as numerous overlapping bureaucracies, has yet to develop a clear, comprehensive energy policy.

Leaders in Beijing want to avoid the fate of other oil-poor countries like South Korea, which buys all of its crude on the open market and is therefore exposed to sharp price rises. The way to do that is to invest in exploration and development in countries that have oil fields but lack the capital or technology to exploit them. Once Chinese companies have a stake in oil coming out of the ground, even if it originates abroad, they’ll have secured long-term supplies independent of the world’s fickle prices. The process of overseas exploration began in 1997, when Premier Li Peng encouraged state-run oil concerns to look outside China’s borders for investment opportunities, and in the past few years the search has ranged all over the world.

CNOOC, for example, signed a deal two years ago to extract a million barrels of oil a day in Indonesia, and a year ago it signed a major contract to produce gas in Australia. In February, President Hu traveled to Gabon hoping to secure agreements in Africa. In June, he led a delegation from China’s natural gas industry to Uzbekistan to build the mainland’s presence in oil-and-gas-rich Central Asia. Chinese oil executives have even begun courting Ecuador and Colombia in hopes of buying oil in the U.S.’s backyard. “Latin Americans feel frustrated that the U.S. has virtually ignored the region, so turning to China is prudent and will pay financial dividends down the line,” says Cynthia Watson, a professor of strategy at the National War College in Washington, D.C.

China’s stepped-up oil diplomacy and its increasingly competitive stance in world oil markets are already creating friction with countries such as India, which like China has a bustling economy and a growing oil habit to satisfy. Earlier this year, ONGC Videsh, the overseas investment arm of India’s largest oil-and-gas producer, was on the verge of completing a deal that would have given it an 11% stake in a proven oil field in Sudan. While the company waited for the necessary approval from India’s Cabinet, CNPC swooped in with an offer that was reportedly 17% higher, and snatched the oil deal for China. “The Chinese are definitely very aggressive in the price they are willing to pay,” says R.S. Butola, managing director of ONGC Videsh. Similarly, Vietnam’s leaders recently complained to visiting Chinese Premier Wen Jiabao about CNOOC’s intent to conduct seismic testing near the Spratly Islands in partnership with the Philippine National Oil Co. The Spratlys, a mostly uninhabited archipelago in the South China Sea, are believed to harbor commercial deposits of oil and gas, but sovereignty over the islands has long been disputed by Vietnam, China, the Philippines, Malaysia and Taiwan.

Undaunted by such diplomatic sensitivities, Beijing has demonstrated its willingness to focus first on protecting its energy interests. Last month, the United Nations discussed imposing sanctions on Sudan as a punishment for sponsoring human-rights abuses in Darfur. China has invested a reported $15 billion in Sudanese oil projects, and Sudan nowadays supplies about 7% of China’s oil imports. China, which sits on the U.N. Security Council, threatened to veto the sanctions. The U.N. instead passed a watered-down measure.

But as assertive as China appears to be in its search for oil, so far it has fallen far short of its goal of energy security. Currently, production from China’s overseas investments supplies just 5% of importsthe rest is purchased on the open market. Mainland oil companies have twice been foiled in their efforts to buy stakes in fields in Kazakhstan, and they haven’t secured any significant drilling rights in Central Asia or the Middle East. The fields that Chinese companies have so far bought into are already mature, and many experts feel they’ve overpaid. “China has been singularly unsuccessful in its overseas ventures,” says Jim Brock, a Beijing-based energy consultant. “They’re trying to learn in a decade what it’s taken big foreign companies a century to master.”

The failure to secure Moscow’s approval to begin construction on a pipeline from Russia has especially frustrated China’s leaders. In its absence, Siberian oil is currently transported into China at great expense in trains and trucks. Beijing has for years lobbied its former Communist brother for a more direct link between oil fields in Russia and refineries in Daqing. The flow could supply as much as 15% of China’s imports. During a visit to Moscow last month, Premier Wen Jiabao repeated China’s entreaties but received no promises. In fact, Russia’s only crude-oil supplier to China, the embattled Yukos, announced only days before Wen’s arrival that it would cut off shipments to China. The move seemed designed to embarrass the Kremlin, but it underscored China’s vulnerability. Meanwhile, Beijing’s planned pipeline is in danger of being thwarted by its regional nemesis, Japan, which has offered to pay for part of the multibillion-dollar projectso long as it terminates in the Russian port of Nakhodka, which is nearer Japan. Moscow seems inclined to take Japan’s offer, and “China feels betrayed,” says Bernard Cole, an expert at the National War College on China’s oil needs.

Even at home, Beijing has faced embarrassing setbacks in its efforts to produce more oil and gas. In August, a consortium led by oil giant Shell pulled out of a just-finished gas pipeline running 4,400 km from China’s western deserts to Shanghai after the firms decided their returns would be too small. A planned oil pipeline covering the same distance has also seen no takers. Shell and Unocal also backed out of a multibillion-dollar project this month to tap gas fields under the East China Sea. And no foreign companies have been willing to participate in drilling in the Tarim Basin, considered China’s last onshore region with major untapped reserves. The oil is thought to be of low quality, and moving it out of the isolated Taklamakan desert is just too expensive. “China’s state-run companies sometimes operate for the national interest,” says a Beijing-based executive of a foreign oil company. “But we have to base our decisions on profitability.”

Still, if China were to discover a major new oil field tomorrow, it takes years to bring production online. So for the next several years at least, China’s import requirements will continue to put upward pressure on crude prices. In a report issued last week, the IEA warned that high oil prices will cool global economic growth next yearand China is expected to continue to be the main contributor to growth in oil demand. The IEA report noted, however, that high prices will “galvanize energy-saving efforts and fuel switching away from oil in China and other non-OECD Asian economies,” which will ease price pressures. Kang Wu, an expert at the Honolulu-based East-West Center on China’s oil use, predicts China’s annual growth rate in oil consumption will fall to 9% next year from 15% this year because of slowing economic growth.

Over the long term, experts say China’s energy appetite will only continue to expand. If its oil demand keeps growing at an average rate of 7% a year, as it has since 1990, the country in less than 20 years will be consuming 21 million barrels a daymatching the current consumption of the U.S. “There’s a big question mark as to whether that’s sustainable,” says Wu.

For now, though, the world is able to produce enough oil to accommodate the Middle Kingdom. “The world has the oil, and China has the money,” says Chen Huai of the Development Research Center, a think tank in Beijing run by China’s Cabinet. The question is: How much is Chinaand the worldwilling to pay for it?