Middle East Economic Survey

VOL. XLIX

No 3

15-Jan-2007

China’s Energy Policy: Strategic Implications

By Gawdat Bahgat

Dr Bahgat is Director of the Center for Middle Eastern Studies, Department of Political Science, Indiana University of Pennsylvania (GBAHGAT@IUP.EDU).

China’s Energy Policy: Strategic Implications

Following the establishment of the People’s Republic of China (PRC) in 1949, the nation was largely self-sufficient in energy. The largest oil field, Daqing, was discovered in 1959 and played a significant role in meeting China’s petroleum demand. Thus, the first two “oil shocks” (1973-74 and 1979-80) had little impact on the Chinese economy and energy sector. Indeed, China exported crude oil to several of its Asian neighbors during this period. Since the early 1980s, China’s economy has grown by an impressive rate. This skyrocketing and sustained economic growth, in conjunction with a population of more than 1bn people, demanded more energy supplies. The country’s domestic production had failed to keep path with its growing energy demand. In 1993 China became a net importer of oil and in 2006 Beijing was the world’s third-largest net importer of oil behind the United States and Japan.

This current large gap between stagnant energy production and fast-growing consumption is projected to expand further in the next two decades. According to the Energy Information Administration (EIA) China’s oil consumption is projected to rise from 5.6mn b/d in 2003 to 15.0mn b/d by 2030 (3.8% average annual change – the highest in the world). Similarly, natural gas consumption will jump from 1.2 trillion cubic feet (tcf) to 7.0 tcf during the same period (6.8% average annual change – again the highest in the world). China’s limited oil and natural gas proven reserves further complicate its energy outlook. In 2006 proven oil reserves were approximately 16bn barrels (1.3% of the world’s total) and gas reserves 83 tcf (also 1.3% of the world’s total).

This combination of limited indigenous energy resources and rising demand has prompted Chinese leaders to adopt a multi-faced energy strategy. Three elements of this strategy can be identified: (a) reform the energy sector to maximize domestic production and attract foreign investment; (b) diversify the energy mix to reduce the nation’s dependency on fossil fuels and contain pollution; and (c) diversify energy sources to restrain over-dependence on one or few producing regions.

Reform Of Energy Sector

Chinese leaders agree that a viable and aggressive energy policy is essential to maintain and further expand the high economic growth of the last two decades. However, unlike many other countries, Beijing lacks a national energy agency to draw and implement it. Since the founding of the PRC several national agencies have been established and dissolved. The Ministry of Fuel Industries was abolished in 1955, when separate ministries for coal, electricity and oil were established. In 1970, a new Ministry of Fuel and Chemical Industries combined the functions of those three ministries, but it was dissolved five years later. In 1988, a Ministry of Energy was launched to oversee coal, oil, nuclear and hydroelectric development, but it was dissolved in 1993. In the early 2000s the central government created the Energy Bureau under the National Development and Reform Commission (NDRC) as an integrated central authority responsible for developing long-term energy strategies. This Bureau was replaced by the State Energy Office in May 2005 – with a mission to safeguard energy security. These continuing changes suggest that China lacks a strong national mechanism to oversee its energy sector.

This institutional instability aside, the oil and gas resources are controlled by three state firms: China National Petroleum Corporation (CNPC), China Petroleum and Chemical Corporation (Sinopec), and China National Offshore Oil Corporation (CNOOC) – the government holds a majority stake in all of them. CNPC and Sinopec operate almost all of China’s oil refineries and the domestic pipeline network, while CNOOC has the most expertise with international transactions. In addition to these state-controlled firms, the country’s first private sector company, the Great Wall Petroleum Group, was founded in 2005. These corporations seek to enhance China’s energy security by investing in domestic exploration and development operations and securing foreign supplies. In addition, Beijing seeks to neutralize threats to oil and gas shipments and to build a strategic petroleum reserves (SPR) as a safeguard against any interruption in oil and gas supplies.

Vulnerability To Attacks

China’s growing dependence on foreign oil supplies has heightened the country’s vulnerability to attacks by terrorists or pirates. Almost all of China’s imported crude oil and refined products are shipped by tankers. However, according to official data, Chinese-owned ships carried only 9% of imported products in 2005. Commercial interests and concern for safe transport of oil shipments have prompted Beijing to develop plans to build a national tanker fleet. By 2010, China intends to transport 40-50% of its oil imports in government-owned tankers, and by 2020 to carry 60-70%. In addition, it has been building up its naval capacity to secure oil shipments, particularly through the Strait of Malacca, linking the Indian and Pacific Oceans. It is the shortest sea route between India, China, and Indonesia and therefore considered the key choke point in Asia. With Chinese oil imports from the Middle East increasing steadily, the Strait of Malacca is likely to grow in strategic importance in the foreseeable future.

Unlike other major oil consuming countries, China has only recently started to build a strategic petroleum reserve (SPR – MEES, 25 December 2006). The idea of building one has been considered since the late 1990s. The Chinese authorities have chosen four sites to store crude stocks: Dalian, Huangdao, Zhenhai, and Zhoushan. Chinese officials assert that eventually the SPR will hold oil stockpiles covering about 90 days supply.

Diversification Of Energy Mix

China’s energy consumption is overwhelmingly dominated by fossil fuels, particularly coal. This energy mix has caused serious environmental pollution and threatens the sustainable energy supply. Indeed, many of China’s cities are among the most polluted in the world.

Table 1

China’s Energy Mix 2000-20

(%)

Source: Development Research Center of the State Council, Overview of the National Energy Strategy, available on line at <www.efchina.org/documents/Draft_Natl_E_Plano311.pdf> accessed June 20, 2006.

For a long time production form the country’s largest oil field, Daqing, met a substantial proportion of its demand; but it peaked in the 1970s, and production has been reduced since 2004. In an effort to offset this decline, the Chinese authorities have sought assistance from international oil companies to boost oil recovery and extend the life of producing fields. Furthermore, heavy investments were made in the exploration and development of new fields, particularly offshore. Since the early 1990s, domestic production has failed to keep pace with growing demand, and the gap between output and consumption has been increasingly filled by imported oil. This trend is certain to endure.    

The figures in Table 1 show two important trends: (a) Natural gas represents a small proportion of China’s energy mix; (b) Natural gas consumption is growing faster than that of coal and oil. Several new discoveries have been made in recent years, but most of China’s current natural gas fields are located in the western and north-central part, away from population and industrial centers in the east and south-east. In order to offset this imbalance, the West-East gas pipeline has been built. Other pipeline projects from Kazakhstan and Russia are under consideration. In addition, two LNG import terminals, one in Guangdong and the other in Fujian, have been built and several others have been proposed. In short, China’s natural gas development is still in its infancy, hence it has great potential. Future consumption growth will come from: higher domestic gas production, emerging LNG import terminals, and international pipeline projects.

China’s heavy dependence on coal is projected to decline slightly in the near future. This dominance of coal underscores the fact that China is the world’s largest consumer and producer of coal. In recent years, the Chinese authorities have sought foreign investment to expand coal liquefaction projects. The goal is to reduce the country’s dependence on oil and to increase energy efficiency and environmental benefits.

Finally, in order to improve environmental conditions and reduce dependence on fossil fuels, the authorities have shown strong interest in other sources of energy, particularly renewable and nuclear power. But despite these plans to diversify its energy mix, the country’s dependence on foreign energy supplies is certain to grow in the foreseeable future. Simply stated, indigenous energy resources are not sufficient to maintain high economic growth rate.

Going Abroad or ‘Zou Chu Qu’

China’s growing dependence on foreign oil supplies has prompted its oil companies to acquire interests in exploration and production abroad. Indeed, securing future energy supplies has become a key aim of China’s energy and foreign policies. Beijing officially joined the World Trade Organization in December 2001. Around this time, then Premier Zhu Rongji, and Hu Jintao, General Secretary of the Communist Party, called on Chinese companies to pursue a “going-out” or “Zou Chu Qu” policy – part of a broader policy of global economic engagement.

Three major characteristics of this policy can be identified. First, Chinese oil companies have only a short history of merger and acquisition activities abroad. The policy was launched and gained momentum only in the last few years. In the mid-1990s most of China’s oil deals were mainly with Indonesia, Oman, and Yemen. A decade later, Chinese companies are actively pursuing oil deals in North and South America, Africa, Asia, and the Middle East. Second, Chinese companies have sought to establish a presence mostly in countries where US and European companies are absent or have withdrawn. These targeted countries, like Iran, Sudan, Uzbekistan and Venezuela, have adopted domestic and foreign policies that are largely in contrast with the interests of Western powers. Furthermore, the absence of American and European companies means the Chinese companies do not need to compete with their more experienced and technologically advanced Western counterparts. Third, despite conscious efforts to diversify import sources, China’s oil suppliers are heavily concentrated in the Middle East and Africa. These two regions are likely to continue providing the bulk of China’s oil needs.

Russia: Theoretically, China and Russia seem to have the necessary basis for energy cooperation. The former has a large energy deficit, while the latter has substantial energy surplus. This potential energy nexus, however, has yet to emerge. Several bilateral, regional, and international forces shape a possible Sino-Russian energy partnership.

On the bilateral level, in contrast to the ups and downs in Moscow’s relations with Washington, and to a less extent with Brussels, relations with Beijing have substantially improved since the early 1990s. Indeed, China has become Russia’s second largest trading partner after the EU. Politically, Moscow supports Beijing’s one-China policy and its hard line on separatism in Tibet and Xinjiang, while China reciprocates on Russia’s handling of the conflict in Chechnya. Militarily, China has emerged as the largest customer for Russian arms exports and the two nations conducted their first ever joint military exercises in 2005.

On the regional and international levels, both Beijing and Moscow are suspicious of Washington’s expanding military and political presence in their “backyard” – Central Asia. In order to counter this perceived “American hegemony” the two nations, along with Kazakhstan, Kyrgyzstan, Tajikistan, and Uzbekistan created the Shanghai Cooperation Organization.

Despite these similar perceptions and joint interests some Russian policymakers are concerned about China’s rising economic and strategic power. In addition, Russia’s Pacific provinces are vulnerable to China’s legal and illegal immigration. Finally, Beijing’s and Moscow’s interests in Central Asia are not identical. The two giant nations vie for influence and power in this vital region. In short, despite significant potential, little tangible progress has been made on joint energy cooperation.

Central Asia: Since the collapse of the Soviet Union in December 1991, several major regional and global powers have engaged in intense strategic and economic competition in Central Asia. These rival powers include China, EU, India, Japan, Russia, and the US. Beijing is eager to secure oil and gas deals with neighboring countries. Central Asia is particularly attractive with its large hydrocarbon reserves: imports from Central Asia would reduce China’s overwhelming dependence on the Middle East; and shipping oil and gas by land from Central Asia would help it avoid the sea-lanes, which are largely dominated by the US navy. Also, by exporting some of their oil and natural gas to China, Central Asian producers would lessen their overwhelming dependence on Russia.

Within this context, China and Central Asian producers have pursued their mutual energy interests. In April 2006 China and Turkemenistan signed agreements for the latter to sell China natural gas and to build a pipeline to deliver it. China will purchase 30bn cu ms/year of natural gas from Turkmenistan over 30 years, starting from the date the proposed Turkmenistan-China gas pipeline is commissioned in 2009.

Considering that it borders on China and has the largest proven oil reserves in Central Asia, it is not surprising that Kazakhstan has been the main focus of Chinese energy investment. In June 1997, CNPC purchased 60% of Kazakhstan’s Aktyubinsk Oil Company for $4.3bn. In October 2005, CNPC finalized the purchase of Petrokazakhstan, whose assets include 11 oil fields and licenses to seven exploration blocks. In May 2006, China began receiving crude oil imports from its first transnational oil pipeline. The pipeline was developed by the Sino-Kazakh Pipeline Company, a 50-50 joint venture between CNPC and Kazakhstan’s KazTransOil. It runs from Atasu in northwestern Kazakhstan to Alashankou in China’s northwestern Xinjiang region and provides Kazakhstan with a non-Russian oil export alternative route for the first time.

Despite Central Asia’s promising hydrocarbon energy resources, it is doubtful that it can substantially meet China’s energy needs. Most of China’s industrial and population centers are in the eastern and southeastern part of the country, far away from Central Asian oil and gas deposits. A cost-effective transportation route represents a major challenge.

Africa: China’s growing economic and strategic cooperation with Africa over the last decade has been a major feature of its international policy, with potential significant ramifications. Chinese leaders view Africa as an open market with massive natural resources, largely neglected by Western multinationals. Furthermore, the great majority of African countries support the one-China policy and do not have diplomatic relations with Taiwan. On the other hand, African leaders see the “China Model” as a guiding example for their development – based on a combination of a free-market economy and an authoritarian political system. With its veto power on the UN Security Council, China is viewed as a potential protector and ally on the international scene.

Against this background of shared perceptions and common interests, the Chinese role in Africa has dramatically changed in the last half century. In the 1960s and 1970s Beijing’s interest centered on building ideological solidarity with other underdeveloped nations to advance Chinese-style communism and on repelling Western ‘imperialism.’ Following the Cold War, Chinese interests evolved into more pragmatic pursuits such as trade, investment and energy. Within this context, China plays on African leaders’ historic suspicion of Western intentions. Unlike their Western counterparts, Chinese leaders avoid controversial political issues such as human rights, promoting democracy, and proliferation of weapons of mass destruction. Instead, China’s approach towards Africa is almost exclusively based on and driven by commercial interests.

The emerging Sino-African partnership has been institutionalized with the establishment of the China-Africa Cooperation Forum (CACF) in 2000. According to the Chinese government, the CACF was founded on the basis of “equal negotiation, enhancing understanding, increasing consensus, strengthening friendship and promoting cooperation.” The forum has been held every three years with China and African countries taking turns in hosting the event – the most recent was in Beijing in November 2006.  At this meeting Chinese and African leaders adopted an action plan in which the two sides ‘resolved’ to bolster joint energy and resources exploration and exploitation under the principle of reciprocity and common development. The document noted that China and Africa were “highly complementary” in energy and resources sectors and that better information sharing and pragmatic cooperation in these sectors served the long-term interests of both sides. Beijing confirmed its intention to help African countries turn their advantages in energy and resources into development strengths.

Over recent years, Africa has become a major oil supplier to China, providing almost a third of its oil imports – mostly from Angola and Sudan. In 2006 Angola overtook Saudi Arabia as China’s single largest oil supplier. Civil war and wide-spread of human rights abuses have prompted Western oil companies to suspend oil exploration and development in Sudan since the mid-1990s. In 1997 the US imposed economic sanctions on Sudan, prohibiting all trade and investment by American firms. These sanctions remain in place. Since then, CNPC has entered Sudan and become a major partner in the Greater Nile Producing Consortium. The Chinese work is built upon earlier work by Chevron. Currently, most of Sudan’s oil industry is dominated by Chinese, Indian, and Malaysian companies and about half of Sudan’s oil exports go to China.

The Middle East: Like African states, Middle Eastern oil producers share significant commercial and strategic interests with China. Iran, Iraq, Kuwait, Saudi Arabia, and the UAE hold 59.7% of the world’s proven oil reserves and their share of total world’s production in 2005 was 27.5%. In addition, production costs are the cheapest in the world and shipping routes are accessible and close. In short, the Middle East region is the world’s largest oil producer and exporter while Chinese oil consumption is growing at the fastest rate in the world. Middle Eastern producers want to secure a buyer to their oil and China wants to secure a reliable supplier.

Besides, these mutual energy interests, the two sides share strategic concerns. Iran has been under US economic sanctions since 1979. Iraq was subject to UN and US sanctions after it occupied Kuwait in 1990 until the toppling of Saddam Husain’s regime in March 2003. Finally, September 11 terrorist attacks dealt a heavy blow to US relations with the Gulf monarchies and the entire Arab world. In the wake of these attacks, many US policy-makers, including President George W Bush, have called for reducing America’s dependence on Middle Eastern oil. The increasing violence between Israel and the Palestinians and the 2006 war in Lebanon have further worsened the US’s image in the Middle East. China, with UN Security Council veto power, is largely seen as a potential and attractive ally. On the other hand, with its growing trade and energy interests in the Middle East, Beijing is eager to consolidate strategic ties with the region. Within this commercial and strategic context, China and Middle Eastern oil producers have taken several steps to consolidate their emerging energy partnership.

For the few years, China has taken an assertive role in developing Iran’s hydrocarbon resources. Unlike in Iraq, there are no security problems there, and unlike in Saudi Arabia Chinese oil companies do not face a competition from their US counterparts. In June 1997, a consortium of Chinese energy companies signed a 22-year production-sharing agreement with Saddam Husain’s regime to develop Iraq’s oilfields after the lifting of UN sanctions. In the post-Saddam period, the status of this agreement remains uncertain.

Relations between Beijing and Riyadh have experienced dramatic improvements in recent years. Visits by top officials from both countries illustrate this growing partnership. In 1999, then President Jiang Zemin visited Saudi Arabia and signed several trade and energy agreements. Shortly after this visit the kingdom has become a major oil supplier to China. After long and unsuccessful negotiations with American oil companies to develop Saudi Arabia’s natural gas, Riyadh awarded concessions to European, Russian, and Chinese companies in 2004. On the other hand, China has attracted Saudi investment in joint ventures to expand and upgrade Chinese refining capacity. In January 2006 King ΄Abd Allah used his first trip outside the Middle East since becoming the Saudi ruler to visit China.

Conclusions

Several conclusions can be drawn from this discussion of China’s energy outlook. First, China’s demand for oil will continue to grow in order to satisfy its high economic growth and the needs of its large population. Given the country’s stagnant domestic production, China’s dependence on imported oil will further deepen. Second, like other major energy consumers (ie, the EU and the US), China has sought to diversify its oil sources. Supplies from Russia, Central Asia, Latin America, and Canada are likely to contribute to Beijing’s energy security. However, Africa and the Middle East are likely to continue to be the main suppliers.

Third, a key challenge to China’s energy security is how to control and regulate the rising demand for energy and create the appropriate governing mechanism to achieve this goal. Fourth, China’s energy security is increasingly an international concern. The nation’s rising demand is pushing prices higher and is raising serious concerns regarding global pollution and other environmental issues. Fifth, securing energy supplies has become a major aim of China’s foreign policy. China is likely to play a stabilizing role in international policy to ensure the non-interruption of oil supplies. Finally, Beijing’s rising demand for energy should not be seen at the expense of the US or other major consumers. Today’s energy markets are well-integrated. The source of energy matters less than its availability.