Middle East Economic Survey

VOL. LI

No 23

9-June-2008

GENERAL/REGIONAL

China’s Energy Strategy In The Middle East

By Xin Ma

Xin Ma, a PhD researcher at the Centre for Energy, Petroleum and Mineral Law and Policy, University of Dundee, UK, wrote the following article for MEES.

The ever growing petroleum-related interaction between China, the fastest growing oil consumer, and the Middle East as the top oil producing region, has been one of the most dynamic trends in the international petroleum sector. China has been actively promoting energy ties with the Middle East, driven not only by the security of supply concerns of the government, but also by the commercial interests of its national oil companies (NOCs). China’s active strategy in the region is also welcomed by the oil producing countries in the interest of secure demand in the fastest growing market. These concerns are further escalated due to the sluggish petroleum demand from matured markets in the US and Western Europe, and an increasing competition from the new African and Eurasian suppliers. China’s energy strategy in the region seems to be effective so far, illustrated by the recent progress in the high profile North Pars Gas project and Yadavaran oil project in Iran. However, there are still many pitfalls and obstacles that remain to be solved for the Sino-Middle East cooperation to develop smoothly.

Energy Strategy Of The Chinese Government: Security Of Oil Supply

In contrast to another equally active player in the region, Russia, China’s interest in the Middle East is more energy related, and less of a political agenda. China needs oil to fuel its impressive economic growth. The country became a net importer of oil in 1993. Its net oil import has grown since then from 0.16 to 3.76mn b/d) in 2006 (Figure 1).¹ The country relied on the Middle East for 44% of its oil import in 2006 (some source put this figure as high as 58%²), making the region China’s top supplier, ahead of Africa (32%) and Eurasia (20%). According to IEA estimates in 2007, China’s net oil import will reach 7.1mn b/d in 2015 and 13.1mn b/d in 2030 under the reference scenario, as much as the entire EU.³ The mere size of the country’s demand for imported oil would not be met without the strong support from the Middle East region.

The vital role of the Middle East in China’s energy strategy is due to their cordial economic and political relationship, the advantages of the region as an oil supplier, and the complexity and difficulty for China to substitute Middle East oil by other sources. Some forecasts envisage China’s reliance on Middle East oil reaching as high as 70% of net import by 2015.⁴

Figure 1

China’s Oil Production And Consumption

Due to their geographical locations, China and the Middle East do not have a history of significant disputes and conflicts. As a result, there are no major obstacles for their energy inter-dependency. Trade between the two regions is developing well: China exports manufactured goods, infrastructure and labor which the Middle East needs, whilst the Middle East provides water technology, oil and gas supply and petrochemical investment to China. Trade among the two regions is growing at a fast pace, and remains balanced.⁵ 

The importance of the Middle East region being an indispensable supplier for China also lies in its rich petroleum reserves, production capacity, well established infrastructure, and convenient geographical location. According to official statistics, the Middle East countries held 742.7bn barrels of proven oil reserves at the end of 2006, 61% of the world’s total reserves. The area produced 25.6mn b/d of oil in 2006, 31.2% of world’s total production. Its reserve/production ratio (R/P ratio) was 79.5 years at the end of 2006, much higher than Africa and Europe/ Eurasia (table 1).⁶

Table 1

Reserve, Production And R/P Ratio Of Major Production Regions

The Middle East region also has other comparative advantages compared to the two other major oil producing regions, Africa and Eurasia, in terms of reliability. Most countries in the region have a strong political will to ensure stability of oil supply due to the high dependency of their economies on oil revenue. Middle Eastern oil also has a comparative price advantage, as the average cost of lifting a barrel of oil in the regions is much lower than other regions.

The importance of China’s Middle East energy strategy is further exacerbated by the difficulty and complexity for China to increase its oil supply from other sources. China pursues a policy of supply diversification, under which Africa and Eurasia also remain strategic suppliers. However, practical barriers prevent significant increases in oil imports from these two regions. China’s efforts in promoting energy ties with Russia and some other Central Asian countries are often overshadowed by the distrust originating from their past relations, by the highly politicized nature of energy issues in these countries, and by surging resource nationalism. China also courts Africa with warm gestures and generous aid packages, making good progress in countries such as Angola, Nigeria and Sudan. However, China is frustrated by the lack of political and social stability, as well as poor infrastructure in these countries. Further, sensitive issues related to human rights, community relationships and environmental issues also frustrate China, as it is eager to send a positive message to the outside world about its increasing global influence.  

Energy Strategy Of Chinese NOCs: Commercial Opportunities

Parallel with the government’s energy strategy, Chinese NOCs also have their specific agenda in the Middle East, that is, to seek new commercial opportunities.

China has four powerful national oil companies, Chinese National Petroleum Corporation (CNPC)/PetroChina (the listing arm of CNPC), China Petrochemical Corporation (Sinopec), China National Offshore Oil Corporation (CNOOC), and China National Chemical Import and Export Corporation (Sinochem).⁷ These companies in total employ more than 3mn employees, and dominate almost the entire domestic petroleum value chain. However, more than 90% of their current revenue is dependant on domestic activities and this is expected to shrink due to fast depleting domestic resources, reduction of government support resulting from commercialization reforms, and increasing competition from foreign and domestic players due to the country’s WTO commitment. As a result, the profitability and even the survival of these oil giants are under severe threat, driving them to desperately seek overseas opportunities. The last decade has witnessed their scramble for overseas assets and resources in order to increase their strategic foothold or book reserves. Support from the government is still relatively easy to obtain, in the form of diplomacy, loans, or package deals, due to the government’s concerns about security of supply and the negative social impact if the NOCs went bankrupt. Under the pressure to survive, and fuelled with the ambition to internationalize, the Chinese NOCs are fully utilizing this window of opportunity, which may not last long.

China’s Middle East Energy Activities

To fulfill the energy strategy of the government and the commercial objectives of the NOCs, China is employing a wide range of diplomatic, economic and commercial measures. The government is focused on macro-measures in order to ensure a smooth and friendly environment for energy deals, for example, in promoting stability in the region using its international influence,⁸ in conducting active energy diplomacy, in promoting economic and energy inter-dependency by promoting package deals including loans, trade and infrastructure, in encouraging direct upstream investment by Chinese NOCs, and also allowing investment by Middle East countries in China’s downstream sector. Chinese NOCs are focused on commercial measures such as actively pursuing projects covering petroleum exploration and production, engineering services, and refineries and petrochemicals. In contrast to IOCs that are restricted by short-term returns, Chinese NOCs can afford to take a long-term view and a more flexible approach in pursuing energy deals in the Middle East.

Although Chinese NOCs are also participating actively in oil and gas projects in other countries such as Kuwait, Oman, Qatar, Syria, UAE and Yemen, their focus is mainly on the three major oil producing countries, Saudi Arabia, Iran and Iraq, with the rationale and nature of their interdependency differing from country to country.

The importance of Saudi Arabia in China’s Middle East energy strategy lies in the scale of its reserve and production capacity, as well as the country’s regional and international influence in the petroleum sector. Saudi Arabia has remained the top oil supplier to China, only briefly surpassed by Angola in 2006. The main rationale of the Sino-Saudi relationship is the issue of security of oil supply, due to Saudi Arabia’s conservative attitude in allowing foreigners to book its reserves. The two sides are investing in each others’ downstream sector in an effort to secure their supply and demand. The most notable deals include a petrochemical Joint Venture set up by Saudi Aramco, ExxonMobil and Sinopec in China’s Fujian Province, which covers a $3.5bn refinery with a capacity of 240,000 b/d.⁹ A separate contract was signed by the partners covering 750 petrol stations and a network of terminals in Fujian. Saudi Arabia is also helping China in building up its strategic storage facility.¹⁰ On the other hand Chinese NOCs’ activities in Saudi Arabia are very much limited to engineering services, such as pipeline, well repair, and seismic data collection, and natural gas projects, which involve higher risks and capital input.

China imports a large quantity of oil and intends to import significant amounts of LNG from Iran.¹¹ The main rationale for cooperating with Iran is not only to secure the supply of oil and gas, but also to seek commercial opportunities for Chinese NOCs, as Iran is one of the few countries in the Middle East that assigns China the right to conduct business in its upstream sector. China is the largest petroleum trade partner of Iran in 2007, and is one of the few countries to break US sanctions against Iran, which “penalizes foreign companies for investing more than $20mn”.¹² Therefore, China is also critically important for Iran in terms of commercial and political support in the international arena. Chinese activities in Iran include refinery upgrades, as well as pipeline and engineering services such as drilling. The two major projects of North Pars gas field exploration and Yadavaran oil field development are among the most important projects between the two countries. A deal involving the development of the North Pars gas field between CNOOC and National Iran Oil Company (NIOC) is said to be finalized soon. The project involves an investment of $16bn from the Chinese side. Another project worth $2bn, the Yadavaran project between Sinopec and NIOC, was finalized in 2007. Sinopec will develop it and buy 10mn tons of LNG over 25 years.¹³

China is also keen to extract the vast reserve base in Iraq, which was made possible after the country was reopened for investors. China’s participation in the country’s oil industry can be traced back to Saddam Husain’s rule, when development and production deals were signed between CNPC and Baghdad involving the Al-Ahdab and Halfaya Fields. However, these deals were frozen as a result of UN sanctions. Since 2006 Iraq invited the Chinese NOCs to participate in its recent licensing round for oil and gas contracts. The Chinese side responded with enthusiasm to the invitation, and was willing to cancel Iraq’s debt and provide further reconstruction aid to Iraq in order to secure cooperation between the two countries.

Not Always A Rosy Picture

Despite the clear good will shown by both China and the countries of the Middle East to interact with each other, and the fast growing energy interdependency, there are still many pitfalls and obstacles that may endanger their energy cooperation. China is concerned about the increasing political and social instability and rising domestic demand¹⁴ in the Middle East and is actively pursuing a supply diversification strategy. This could increase the Middle East countries’ concerns relating security of demand and cast a shadow on their energy relationship with China. At the same time, the investment of the Middle East companies in China are often frustrated by delays and tough negotiation due to heavy bureaucracy, regional protection, and other policy restrictions such as the government regulated oil prices.

Meanwhile, China’s growing involvement in Iran may jeopardize its international reputation. This increasingly concerns China’s government, especially when the country is deliberately trying to send a positive message to the outside world about its increasing global influence. Some speculation attributes the delay to the signature ceremony of the North Pars deal to the Chinese concerns over the sensitivity of Iran’s nuclear issue. Furthermore, the Chinese practice of bringing large numbers of their own employees to the projects may cause uneasiness among many Middle Eastern countries, like Iran, struggling with a rising population and a high unemployment rate among its youth. Moreover, increasing Chinese activity in the region potentially contradicts interests and policies of other major powers such as the US. This power shift may not be smooth and easy.

Notes:

1.    Calculated according to the BP statistics review, BP, (2007): BP Statistical Review of World Energy 2007.   

2.    http://www.middleeastprogress.org/2007/08/china%E2%80%99s-trade-relations-with-the-middle-east/

3.    IEA(2007), World Energy Outlook 2007, China and India Insight, p 326.

4.    John Calabrese, “The Risks and Rewards of China’s Deepening Ties with the Middle East,” Jamestown Foundation China Brief, Vol 5, Issue 12 (24 May, 2005), p 3, at

        http://jamestown.org/images/pdf/cb_005_012.pdf  (30 May 2006).

5.    Mgnus, G, & Burnett, P (22 December 2006). A Route to Riches on the New Silk Road. Financial Times p 15. China’s import from the region reached $41.8bn, while export to the region reached $40.2bn in 2006.

6.    BP. (2007). BP Statistical Review of World Energy 2007.

7.    CNPC and Sinopec are both integrated petroleum companies that jointly dominate China’s domestic onshore E&P arena. In contrast, CNOOC is a much smaller NOC dominates China’s domestic offshore E&P sector. Sinochem is a trade company used to monopoly the petroleum import and export.

8.    China is actively pursuing “stabilization” policy in the region in order to maintain peace and stability. For example, China established a China-GCC Forum to discuss its relationships with the region. Further, Beijing acquiesced in July 2006 the passage of UN Security Council Resolution 1696, which gave Tehran until 31 August to suspend its uranium enrichment.

9.    http://www.uofaweb.ualberta.ca/chinainstitute/nav03.cfm?nav03=57205&nav02=43884&nav01=43092.

        The Joint venture also contains an ethylene steam cracker with a capacity of 800,000 tons/year, a polyethylene unit (800,000 t/y), a polypropylene (400,000 t/y) and an aromatics complex (700,000 t/y of paraxylene.

10. http://www.uofaweb.ualberta.ca/chinainstitute/nav03.cfm?nav03=59950&nav02=57598&nav01=57272

11. Magnus, G, & Burnett, P (22 December 2006). A Route to Riches on the New Silk Road. Financial Times p 15.

12. Gundzik, J P (4 June 2005). The ties that bind China, Russia and Iran, Asia Times Online.

13. According to Middle East Business Intelligence, the field has 18.3bn barrels of oil reserves, of which about 3.2bn barrels are recoverable, while its gas reserves amount to 12.5 trillion cu ft, with 2.7 trillion recoverable.

14. http://www.uofaweb.ualberta.ca/chinainstitute/nav03.cfm?nav03=76728&nav02=57598&nav01=57272