BEIJING (Interfax-China) -- It is well known that China's thirst for oil is increasing rapidly. What is often overlooked is that China is itself quite a significant oil-producing nation, and for a long period domestic output was enough, with the Daqing oilfield pumping 50 million tonnes out per year.
China's Production and Import Levels
By 1993, however, economic growth had stretched domestic capacity to its limits, and China became a net importer for the first time in its history.
Since then, economic growth has continued at a rapid rate, and the volume of imports has increased relentlessly. Efforts to boost production, particularly in the relatively new oil fields of Xinjiang in China's far west, have not kept up with the rise in demand.
Output was up to 175 million tonnes in 2004, a meager rise of 2.9%. Consumption, however, was up 16.8% to 288 million tonnes. The import volume of 115 million tonnes was another new record, and placed China behind only the United States in the list of top crude importers, overtaking Japan.
Although imports rose massively, constituting almost 40% of total domestic demand, China's per capita consumption levels were still way behind the United States and other developed economies. An average U.S. citizen consumes 25 barrels of oil a year, compared to just 1.3 barrels on China. There is still huge and somewhat alarming room for growth in China, especially if the government meets its targets to double 2000 GDP by 2020.
The Daqing oilfield is depleting. The second biggest, Shengli, and the third, Liaohe, are also nearing the end of their productive life, and are having to rely on reserves on the outskirts of the fields, or on enhanced oil recovery techniques, in order to maintain production levels.
At Daqing, after maintaining the 50 million tonne output level for 27 years, the operators began to reduce the volume in 2003. The field produced 48.3 million tonnes in 2003, and that was down to 46.4 million tonnes last year. It was originally expected to cut output to 30 million tonnes by 2010, but officials are now optimistic that they can maintain current levels of production by searching for new reserve pools on the outskirts of the field.
With traditional fields like Daqing, Liaohe and Shengli in the east going through the aging process, China had great hopes for Xinjiang. Output has been inching up slowly over the years, reaching about 30 million tonnes last year, but it hasn't been quite the bonanza that the government was expecting. Production conditions are extremely difficult in the deserts of Xinjiang.
Some Predictions
Demand will, of course, continue to increase. CNPC predicts that the consumption level will hit 320 million tonnes this year, up 12%. The increase will be met mainly by imports, which will reach 140 million tonnes, up by more than 20% compared to last year. Sinopec's prediction that demand will increase to 350 million tonnes by 2010 therefore seems slightly conservative.
Meanwhile, the U.S. Energy Information Administration says that 2000 consumption levels will be more than doubled by 2020.
The International Energy Agency (IEA) says that China will invest $119 billion in its oil industry from 2000 to 2030, mainly to provide the infrastructure to handle, refine and increase imports. It needs to upgrade refineries, boost refinery capacities, and invest in pipelines. China also intends to build its own oil tanker fleet - at present it depends on others to ship the oil to China.
So obviously, China's role on the international market will grow. And that growing role has already been subject to criticism.
U.S. Criticism
The US-China Commission, for example, has lambasted China for failing to set up a reserve system and its unwillingness to participate in "price stabilizing arrangements". China is of course building a reserve system right now.
The IEA has also suggested that the current high price is a result of China's increasing demand, and its desire to build up those strategic reserves.
Chinese officials, of course, say that this view is unfair because Chinese demand is still nothing compared to the U.S. A number of prominent government figures - including Zhou Dadi of the NDRC Energy Research Institute - have refuted IEA criticisms about China's role on the international market and instead turned the blame on the U.S., attributing the high prices to the war in Iraq and the subsequent production disruptions. They say that Chinese imports are still only a seventh of the world total, and that its impact on the world market is still, in fact, less than Japan.
Nevertheless, while the actual extent of China's impact on the market can be disputed at present, it is clear that it will continue to grow.
Dependence on the Middle East
China is still heavily reliant on the Middle East, with three-fifths of its imports coming from the region - and through the Malacca Strait. Saudi Arabia and Oman are the biggest sources.
There is, furthermore, a so-called "Asian premium" of up to $2 per barrel for oil shipped from the Middle East to the Far East, which is a significant increase in costs. This is something that Japan has put a lot of thought into as well. Japan has been suggesting joint regional efforts to try to remove the tariff.
China wants to boost the proportion of oil imported from Russia, and the volume is set to increase even though the plan to construct a pipeline from Siberia to Daqing has suffered a setback. A number of deals have been signed to boost the amount of oil coming in by rail and by truck across the border. Kazakhstan is also expected to lift its imports to China by a significant proportion in a few years.
Transportation problems are significant. All China's oil shipments from the Middle East must pass through the narrow Malacca Strait, a hotbed of pirates and - some fear - a potential target of terrorist attacks.
China is trying to get around this by creating an alternative route for Middle East oil. Burma has put forward a proposal to build a pipeline from its Indian Ocean coast to its northeastern border with China, eventually connecting up to Kunming, where pipelines are already in place to feed the oil to refineries across China.
Vietnam has also suggested a similar proposal to China. Both countries are competing for the significant transit fees they can earn through the pipeline. China, in the meantime, is rapidly boosting transportation capacity in southwestern China, and this could be a long-term option. Still, they would prefer not to rely on a third party like Burma or Vietnam.
The Kazakhstan pipeline route could provide another way of shipping Middle East oil to China through what is described as the Caspian Sea Oil Swap mechanism.
Energy-Dominated Foreign Policy
China's foreign policy is almost completely dominated by these energy concerns. Liu Jianchao, the Foreign Affairs Ministry spokesman, last year said that energy was the single most important issue for China on the world stage.
The big oil companies have also been urged to "go abroad" to search for resources, which they have been doing consistently, often carried along in the diplomatic slipstream of China's top leaders as they sweep through Asia and Africa. Whenever there is a foreign visit, you can bet that CNPC will be there, signing deals and memoranda on "boosting oil cooperation". Hu Jintao made a tour of Africa last year, and constantly by his side was the senior management of CNPC. Vice-Premier Zeng Peiyan recently completed an "energy tour" of Asia.
There has, again, been criticism of China's approach. The U.S. China Commission said that China pursues bilateral deals rather than going through international mechanisms. It is clear that China prefers the government-to-government approach, which works quite well with "countries of concern" such as Sudan, and perhaps with Turkmenistan, Uzbekistan and Kazakhstan, where governments play an overwhelming role in the energy business.
However, it has been said that such an approach in Russia let it down severely. While Beijing concentrated on the circles of power in Moscow, hoping to strike secret deals in the Kremlin corridors, Japan was performing a very effective lobbying job in Russia's far east, persuading local politicians and the local population that a pipe to Japan would mean more investment in the local economy, and playing up the possible dangers of relying entirely on China as the market for its resources.
In any case, the Chinese strategy, says the U.S. China Commission, is to "gain control of overseas oil at the source". But the new Great Game in Central Asia involves lots of different parties, all vying for position in the most promising energy resource base to have emerged for years. Each side is, essentially, trying to gain control at the source.
The Great Game involves Russia trying to exert pressure on its traditional sphere of interest, and trying to ensure that all the new oil in Central Asia goes through Russia, and through Russian ports.
It involves the U.S., which has become an influential presence in Russia's backyard following the "war on terror".
It involves Iran, which despite being part of the U.S.'s "axis of evil," is another influential regional player, especially as it cultivates its ties with China and Russia.
Of course, it also involves China, flexing its growing economic muscles and increasingly desperate for resources. In Central Asia, China has the advantage of not being Russia, but countries like Kazakhstan are still trying to hedge their bets and avoid depending on a single market.
China has repeatedly accused the US of "politicising" the energy industry, and turning the worldwide quest for resources into a geopolitical power struggle. Of course, every country "politicises" energy resources. As a crucial part of national security, energy plays a part in the political strategies of all governments. Political factors intervene in the decision to build pipelines and in the direction of those pipelines. They led the US to put its weight behind the pipeline running west from Baku to Ceyhan via Georgia, much to the chagrin of the Russian Federation. Political concerns are also behind the possibility of a pipeline running south from Turkmenistan, through Afghanistan and to the Pakistan coast.
Politics was at least partly in command when Russia decided to give priority to Japan in the construction of the pipeline from western Siberia - the China pipeline was easier to construct, more economically feasible and involved a guaranteed market and guaranteed sales contracts. The capacity to feed the Japanese route does not yet exist.
China's Current Holdings
China has assets and interests in more than 20 countries through CNPC, Sinopec and CNOOC. CNPC produces 25 million tonnes a year from overseas interests.
These are often risky ventures. Usually, the state-owned CNPC buys the assets, stabilizes them, makes sure they are viable, and then transfers them to the listed company, PetroChina. CNPC has admitted that setting up oil ventures overseas is sometimes like "dealing with the devil.”
The big problem remains one of transportation. How can the oil be transferred back to China, where it is most needed? Because the volume was not commercially viable to justify a pipeline, the oil produced by CNPC at the Aktobe oilfields in Kazakhstan has for the large part gone to Russia, rather than east to China.
Apart from the Aktobe oilfields in Kazakhstan, China holds some old fields in Azerbaijan, which is otherwise dominated by BP Amoco. There are agreements or investments with a variety of African countries including Egypt, Niger, Gabon, Algeria, Chad and Libya. There are exploration deals in Mozambique, Congo, Syria, Pakistan and Saudi Arabia. Substantial deals exist with Venezuela, and Venezuelan President Hugo Chavez is anxious to reduce dependence on the US. Plans are underway to build a pipeline from Venezuela to the Pacific coast of Columbia, enabling oil to bypass the Panama Canal and be shipped across the Pacific to East Asian markets, including China.
There is also the oil sands deal in Canada, and also an agreement to build pipelines on the western coast of Canada with Enbridge. There are oilfield investments in Ecuador and Peru, exploration contracts and refinery renovation deals in Iran. There were oilfield deals with Saddam Hussein's government in Iraq, but these were cancelled. Chinese companies are now being invited to take part in the bidding for oil projects by the new Iraqi government.
Most of the promising development areas have already been taken, in Nigeria, the Caspian Sea, and most of the Middle East. China claims, therefore, to have been forced to go to less fashionable places, even - recently - being linked with concessions in the politically troubled Ferghana Valley in Uzbekistan. China has tended to go to regions that few Western companies will touch, and they blame the fact that they are not being allowed to compete on the international market. China claims that it is being squeezed out, usually for political reasons.
The most well known example of dealing with "rogue states" is Sudan, the location of China's biggest overseas oil production assets. Sanctions on Sudan meant that CNPC had to "ringfence" its assets in the country and scale-back its listing plans in New York.
One hope that China had, and one in which it thought that politics was on its side, was in Russia, and the 25-million ton a year pipeline from Angarsk to Daqing in northeastern China. However, when all seemed well, Japan intervened.
The Russian Pipeline
Once negotiations got underway in 1994, the deal would have seen Russia supplying refineries in northeastern China through a pipeline running from western Siberia to Daqing, China's main oil production base. But after years of wheeling and dealing, Japan decided to get in on the act. By the end of 2003, what seemed to be a done deal - backed by the highest levels of the Chinese and Russian governments - had actually been gazumped by the Japanese. First, the Russian side tried to say that both projects could be built. A pipeline would connect Angarsk to Nahodkha with a branch running to Daqing. The issue, thereafter, was which route was to be prioritized.
The China route was more economically feasible. Mikhail Khodorkovsky, the Yukos boss, was firmly in favor of it, and told the media in 2003 that the Japan route would be akin to throwing away billions of dollars.
Internal Russian politics also played a part. The Russian government did not want private company Yukos involved, preferring state-owned Transneft, which favored the Japan route. Japan wanted 50-million tonnes a year sent to the far-east Pacific port of Nakhodka, far higher than current capacity and requiring much more exploration.
Japan, for its part, did the lobbying much more effectively, touring the regions involved and promising investment in the local economy and infrastructure.
Russia, on the other hand, was worried about depending on a single market. The Nahodkha route at least allows the oil to be shipped not only to Japan but to other markets in the Asia Pacific region, including the U.S.
Chinese analysts have said that it was the so-called "China Threat Theory," prevalent in Russia, and especially in Siberia, that helped to derail the deal.
China ought to be cooperating with Japan on energy issues. Not only on Russian oil, but on Middle East imports, on general Asian energy security, and on the gas reserves of the East China Sea. Unfortunately, history and politics get in the way. Many believe that Russia has played the two long-term enemies off against each other.
Now, Japan is lobbying to build up their influence in Central Asia. And China is worried about that too.
In the meantime, exports to China from Russia are still set to increase. Russian Railways has made promises to increase oil exports, and long-term supply contracts have been signed by Russian and Chinese companies.
China was also involved, to some degree, in the auction of Yukos's main production assets last year. It seems clear that the financing of the purchase by state-owned Rosneft was ultimately provided by Chinese banks. CNPC was in Moscow on the eve of the auction talking to Gazprom, which was the original favorite for the auction but had to back out when a Texan Bankruptcy Court decision made it clear that Gazprom's assets could be under threat if it participated in what was regarded by the U.S. as an illegal sale. CNPC at some point seems likely to be given a stake in Yugansk.
China has been trying to get hold of a number of oil companies in Russia, but has failed each time, mainly for political reasons. In 2003, the Duma was forced to redraft the Privatization Law in order to prevent CNPC from buying Stimoil, a Russian oil company. Again, China cites the "China Threat Theory", the belief in Russia that the rise of China represents a material threat to its own interests.
Caspian Sea Reserves
The new reserves of the Caspian Sea are equally crucial for China, because it offers a relatively easy land route for oil and an effective alternative to the Middle East. Unfortunately, many other parties are vying for the same oil, creating a new great game with very high stakes. The idea is that there will be a large-scale network of interconnected pipelines criss-crossing Asia and Europe and known as the Global Energy Bridge. But again, politics has been getting in the way and disputes are going on about the way the plentiful but finite resources of the Middle East, Russia and Central Asia are distributed.
The discovery at Kashagan in the Caspian Sea was the biggest since Prudhoe Bay in Alaska in 1970. Experts suggest 30 bln barrels of oil are buried in the shallow waters. The Kazakh government says 50 bln barrels.
Both Sinopec and CNOOC tried to buy stakes in the field in 2003, but were blocked by the "pre-emption" rights of the existing shareholders. China, perhaps unfairly, suggested political interference. Even if politics wasn't involved, the case draws attention to one of China's biggest problems - how does it squeeze itself into these promising oil concessions, most of which have already been bought up by other, longer-established multinationals?
Negotiations on a Sino-Kazakh pipeline, crossing the border into China at the Alataw Pass, have been going on for some time. The crux of the negotiations, and the source of periodic disputes, has been the volume of oil being sent to China.
China has already bought a stake in the Aktobe oilfields in Kazakhstan, which it expected to be able to use to feed a cross-border pipeline. However, after paying over the odds for the field - $3.5 billion - China discovered that the reserves at Aktobe weren't enough to justify constructing the pipeline. The reason why it won the bid over the likes of Unocal, Amoco and Texaco was its ability to construct pipelines running to a guaranteed market, but China decided it could not justify the construction. Kazakhstan accused China of reneging on the deal. China asked to be able to develop other oilfields in order to boost the pipeline's capacity, but negotiations subsequently stalled.
Eventually, the pipelines began construction. Currently, much of China's oil production in Kazakhstan is shipped westwards through Phase 1 of the Sino-Kazakh pipeline and sold at the Russian Black Sea port of Novorossisk. If all goes to plan for China, the direction of the first phase pipeline from Kenkiyak to Atyrau on the Caspian Sea will be reversed, and Caspian Sea can then be moved to China. However, Transneft, Russia's biggest pipeline operator, claims that the plan to reverse the Kenkiyak-Atyrau route is not feasible.
Negotiations about the precise volume of Kazakh oil shipped to China are still ongoing. Last year, China asked Kazahkstan to consider boosting the transmission volume of the pipeline to 50 million tonnes, actually higher than Kazakhstan's total production at the time. Kazakhstan, naturally, has the same worries as Russia about its increasingly dominant eastern neighbor. Once again, it does not want to depend on a single market.
China's long-term aim is to see its pipeline to Atyrau on the Caspian Sea connected with those in Iran. China has been involved in the Caspian Sea Oil Swap mechanism, which - in the face of US opposition - allows Kazakhstan to sell Iranian oil on the world market in exchange for supplying its own oil to markets in northern Iran. If the trans-Asian pipeline from Iran to China were in place, China could use the same initiative, swapping Iranian oil for Kazakh oil and moving it into China through Xinjiang.
(This is a transcript of a presentation given at an American Chamber of Commerce event on Thursday, June 23 in Beijing.)
© InterFax-China 2005. For more intelligence on Chinese metals and mining, or call Alison Crawford in London on +44 (0) 20 7256 3919.
