Red Dragon, Black Gold

Saturday, April 30, 2005

Muscat, Oman—China has gone through a historically unprecedented period of development since the death of Mao Zedong in 1976. Between 1980 and 2003, the country’s average growth rate was approximately 9.5 percent annually and hundreds of millions of Chinese have seen their living standards improve significantly. This success has created its own expectations and challenges, however, and leaders of the ruling Communist Party seem to believe that national stability depends on annual growth continuing at 7 percent or more. Much of China’s industrial output is energy driven. Thus China’s growth goal has led to unprecedented demands for energy resources. China has become the fastest growing market for all sorts of energy and has been much criticized for its consumption of oil and the resulting “scramble” for this resource, though China’s use of oil is still only one-quarter that of the United States.

But for some Chinese leaders the challenge is more than growth, for they have, justifiably or not, a profound concern about national security and perhaps personal or party survival. Although China has cooperated in some respects with the United States since 9/11, on issues ranging from Islamic terrorism to North Korean disarmament, many Chinese fear that Washington wants to slow down or even prevent China’s emergence as a major world power. The expansion and nature of U.S. military activities around the world, particularly since 9/11, and the U.S. cultivation of allies on all sides of the Middle Kingdom, feed these concerns and suspicions. All are magnified by the fact that China is so dependent on imported energy and because its supply lines are highly vulnerable. Because about 80 percent of China’s imported oil passes by ship through the Strait of Malacca, some Chinese fear that the United States may try to cut or squeeze their petroleum lifeline there or elsewhere between the resource’s points of origin and its destination. These political factors play a major role in resource-related tensions worldwide and blow some other problems out of proportion.

Thus China’s energy security—needed to continue its economic growth and maintain domestic political stability—is also perceived by many in Beijing as essential for national security. Predictably, it has become a dominant theme in Chinese domestic and international relations. In the past two years alone, China’s top leaders have visited every corner of the earth making promises, striking deals, investing money, and sending labor and expertise.

In his study “China Scrambles for Energy Security,” International Energy Agency senior analyst Jeffrey Logan notes China’s multipronged strategy with respect to energy, consisting of (1) overseas equity investment, (2) supply diversification, (3) demand-side reductions, (4) substitution, (5) strategic petroleum reserves, and (6) maximum domestic production. I focus here on China’s efforts to develop petroleum security through creating and diversifying oil sources and through working out reliable delivery routes and networks.

Oil: Domestic Production and Diversifying Importation

Until 1993, China produced all the oil it needed, mainly in the northeastern region in the fields of Daqing, Shengli, and Liaohe; today some 90 percent of its petroleum production is onshore. But the largest field, Daqing, is aging, and domestic resources are proving to be woefully inadequate for China’s needs, despite efforts to open new fields in the west. Some offshore exploration is under way as well in the East and South China Seas, so far bringing in little oil but causing tensions with Japan and some Southeast Asian nations. Although one former senior Chinese oil official has said that by 2020 the country will have cut its imports to 25 percent of total consumption, few take that projection very seriously. A recent Chinese Ministry of Land and Resources report says that China has abundant oil resources but that, because of unfavorable geography and geology, tapping them is and will remain difficult. This reality necessitates a national policy that will utilize and develop alternatives, including coal (still by far China’s most widespread source of energy), natural gas, hydroelectric, nuclear, wind, and other energy resources, backed up by substantial strategic reserves. Most independent studies conclude that China’s domestic production of oil will fall farther and farther behind the country’s needs.

“A Profile of China’s Oil Industry,” released by China’s Xinhua Economic News Service in February 2005, shows the percentage of imported oil in China’s total consumption rising year by year. In 2004 it was 41.3 percent, up from 34.9 percent in 2003, 29.4 percent in 2002, and 26.9 percent in 2001. As the IEA’s “Oil Market Report” noted in March 2005, the dramatic trajectory of this increase is due not only to a booming economy but also to “power shortages that induced a dramatic rise in the use of gasoil and residual fuel oil in power generation,” though some reports in early 2005 indicate that the demand for fuel oil in power generation has begun to decline. China is also very inefficient in its use of oil in relation to other regions of the world, particularly Japan. Thus China’s demand for crude oil will likely continue to grow at something like 10–12 percent annually for the foreseeable future. (In 2003 China passed Japan to become the second largest oil importer in the world, still far behind the largest, the United States.) Chinese economists see China’s dependence on imported oil reaching about 50 percent by 2020, while U.S. Energy Information Administration reports suggest it will be closer to 66 percent or even 75 percent. Non-Chinese experts expect Chinese use to reach between 12.5 and 14 million barrels a day by 2025, at least twice the current level, much of it because of an anticipated rise in the use of private automobiles.

China’s oil imports today come from more than 20 countries. Its most important suppliers in 2004 were Saudi Arabia (17.24 million tons, an increase of 21.6 percent over 2003) and Oman (16.35 million tons, an increase of 76.2 percent over 2003). Next in order of importance were Angola (very close to Oman), Iran, Russia, Sudan, Vietnam, and many lesser sources. Thus China already has relatively diversified sources. For example, China’s imports from the Middle East were 45 percent in 2004, down from 51 percent in 2003, in contrast to Japan’s 90 percent from the Middle East and South Korea’s roughly 80 percent from that region. Africa’s share of the Chinese market increased to 29 percent in 2004, from 24 percent in 2003, whereas imports from Europe were 14 percent, up from 10 percent in 2003. Other regions of increasing importance are Asia, including Central Asia, and even Latin America.

The European increase was accounted for almost entirely by Russia. During the past few years, Russia, China, and Japan have fought long and hard over whether a Russian pipeline across southern Eastern Siberia should end in Daqing, China (favored by China), or Nakhodka, a Russian port near Vladivostok (favored by Japan). The pipeline is currently expected to cost up to $10 billion and eventually transport up to 80 million tons of oil per year. For a while China seemed to be winning, then Japan, but at this writing Moscow has put the decision off. Russia has already agreed to greatly expand the amount of oil sent to China by train, though Beijing may be wondering what a Russian commitment is worth. Until October 2004 only Yukos, Russia’s at-one-time largest private company (recently clobbered by Vladimir Putin’s “justice” system), sent oil to China by rail. In November 2004, Russian railways and Chinese railways agreed to greatly expand deliveries—10 million tons in 2005 and up to 60 million tons by 2010—though RIA Novosti reported in mid-April that Russia’s current railway system cannot handle even the projected 10-million-ton deliveries of 2005, much less the additional increase. Russia and Saudi Arabia are now vying to be the largest oil producer in the world, though Saudi reserves, and the ease of extraction, remain unchallenged.

Looking at China’s move toward crude oil source diversity over the 1996–2004 period, we find, first, that the main common denominator throughout has been the major role of Oman, with Angola moving from fairly important to very important; second, that the importance of Yemen and Indonesia has substantially declined; and third, that the role of Iran, Saudi Arabia, Russia, and Sudan has risen significantly.

China’s Overseas Investing and Strategic Realism

But China does not just buy oil abroad, it invests in oil exploration, production, and infrastructure with the long-term objective of increasing its control over and securing foreign sources. According to Xinhua in March 2005, China has so far signed oil cooperation contracts with 19 countries. China’s first and most extensive move into this area was in the 1990s with Sudan, which is believed to have the largest untapped reserves in Africa. In Sudan, China is the single largest shareholder (40 percent) in the Greater Nile Petroleum Operating Company, the oil company consortium that dominates the country’s oil industry. In Iran, China has a 50 percent share in the Yadavaran oil field. Together, Sudan and Iran supply some 20 percent of China’s imported oil. China is also working toward a role in oil production in areas from Central Asia to Egypt to Venezuela.

This involvement demonstrates some of the characteristics, advantages, and potential problems of China’s approach to foreign policy and equity investment. Seven years ago, China reorganized state-owned oil assets into two vertically integrated firms named the China National Petroleum Corporation and the China Petrochemical Corporation. In 2003 these came under the watchful eye of the State Energy Administration; their activities are an integral part of China’s domestic and foreign strategies. The primary concern is not in economically productive investments in the short or even medium terms but in the acquisition of resources and rights that will presumably serve the long-term strategic interests of the nation. This means that Chinese companies are willing to take risks no commercial company could even contemplate and that China is prepared or even eager to step in where most Western companies or governments would not dare to go. Two cases in point are Sudan and Iran, both strongly criticized by many countries in the United Nations: Sudan for its genocidal polices in its Darfur region and Iran for its nuclear program. China has blocked sanctions and other disciplinary policies against these governments in the U.N. Security Council, though undoubtedly with some hesitation because it does not wish to get a reputation as a guardian of rogue states.

Securing Delivery Routes and Networks

Because China is so increasingly dependent on sources of oil that come from up to half a world away, Beijing is looking for ways to guarantee the arrival of the resources as safely, quickly, and inexpensively as possible, with the cost often an expendable factor. The most obvious concern China has is the Strait of Malacca, through which about a third of the world’s trade and 80 percent of China’s oil now pass. The strait is notoriously infested with pirates, some operating closely with organized crime. Attacks, which stopped for two months after the Christmas 2004 tsunami, have begun again with a vengeance. Malacca is also a potential site of a terrorist attack, also perhaps involving organized crime, that could close the narrow waterway for a time and seriously disrupt the Chinese and other Asian economies. For those Chinese who believe that the United States wants to “squeeze” China, the Strait of Malacca is the major logistic concern in the delivery of oil. This is particularly so because strategically located Singapore has close ties to the United States and thus itself seems slightly suspect.

What are the alternatives? Other channels through Indonesian waters, such as the Sunda and Lombok Straits, are more distant and also subject to piracy, terrorism, and blockage. Above all China is looking to alternatives that would bypass the dangerous passages around and through Indonesia altogether. One rather limited option is delivery by rail, as in the case of Russian oil noted earlier. More practical is pipelines, though such systems are themselves subject to sabotage. Among these options is one already well under construction, the $1 billion pipeline from Atasu in Kazakhstan to China’s Xinjiang Uigur Autonomous Region, which in time will link China to Caspian Sea oil and is expected eventually to bring in an estimated 20 million tons of oil a year. Another pipeline option would run from Myanmar’s deepwater port of Sittwe to Kunming in China’s Yunnan province. Such a pipeline would be much shorter and quicker, and presumably safer, than Malacca or any other route involving Indonesia. Another option is a route across the narrow southern peninsula of Thailand, either a canal, which would probably be too expensive, or a “land bridge” road or pipeline.

Another China-funded project that is intended to critically affect delivery of oil and other products is the Gwadar deep-sea port on the southwestern coast of Pakistan about 250 miles from the Strait of Hormuz. (So far the Chinese have paid 80 percent of the cost; the eventual price tag for China is expected to be about $1 billion.) The first phase of construction at Gwadar was completed early in 2005 after an accelerated push. When the port is fully operational, it will be able to handle very large crude carriers, the supertankers, with a capacity of between 100,000 and 500,000 deadweight tons, that are now so critical to oil deliveries worldwide, as well as the largest container ships. China’s obvious intention is to move all sorts of products through Pakistan—by rail, road, pipeline, and perhaps air—into Xinjiang and maybe even to link Gwadar through Iran to the Caspian, Kazakhstan, and then China. These connections will not be easy, for much of the terrain is extraordinarily difficult.

A major Chinese presence in Pakistan and near the Strait of Hormuz, which the U.S. Energy Information Agency describes as “by far the world’s most important oil chokepoint,” is considered a problem by some in Washington, particularly if the port and region are frequented by the Chinese navy. Of course, the Chinese regard an overwhelming U.S. presence there as provocative and potentially disruptive to its oil deliveries. A U.S. foreign service officer in the region remarked that, as long as General Pervez Musharraf is president in Pakistan, this Chinese role will not happen, though recent reports are that the Chinese navy has already been given a green light on eventually using the port. But other political obstacles loom as well. Pakistan is highly unstable, and several Chinese workers on the Gwadar project have already been killed, allegedly by Baluchistan separatists. And Iran and several Central Asian countries that the pipelines might pass through on the way to China are current or potential hot spots.

China’s concerns over the security of its energy sources and delivery networks are based on legitimate questions about the stability and predictability of the sources themselves, real or imagined obstructions to delivery engineered by Washington or Islamic terrorists, and broader global issues not discussed here. At the same time, some of China’s and America’s concerns are political and can be minimized or maximized by decisions and policies formulated in Beijing and Washington. U.S. leaders from President George Bush on down have expressed concern over the pace of China’s military development and its possible effect on the international balance of power. The Chinese consider the development of its decrepit military part of their country’s emergence as a major world player, particularly in view of increasing U.S. military involvement all over the world, especially in Central, East, and Southeast Asia. Although some leaders in both countries like to condemn and threaten, policies that reduce rather than heighten tensions and provocations are now desirable for all concerned.