IN DEPTH

Fuelling the dragon

China's inexorable rise in the global oil game has severe consequences for just about everybody

 

Jehangir S. Pocha

 

Despite the bonhomie of recent diplomacy, China, India and the US are locked in an increasingly aggressive wrangle over the world's most critical economic commodity: oil. The outcome of this tussle will shape the future of the three countries - economically, environmentally and geo-politically - more than any other issue.

Ensuring a steady flow of cheap oil has always been one of the central goals of US foreign and economic policy, and Washington's pre-eminent position in the world is based in a large measure on its ability to do this. But with China and India's fuel consumption rising sharply even as global supplies are shrinking, both these nations are beginning to assert themselves in the global energy markets. And in the process, they are often rubbing the US, and each other, the wrong way.

Over the last two years, Chinese and Indian oil companies have competed with each other and western and Japanese firms to secure oil exploration rights in Africa, South-east Asia, Central Asia and Latin America. India has invested more than $3 billion in exploration ventures and has said it will continue to spend $1 billion a year on more acquisitions. But China, which has already invested about $15 billion in foreign oil fields, is expected to spend ten times more over the next decade. For this, Beijing has been competing fiercely with New Delhi and others to ink multi-billion dollar energy deals with countries such as Russia, Iran and Myanmar.

The motive, says Zheng Hongfei, an energy researcher at the Beijing Institute of Technology, is that "there is just not enough oil in the world" to cover China's growing energy needs.

Indian consumers watching prices going up at petrol pumps and kerosene shops might blame it on the bad news from Iraq. But some experts say Chinese drivers tanking up their newly-acquired cars are proving to be much more destabilising for the global energy markets.

Over 4.5 million new vehicles are expected to hit China's roads this year, a far cry from the time when a family saved for months to buy a Flying Pigeon bicycle. Despite talks of an economic slowdown, industrial demand for fuel is also expected to grow 20 per cent a year. The effect of this is felt in the yellow haze of pollutants that crowns most Chinese cities by mid-day. Beyond the obvious health and environmental concerns, the World Bank and others warn that China's galloping consumption is depleting global energy fields and threatening another global energy crisis.

Last month, China overtook Japan to become the world's second-largest consumer of oil after the US. Economists say China's energy-hungry and inefficient economy will burn almost 2.2 billion barrels of oil this year, and that this figure will double by 2014.

Currently, global oil production is barely 1 million barrels over the global consumption rate of 81 billion barrels a day, even though producers are working at 99 per cent of capacity, says the International Energy Agency (IEA). In the medium term, producers could meet the demand surge by using new technology for squeezing the existing oil wells and drilling new ones that remain unexploited. But Stephen Roach, chief economist at Morgan Stanley, says the surge in demand from China could eventually lead global demand to outstrip supply, causing fuel prices to shoot up beyond their recent highs of around $50 a barrel.

The impact on this on the global economy and developing countries such as India, which imports 70 per cent of its fuel, would be severe. The IEA says that for every $1 increase in oil price, the global economy loses $25 billion. This year alone, India will spend $20 billion - $9 billion more than it had originally planned for - to import the 900 million barrels of oil it needs.

Even in the US, where the Bush administration is anxious to lower oil prices during the election season, concern is rising over how China's fuel consumption is throwing an already-nervous oil market into further disequilibrium. Last month, Michael Rothman, a senior energy analyst at Merrill Lynch, said the rising prices were not so much a result of the Iraq war or political instability in Venezuela and Sudan, but of extensive "hoarding" by China. According to his analysis, China is buying 500,000 barrels of oil a day more than it needs. Without such hoarding, oil prices would be in the range of $30 a barrel, said Rothman.

Though Beijing has not explicitly responded to questions about oil purchases, Rothman and other analysts say China is creating an oil reserve along the lines of the US's Strategic Petroleum Reserve (SPR), which is designed to provide the minimum cache the country needs to ride out a crisis. China's stock is estimated to be just a fraction of the

700 million barrels in the SPR and the similar amount held in reserve by other OECD (Organisation of Economic Cooperation and Development) countries, led by Germany and Japan. India has also just built up a modest oil reserve of about 25 million barrels. But critics say the timing of China's decision, coming just as the global economy seemed to be recovering and the US was questioning the value of its own reserve, is unfortunate. Yet, with both India and China flush with forex reserves that are threatening to infect their economies with bouts of inflation, creating an oil stock seems a sensible solution.

Morgan Stanley's Roach, however, acknowledges that there is a tendency to unfairly blame China for any disturbance in world trade. "Last year, people said China was driving deflation (because of its cheap manufacturing) and now they are saying it's driving inflation. In reality, the Chinese are very responsible economic players," says Roach.

But the sheer size of the Chinese juggernaut and the prospect of it indiscriminately swallowing global resources scare economic planners and consumers alike.

The biggest concern is the environment. Seven of the world's 10 most polluted cities are in China, says the World Health Organization. With even medium-sized Chinese towns now sprawling out as far as some cities, the prospect of two-hour commutes is leading many middle class people to pursue the dream of owning a car.

And it's a dream that is well marketed. With the average profit-per-car-sold of about $900 in China, as opposed to $200 in the US, global automakers have made a beeline for China. In a society predisposed to seeking self-satisfaction from the overt display of wealth, giant billboards and slick television campaigns by companies such as General Motors and Volkswagen have enshrined the car as a totem of success. Local companies are also introducing indigenous models, such as the QQ, a mini car critics say is reversed-engineered from the Daewoo Matiz, and the Zhongguo, a plush, gas-guzzling six-cylinder sedan.

The answer is blowing in the wind

 

Air pollution kills as many as 4 million Chinese every year, says the World Health Organization. To reverse this alarming trend, China is increasingly looking at alternative energy technologies like solar and wind power, and electric cars.

"By 2010, the government wants 10 per cent of our energy to come from alternative sources," says Meng Xian Gan, director of the Chinese Solar Energy Society, a think-tank in Beijing.

That's easier said than done. The promise of alternative technologies - which, theoretically, could produce infinite, environmentally-friendly energy from renewable resources - sounds good on paper. But nowhere have these technologies replaced traditional power plants by generating cheap and reliable energy in meaningful quantities.

But Meng says China has no choice but to develop this nascent industry, which today produces about 20,000 MW of power, about 4 per cent of China's total energy consumption. By contrast, India's produces almost 4,000 MW of power from alternative sources, also close to 4 per cent of its total.

Coal, which currently provides about 70 per cent of China's energy (just as in India), needs to be phased out if China is to meet its commitments to the Kyoto Climate Control Protocol. And rising demand for oil and natural gas from nouveau riche consumers and fast-expanding industries is exhausting China's domestic oil fields and straining its exchequer. This year, China will spend $100 billion on importing oil. When the cost of locally produced oil is added, the total oil bill rises to almost $300 billion. The cost of the alternative technologies is a deterrent to their large-scale adoption. Lou Hai, sales manager at New Sunshine Solar Company, hopes he is doing his part in resolving this problem. "Our equipment has been instrumental in helping companies reduce the cost of solar-powered energy by over 25 per cent," says Lou, whose firm develops the electronic controllers and batteries needed to modulate and store electricity generated from solar panels. Three years ago, solar-powered electricity cost three times as much as coal-generated electricity. But Lou says today it is costs only 30 per cent more, and by 2006 it should cost the same.

In wind energy, China is estimated to have the potential to produce up to 250,000 MW. Numerous wind parks, with a capacities adding up to over 400 MW, have been installed, mainly in the western plains and along the northeastern coast.

Much of the impetus comes from the Central government, which spends about $500 million a year on supporting renewable energy technologies, the Energy Research Institute in Beijing reports. Through agencies such as the National Development and Research Commission and the ministry of science and technology, the government is encouraging businesses and local governments to adopt renewable energy.

Many of China's alternative energy projects are also being set up in collaboration with European companies. To leverage their expertise, the Chinese government has instituted several programmes that give foreign investors access to domestic energy markets in exchange for technology . The most successful of these have been the 'Ride the Wind' and 'Brightness' programmes, which have brought in about $10 billion, mainly from European corporations and foundations such as the World Nature Fund and Shell Energy Foundation. The plants they have set up now bring power to over 30 million rural consumers who were once outside the national power grid.

Zhou Heliang, head of the Beijing 863 Electronic Vehicle Program, a government-funded project competing to develop an electric bus for the 2008 summer Olympics, says China is also investing heavily in developing its own alternative technologies. "The idea is that apart from reducing pollution, we will become world leaders in a totally new field," he says.

Such optimism may be overstated; but it is infectious. The main reason Chinese entrepreneurs have faith in the potential of alternative energy making it to the marketplace is only spoken sotto voce - with government backing, these technologies are bound to grow.

Lou of New Sunshine Solar says he knows some people smirk when he tells them what he does for a living. "I just keep thinking ahead, of the future," he says. "That's what this business is all about."

 

To stanch the consumer demand for petrol, the Chinese government, which controls energy prices, has taken the unpopular step of raising retail petrol prices 6 per cent this year. It is also using incentives and subsidies to support the development of electronic vehicles and renewable energy sources such as wind and solar power (See 'The Answer Is Blowing In The Wind'). Public transportation is also a priority for China's leaders, and Beijing alone is spending $8 billion to build 140 km of new light rail and subway lines that will open in time for the 2008 Summer Olympics.

But, in the foreseeable future, the bulk of China's energy will continue to come from fossil fuels. Despite the serious environmental consequences of this - the World Bank calculates China's annual environmental costs at $50 billion - Beijing is putting in place extensive plans to secure supplies.

At home, Chinese firms are investing heavily in local energy fields, such as the 200,000-square-mile Ordos Basin that stretches across the provinces of Shaanxi, Shanxi, Gansu, Ningxia and Inner Mongolia in north-western China, and is reported to have oil reserves of up to 60 billion barrels.

To defray the substantial costs of exploration, China has privatised two of its largest state-owned oil companies, PetroChina and Sinopec. Both have listed subsidiaries on Wall Street, and are using the billions of dollars in new capital to restructure and modernise operations. Other public sector oil units are also undergoing massive recapitalisation and restructuring, including the retrenchment of thousands of workers.

Significantly, China has also opened up its energy sector - previously considered strategic, and therefore, off limits to foreign investors. Companies such as ExxonMobil, which owns a 19 per cent stake in Sinopec, are being wooed not just for their capital, but also for their refining and marketing capabilities. For example, ExxonMobil is helping Sinopec establish over 500 gas stations across the country and build at least two refineries in southern China.

Sharon Hurst, a Beijing-based executive with ConocoPhillips, the largest refiner in the US, says: "Western investment is helping Chinese oil companies morph into world-class players."

Whereas giant exploration and pipeline deals were once almost exclusively the domain of western and Japanese oil companies, Chinese dealmakers are now winning contracts with governments all over the world. Western energy industry officials in Beijing complain that they are often elbowed out of such deals by Chinese firms that operate at lower costs and observe few environmental standards. This is particularly true in Africa, where transparency is low, regulation almost non-existent, and government officials easily bought. Though western and Japanese oil companies are hardly paragons of virtue, they must deal with a level of public scrutiny that China is free of.

Beijing is also taking full advantage of the US's strained ties with Iran, Libya, Vietnam, and Myanmar by extending military and political support to these countries in exchange for energy supplies. And a Washington preoccupied with Iraq, the war on terror, and nuclear crises in Iran and North Korea has been unable to checkmate China as successfully as it did earlier. For example, nervousness over China's intentions in Latin America had led the US to use its leverage in Panama to impede China's access to the all-important canal that connects Pacific and Atlantic routes.

But Beijing recently signed a landmark deal with oil-rich Venezuela and its neighbour Columbia, under whose terms a pipeline will be constructed linking Venezuelan oilfields to ports along Columbia's Pacific coastline. This will allow Venezuelan oil to bypass the Panama Canal and create a new and direct route to China.

Robert Karniol, Asia editor of Jane's Defence Weekly, says China's aggressive oil shopping could also bring it into conflict with western, Japanese and regional interests.

Diplomatic sources in Beijing complain that China's extensive oil interests in Sudan are leading it to rein in the United Nations Security Council from passing sanctions against the government in Khartoum, which the US secretary of state Colin Powell recently accused of abetting genocide in Darfur.

And earlier this year, the already-tense relations between China and Japan sunk to a new low when Tokyo played last-minute spoiler in a multi-billion-dollar energy and pipeline deal Beijing was about to clinch with Moscow. China has vowed to re-insert itself into the deal, something that might have played a role in Japan's recent decision to view China as a "major threat" for military planning purposes.

The murky waters of oil politics make it unclear what all this forebodes for India. The optimists, mostly people from Indian industry such as former CII director-general Tarun Das, say a boom in China's auto industry will benefit Indian auto ancillary manufacturers and companies such as Tata Motors, which is planning a major foray in the Chinese market. They also say Indian and Chinese oil companies can share the costs and benefits of pipelines from common suppliers such as Russia and the Central Asian republics, and jointly explore new fields.

But the pessimists - mostly people from India's security establishment, such as security guru Brahma Chellaney - say two energy-hungry giants seeking resources will ultimately clash. As evidence, they point to Vietnam, Myanmar and Central Asia, where the two countries are increasingly striking conflicting poses.

The truth, as always, will lie between the extremes, with Sino-Indo relations probably fluctuating unpredictably from being cooperative to being contentious. Going forward, the most secure path for India and China would be to learn how the OECD countries have cemented a more or less common energy agenda. This model - competition within an agreed framework - has been known to yield the best results.

Standing at the periphery of an amateur stockcar racing track in Beijing, the prospect of geo-political conflict between India and China seems far away to a freshly minted graduate. "I can't wait to get my own," he says, as he watches his friends tinker with the engine of a souped-up Volkswagen Jetta. "It's my dream."

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