China, the US and the geopolitics of oil

The CNOOC Unocal saga is over. But CNOOC's ambitions remain:

Energy market experts now expect Cnooc, which is controlled by the Beijing government, to explore opportunities throughout the Asia-Pacific region, Central Asia, Russia and West Africa to find energy supplies for China's booming economy.

Neither China's quest for energy security nor the Sino-American rivalry over petroleum seems likely to end soon.

In 2025, China may import 80% of the oil it consumers - relative to under 40% now.  See p. 10 of the Defense Department's report on China.

Europe too will need to import more of its consumption, perhaps 90% v. 50% now.  North Sea oil is a finite resource.

The US has a bit more oil; i think it may only need to import something like 70% of its oil consumption in 2025 (but am happy to be corrected by those who know more).

In other words, in 2025, the three big industrial regions of the world economy will all look a bit like Japan now; they all will depend almost exclusively on imported oil.

 Japan not only imports almost all its oil, but relies on a combination of national oil companies in producing countries and the American, British and French oil "majors" to find and produce the energy Japan needs. There is no Japanese oil major.   Nor a German one.  The skill needed to find oil and the skills needed to make the cars that use the oil do not seem to be correlated at all ...

National security types would say Japan doesn't just depend on the market to meet its energy needs.  It also depends on the US Navy to connect Japan to Indonesia and the Middle East, and its security alliance with the US more generally.  And so long as Japan is allied with the US, the US government has strong incentives to make sure that US -- if not all -- oil companies sell oil to Japan even if supplies are right.

One thing should be clear by now.  China may hope to avoid the mistakes Japan made when it tried to set up Japanese oil production firms, but it does not intend to follow the strategy Japan ultimately adopted, and rely on the international majors and national production firms to meet its need for energy.  China's national oil companies have ambitions to go out and find -- or buy -- the production facilities needed to meet China's growing demand.  

I don't always like Tom Friedman's column, but I liked part of what he said a couple of weeks ago.

The real issue is that we have slipped into a symbiotic relationship with another major power that is neither a free market nor a democracy. We have both grown dependent on that relationship - the U.S. for cheap goods and cheap mortgages, and China for high employment and regime stability. We now have to adjust the bargain at the heart of that relationship. Whether we can do that delicately, without destabilizing Beijing or the global economy, could be the big geopolitical story of 2005.

Friedman focused on the need for China to buy more goods and less US debt.   I certainly think that is important -- some say I rarely write about anything else.  But it is not the only part of the bargain that has to adjust.  So too will control over some fraction of the world's energy reserves. 

Remember the scene in the Godfather, when the other families complain that the Corelones have bought up all the Senators and won't share them out?  Right now US - and European - capital controls a large share of the (shrinking) share of the world's available oil reserves that is not under the exclusive control of national production companies.  China just wants what it perceives as its fair share.

Yousef Imbrahim, an oil analyst with Strategic Energy Investment Group of Dubai, United Arab Emirates, is right (quote from the LA Times):

"The bottom line is, the U.S. will have to make room for China. If it doesn't make room for China, China will take the room." 

Take may be the wrong verb.  Buy may be better.

That does not mean that the process will be frictionless.   If China buys up existing oil assets, that benefits their existing owners.  But if China bids up the price of access to all oil assets, that likely will require that the Western majors reduce their expected returns - or lose out to the Chinese.

Chinese state oil firms not only have access to financing on terms that even the best Western firms would struggle to match, but increasingly seem willing to do business on financial terms that the Western majors are not.  The Chinese state does not insist on a minimum 15% return on equity.   And Chinese firms (though not necessarily CNOOC) are willing to do business in places where Western firms are not allowed to go.

Dangling cash and access to its huge market, China is dispatching legions of diplomats, surveyors and engineers across the globe to help quench the Middle Kingdom's insatiable thirst for energy.

During the last two years, President Hu Jintao and Premier Wen Jiabao have taken oil executives on trips to oil-rich countries from Algeria to Uzbekistan to seal major deals. The government in Beijing has welcomed top officials from all 11 members of the Organization of the Petroleum Exporting Countries. A major point of a trip Hu made to Moscow this month was to secure access to Russia's vast reserves.

Chinese crews are building roads in Africa in exchange for the right to extract oil from remote regions. Viewers in Saudi Arabia, a nation that U.S. oil firms once had to themselves, now watch Chinese programs on satellite TV as China drills into Saudi sands. China is also taking advantage of tensions between the Bush administration and Venezuelan President Hugo Chavez to wrest oil from one of the largest U.S. suppliers.

To secure deals worth tens of billions of dollars, Beijing is cozying up to regimes in nations, including Iran and Sudan, that Washington labels pariahs. And it is flexing its military muscle to lay claim to contested fields in East Asia.

LA Times article went on to lay out the full range of Beijing's energy interests, including the $2 billion "infrastructure" loan to Angola that Steve Kyle has mentioned in the comments section of this blog.  

The financial logic behind China's quest for oil is pretty clear.  It hardly makes financial sense for all of China's cash to be parked in dollar-denominated US treasuries and other US bonds.  The RMB is sure to rise against the dollar.  But it oil also rises against the dollar, the RMB may not rise as much against oil over time as against the dollar.  Plus, dollar bonds don't pay that well.  It is hardly surprising China thinks it might get a better return from financing the oil business.  Chinese firms then could get a higher share of the (anticipated) profits from the (anticipated) increase in Chinese demand for energy.

China is not making the mistake Japan made before World War II.  It is not looking to obtain military control of the regions that supply the resources it needs.  The greater East Asia Co-Prosperity sphere did not work out so well.  China is not seeking to create a formal empire -- even if it may end up (like the US?) with an informal one. 

But a small part of me also wonders if (rapidly industrializing) China's quest for energy security and desire to build world class Chinese petroleum firms doesn't have some parallels with (rapidly industrializing) Germany's decision to build a navy in the years preceding World War 1.  Germany had the cash and the technology needed to build a navy.  German burghers got rich selling the navy the needed steel.  But it also put Germany on a course that clashed with Britain, and helped push Britain into the arms of France.

The British empire took its naval supremacy for granted.  The US may take its supremacy in the world's oil business for granted.  The US certainly long has taken cheap oil for granted. 

The analogy between Germany's navy and turn of the century Britain and China's oil firms and the turn of the century United States may be too dark.  I certainly hope so.  

But many in the US assumed - I think incorrectly - that US capital would capture most of the profits from meeting rising Chinese demand for oil.   That was part of a broader assumption that China would need US (and European and Japanese) capital to develop.  It turns out that China has all the savings it needs to finance very high levels of investment on its own; it is the US that needs Chinese capital to keep its housing boom going.

That changes the equation a bit.  Many are a bit surprised that China is able to buy US oil companies; they expected that US oil companies would be buying Chinese oil companies.  China certainly doesn't need US capital and soon probably won't need US petroleum technology either. 

It is equally hard to avoid a sense that Chinese-American political rivalry is growing as well.  Many in the US don't like the fact that China is willing to do business with people - read regimes - the US does not like.  Regimes like Iran that the US has not liked for some time.  And regimes like Uzbekistan, which was a US ally (of sorts) until recently.  Now it seems to be breaking up with the US - and getting into bed with China.

That irritates at least part of  conservative opinion in the US.  Look at this rather over the top argument coming from Max Boot, or Justin Logan's commentary on the debate in the AEI (Link via DeLong).

The US is not so preoccupied in the Middle East that it cannot make some moves of its own. Just consider the United States' budding alliance with India, Asia's other potential super-power.

Yet all this is happening even as China becomes ever more dependent on the US as an export market, and the US becomes ever more dependent on Chinese savings to keep US interest rates low.

Two closely intertwined economies.  Two very unbalanced economies.  The world's biggest creditor.  The world's biggest debtor.   Two very different economic systems.  Two very different political systems.   And two countries with a common interest in one (it seems) increasingly scarce commodity.
 
No wonder everyone now likes the Saudis.