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Oil-Hungry China Needs to Rethink Energy Security

by Trevor Houser, Peterson Institute for International Economics

Op-ed in the Financial Times
March 17, 2011

© Financial Times

Beijing's decision to suspend approval for new nuclear facilities in the aftermath of the Japanese nuclear crisis caught world markets by surprise and suggested a Chinese energy policy in crisis. But it is vulnerability to oil market disruptions emanating from ongoing events in the Middle East, not the ability to diversify future power supply, that is currently upending China's energy game plan.

China's recent nuclear decision, driven by short-term politics, is not likely to change its long-term energy path. The country's oil dependence, however, is a much more pressing concern. China's economy is more oil intensive than either America or Europe, while half of its imported oil comes from the Middle East and North Africa, compared with one-quarter for the United States. If crude stays at current prices China will spend more on oil this year than it earns selling goods to the United States.

What really worries China's leadership, however, is the risk that oil prices will add to already elevated inflation. Inflation pressures helped to fuel 1989's Tiananmen Square protests, just as it more recently helped to spark the current uprisings in the Middle East. Consumer prices are now rising at least 5 percent year-on-year; less than the 11 percent seen in Egypt but double last year. Unofficial estimates are higher.

The state has the option of stepping in to stop costs reaching China's drivers, but even price controls have their limits. During the 2008 oil price spike, for instance, refiners found excuses to stop selling petrol and diesel at all, rather than take government-mandated losses. The resulting fuel shortages prompted widespread protests.

Worse, most oil in China is not used in passenger vehicles but in industry and agriculture, where government price controls are either absent or less effective. Energy accounts for a third of the cost of grain production, and oil prices are increasing demand for biofuels. Food prices are rising twice as fast as consumer prices overall.

Over the long term, China's best bet is to reduce the oil required to fuel its growth. But planned investments in energy efficiency, electric vehicles, and high-speed rail will take time. A strategy for stabilizing international supply is thus the only near-term option. Previous attempts have seen China encourage its three largest oil companies to take equity stakes in international oil projects. This policy, known as "equity oil," hoped to guard against price volatility and interruptions in supply. The companies were happy to oblige: With domestic fields maturing, their best route to increased profits was to expand their businesses overseas.

But a decade later it is clear that, while the companies have profited, neither Chinese citizens nor policymakers have seen much reward. If all the equity oil produced outside China were transported home (which it is not) it would still only meet a fraction of the country's import needs. This means it actually provides little insurance against supply disruptions. The oil that China-owned companies do send is then sold to domestic refineries at international prices, so there are no savings for the country as a whole.

Worse, the proliferation of Chinese resource investment around the world is now creating foreign policy headaches for Beijing. The current unrest in Libya is one obvious case in point: Last month more than 30,000 Chinese citizens had to be evacuated from the country after a group of oil workers was attacked.

China can probably weather current prices, and keep inflation at bay, provided oil doesn't rise further. But its best hope to guard against future rises is to end its failing policy of hoping for preferential access to foreign supplies. Instead, a new approach of coordinating with oil-consuming nations is needed.

Here there are some encouraging signs. China has been relatively constructive during UN Security Council deliberations on Libya, certainly when compared with previous UN efforts relating to unstable oil-producing states. The crisis may have made Beijing realize both that its reliance on global energy markets makes such cooperation a necessity, while insistence on national sovereignty becomes harder when it's your own citizens who are under attack.

A united approach to Libya can prevent other regimes in the region from responding violently to popular protests. As it is the violent response more than the initial protests that takes oil off the market, this is likely to lower the chance that current disruptions to supplies will spread.

If they do, however, oil-consuming countries may need to tap their strategic reserves. And that includes China. Speculation that China will respond by building its own stockpiles, rather than using them to calm world prices, is already starting to increase oil costs. Greater transparency from Beijing can help to deliver price relief. If China starts working with other oil-consuming countries to develop a game plan for coordinating stockpile releases, it will find itself far more secure than simply relying on the limited international oil that its companies produce.


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