Middle Kingdom Takes Center Stage

China’s Energy Policy: Strategic Implications

By Gawdat Bahgat

Following the establishment of the People’s Republic of China (PRC) in 1949, the nation was largely self-sufficient in energy. The largest oil field, Daqing, was discovered in 1959 and played a significant role in meeting China’s petroleum demand. Thus, the first two “oil shocks” (1973-74 and 1979-80) had little impact on the Chinese economy and energy sector. Indeed, China exported crude oil to several of its Asian neighbors during this period.

Since the early 1980s, China’s economy has grown by an impressive rate. This skyrocketing and sustained economic growth, in conjunction with a population of more than 1bn people, demanded more energy supplies. The country’s domestic production had failed to keep path with its growing energy demand. In 1993 China became a net importer of oil and in 2006 Beijing was the world’s third-largest net importer of oil behind the United States and Japan.

This current large gap between stagnant energy production and fast-growing consumption is projected to expand further in the next two decades. According to the Energy Information Administration (EIA) China’s oil consumption is projected to rise from 5.6mn b/d in 2003 to 15.0mn b/d by 2030 (3.8% average annual change – the highest in the world).

Similarly, natural gas consumption will jump from 1.2 trillion cubic feet (tcf) to 7.0 tcf during the same period (6.8% average annual change – again the highest in the world). China’s limited oil and natural gas proven reserves further complicate its energy outlook. In 2006 proven oil reserves were approximately 16bn barrels (1.3% of the world’s total) and gas reserves 83 tcf (also 1.3% of the world’s total).

This combination of limited indigenous energy resources and rising demand has prompted Chinese leaders to adopt a multi-faced energy strategy. Three elements of this strategy can be identified: (a) reform the energy sector to maximize domestic production and attract foreign investment; (b) diversify the energy mix to reduce the nation’s dependency on fossil fuels and contain pollution; and (c) diversify energy sources to restrain over-dependence on one or few producing regions.

Reform Of Energy Sector

Chinese leaders agree that a viable and aggressive energy policy is essential to maintain and further expand the high economic growth of the last two decades. However, unlike many other countries, Beijing lacks a national energy agency to draw and implement it. Since the founding of the PRC several national agencies have been established and dissolved. The Ministry of Fuel Industries was abolished in 1955, when separate ministries for coal, electricity and oil were established.

In 1970, a new Ministry of Fuel and Chemical Industries combined the functions of those three ministries, but it was dissolved five years later. In 1988, a Ministry of Energy was launched to oversee coal, oil, nuclear and hydroelectric development, but it was dissolved in 1993. In the early 2000s the central government created the Energy Bureau under the National Development and Reform Commission (NDRC) as an integrated central authority responsible for developing long-term energy strategies. This Bureau was replaced by the State Energy Office in May 2005 – with a mission to safeguard energy security. These continuing changes suggest that China lacks a strong national mechanism to oversee its energy sector.

This institutional instability aside, the oil and gas resources are controlled by three state firms: China National Petroleum Corporation (CNPC), China Petroleum and Chemical Corporation (Sinopec), and China National Offshore Oil Corporation (CNOOC) – the government holds a majority stake in all of them. CNPC and Sinopec operate almost all of China’s oil refineries and the domestic pipeline network, while CNOOC has the most expertise with international transactions.

In addition to these state-controlled firms, the country’s first private sector company, the Great Wall Petroleum Group, was founded in 2005. These corporations seek to enhance China’s energy security by investing in domestic exploration and development operations and securing foreign supplies. In addition, Beijing seeks to neutralize threats to oil and gas shipments and to build a strategic petroleum reserves (SPR) as a safeguard against any interruption in oil and gas supplies.

Vulnerability To Attacks

China’s growing dependence on foreign oil supplies has heightened the country’s vulnerability to attacks by terrorists or pirates. Almost all of China’s imported crude oil and refined products are shipped by tankers. However, according to official data, Chinese-owned ships carried only 9% of imported products in 2005. Commercial interests and concern for safe transport of oil shipments have prompted Beijing to develop plans to build a national tanker fleet. By 2010, China intends to transport 40-50% of its oil imports in government-owned tankers, and by 2020 to carry 60-70%.

In addition, it has been building up its naval capacity to secure oil shipments, particularly through the Strait of Malacca, linking the Indian and Pacific Oceans. It is the shortest sea route between India, China, and Indonesia and therefore considered the key choke point in Asia. With Chinese oil imports from the Middle East increasing steadily, the Strait of Malacca is likely to grow in strategic importance in the foreseeable future.

Unlike other major oil consuming countries, China has only recently started to build a strategic petroleum reserve (SPR – MEES, 25 December 2006). The idea of building one has been considered since the late 1990s. The Chinese authorities have chosen four sites to store crude stocks: Dalian, Huangdao, Zhenhai, and Zhoushan. Chinese officials assert that eventually the SPR will hold oil stockpiles covering about 90 days supply.

Diversification Of Energy Mix

China’s energy consumption is overwhelmingly dominated by fossil fuels, particularly coal. This energy mix has caused serious environmental pollution and threatens the sustainable energy supply. Indeed, many of China’s cities are among the most polluted in the world.

For a long time production form the country’s largest oil field, Daqing, met a substantial proportion of its demand; but it peaked in the 1970s, and production has been reduced since 2004. In an effort to offset this decline, the Chinese authorities have sought assistance from international oil companies to boost oil recovery and extend the life of producing fields.

Furthermore, heavy investments were made in the exploration and development of new fields, particularly offshore. Since the early 1990s, domestic production has failed to keep pace with growing demand, and the gap between output and consumption has been increasingly filled by imported oil. This trend is certain to endure.

Figures show two important trends: (a) Natural gas represents a small proportion of China’s energy mix; (b) Natural gas consumption is growing faster than that of coal and oil. Several new discoveries have been made in recent years, but most of China’s current natural gas fields are located in the western and north-central part, away from population and industrial centers in the east and south-east.

In order to offset this imbalance, the West-East gas pipeline has been built. Other pipeline projects from Kazakhstan and Russia are under consideration. In addition, two LNG import terminals, one in Guangdong and the other in Fujian, have been built and several others have been proposed. In short, China’s natural gas development is still in its infancy, hence it has great potential. Future consumption growth will come from: higher domestic gas production, emerging LNG import terminals, and international pipeline projects.

China’s heavy dependence on coal is projected to decline slightly in the near future. This dominance of coal underscores the fact that China is the world’s largest consumer and producer of coal. In recent years, the Chinese authorities have sought foreign investment to expand coal liquefaction projects. The goal is to reduce the country’s dependence on oil and to increase energy efficiency and environmental benefits.

Finally, in order to improve environmental conditions and reduce dependence on fossil fuels, the authorities have shown strong interest in other sources of energy, particularly renewable and nuclear power. But despite these plans to diversify its energy mix, the country’s dependence on foreign energy supplies is certain to grow in the foreseeable future. Simply stated, indigenous energy resources are not sufficient to maintain high economic growth rate.

Going Abroad or ‘Zou Chu Qu’

China’s growing dependence on foreign oil supplies has prompted its oil companies to acquire interests in exploration and production abroad. Indeed, securing future energy supplies has become a key aim of China’s energy and foreign policies. Beijing officially joined the World Trade Organization in December 2001. Around this time, then Premier Zhu Rongji, and Hu Jintao, General Secretary of the Communist Party, called on Chinese companies to pursue a “going-out” or “Zou Chu Qu” policy – part of a broader policy of global economic engagement.

Three major characteristics of this policy can be identified. First, Chinese oil companies have only a short history of merger and acquisition activities abroad. The policy was launched and gained momentum only in the last few years. In the mid-1990s most of China’s oil deals were mainly with Indonesia, Oman, and Yemen.

A decade later, Chinese companies are actively pursuing oil deals in North and South America, Africa, Asia, and the Middle East. Second, Chinese companies have sought to establish a presence mostly in countries where US and European companies are absent or have withdrawn. These targeted countries, like Iran, Sudan, Uzbekistan and Venezuela, have adopted domestic and foreign policies that are largely in contrast with the interests of Western powers.

Furthermore, the absence of American and European companies means the Chinese companies do not need to compete with their more experienced and technologically advanced Western counterparts. Third, despite conscious efforts to diversify import sources, China’s oil suppliers are heavily concentrated in the Middle East and Africa. These two regions are likely to continue providing the bulk of China’s oil needs.

Conclusions

Several conclusions can be drawn from this discussion of China’s energy outlook. First, China’s demand for oil will continue to grow in order to satisfy its high economic growth and the needs of its large population. Given the country’s stagnant domestic production, China’s dependence on imported oil will further deepen.

Second, like other major energy consumers (ie, the EU and the US), China has sought to diversify its oil sources. Supplies from Russia, Central Asia, Latin America, and Canada are likely to contribute to Beijing’s energy security. However, Africa and the Middle East are likely to continue to be the main suppliers.

Third, a key challenge to China’s energy security is how to control and regulate the rising demand for energy and create the appropriate governing mechanism to achieve this goal.

Fourth, China’s energy security is increasingly an international concern. The nation’s rising demand is pushing prices higher and is raising serious concerns regarding global pollution and other environmental issues.

Fifth, securing energy supplies has become a major aim of China’s foreign policy. China is likely to play a stabilizing role in international policy to ensure the non-interruption of oil supplies. Finally, Beijing’s rising demand for energy should not be seen at the expense of the US or other major consumers. Today’s energy markets are well-integrated. The source of energy matters less than its availability.

Gawdat Bahgat is Director of the Center for Middle Eastern Studies, Department of Political Science, Indiana University of Pennsylvania (GBAHGAT@IUP.EDU). This commentary was originally published by first publish by Middle East Economic Survey (MEES), on January 15, 2007(VOL. XLIX, No 3 ).