China Oil Demand Rockets & But Govt. Still Lacks Energy Strategy.

China's oil imports doubled over the past five years and surged nearly 40% in the first half of 2004 alone. The IEA on Oct. 26 said China's 11% increase in oil use in 2003 and a 15% increase in the first half of 2004 was a "major cause" of the recent price spike. Yet the government in Beijing still has no coherent energy strategy, with a Communist culture of secrecy continuing to blind Chinese consumers to the risks of their high consumption of gasoline, heating oil, coal and LPG.

Currently, world producers are pumping just 1m b/d more than the 81m b/d average of global oil demand forecast for this year. China accounted for about one-third of the increase in world oil consumption this year, more than any other single nation. While some of the factors that have caused crude oil prices to rise are temporary, such as the switch to oil by hedge funds and other speculators in futures trading, there may be no respite from Chinese demand for the foreseeable future.

The country's industrial base is gobbling up vast amounts of petrochemicals to make everything from fertiliser to Barbie dolls. But, more important where oil is concerned, China is consuming too much gasoline relative to the size of the nation's per capita GDP. The number of cars on mainland roads - about 20m - is expected to increase by 2.5m this year alone.

Even if China's GDP growth of 9.4% this year moderates to 8% in 2005, as the Chinese Academy of Social Sciences predicts, the country is a permanent major player in the global competition for oil. Bo Lin, an energy specialist at the Asian Development Bank, says: "More than a billion Chinese are joining the oil market. How can prices go down?"

China is not only the world's second biggest oil market, with an average consumption in 2004 expected to exceed 6.6m b/d - compared to about 20.4m b/d in the US. It is the world's second largest energy market, with an average consumption of primary energy in 2004 expected to reach 1,275.3m tons/year of oil equivalent - compared to about 2,366.7m tons/year oe. China's oil production in 2004 is expected to average about 3.5m b/d, up from 3.396m b/d in 2003. This means Chinese imports of crude oil and petroleum products this year may exceed 3m b/d, including LPG.

China's oil refining capacity is less than 5.5m b/d, compared to 16.9m b/d in the US. This means the US and China this year will be the biggest importers of petroleum products.

Most interesting is the comparison with Japan, the world's second largest economy, where primary energy consumption in 2004 is expected to average close to the 2001 level of 514.8m tons/year. Japan is the world's most energy efficient economy with primary energy consumption having peaked in 2000 at about 515.9m tons/year.

China is the world's biggest consumer of coal, with the use of this source of energy in 2004 expected to exceed 800m tons/year oe, compared to about 575m tons/year in the US which has the world's largest reserves of coal estimated at 249,994m tons by end-2003. China's coal reserves are the world's third largest, estimated at 114,500m tons by end-2003. The world's second largest coal reserves are in Russia, estimated at 157,010m tons by end-2003.

China's consumption of natural gas, excluding LPG and other gas liquids, in 2004 is expected to average more than 34 BCM/year, up from 32.8 BCM in 2003, 24.5 BCM in 2000 and 16.2 BCM in 1993. China's gas production in 2004 is expected to reach 35 BCM, up from 34.1 BCM in 2003 and 16.2 BCM in 1993. But Chinese imports of liquefied natural gas LNG, expected to begin in late 2006, will increase sharply in the subsequent years. With more than 10 LNG receiving and regasification terminals proposed - two under construction and three more approved - China's LNG imports could reach or exceed 35 million tons/year by 2010/12.

China is the world's third largest producer/consumer of hydro-power, next to Brazil and Canada, with the US being the fourth. Chinese hydro-power consumption this year is to exceed the 64m tons/year level reached in 2003, up from 62.2m t/y in 2002, 55m t/y in 2000 and 32.7m t/y in 1993. To compare, Brazil's hydro-power use in 2003 amounted to 68.9m t/y, up from 68.6m t/y in Canada and 60.9m t/y in the US.

China's production/consumption of nuclear energy is very small, this year estimated to exceed 10m t/y in 2004 - compared to Japan (estimated at 72.5m t/y in 2004), which is the world's third biggest generator/consumer of nuclear energy next to the US (183m t/y) and France (100m t/y). But China's nuclear power generation has risen sharply since 1994, when it amounted to 400,000 t/y.

Now, about one-third of Japan's electricity is generated by nuclear reactors, and policy makers in Tokyo hope to raise this ratio to 40% by 2010. At the same time, the popularity of small, fuel-efficient cars and a well-developed and widely used public transportation network mean that spending on gasoline accounts for only about 1.2% of the average Japanese consumer's budget, compared with about 3% for the average American gasoline consumer, according to Mizuho Securities. So, even though prices at the pump have risen in Japan this year just as they have in the rest of the world, the rise does not have as big an impact on Japanese spending habits. And because of the high concentration of high-tech companies, like Canon, Sharp and Sony, Japan's manufacturers depend less on oil than do its Asian neighbours, like South Korea, where shipbuilding and other heavy manufacturing make up a relatively larger part of the economy.

Just as oil is driving US foreign policy, so too is China's geo-political ambition increasingly influenced by the country's inability to meet its energy needs only from domestic production. Although prices eased last week, eyes are set on $60/barrel WTI. Bernard Dan, president of the Chicago Board of Trade (CBT), was on Oct. 28 quoted as saying: "Given that some production is going on around the world, I can't see it much higher than $75 unless there are disruptions in supply lines". The CBT is the second biggest US futures market next to NYMEX.

When Russian President Vladimir Putin visited Beijing recently, Chinese President Hu Jintao pressed for a swift approval of several proposed billion-dollar, oil and gas joint ventures between the two countries, including a pipeline to connect Russia's oilfields with China's main domestic distribution network. However, Russia is favouring a major crude oil pipeline to the Far Eastern port of Nakhodka, close to the Japanese and South Korean markets.

China was not always so heavily dependent on imported oil. The discovery in 1959 of the Daqing oilfields under the Manchurian grasslands meant the once largely agrarian country was for decades able to produce more crude oil than it required. Oil and gas discoveries in the South China Sea and Bohai Gulf, where drilling began in 1979, made China seem all the more invulnerable to oil shocks, and the country remained an oil exporter until 1993. Today, however, output from China's top four oilfields is in decline. By some estimates, the country's current proven oil reserves will be depleted in as few as 14 years, although the BP Statistical Review of World Energy of June 2004 put China's oil reserves R/P ratio at 19.1 years.

Largely untapped petroleum pools believed to lie beneath western China's desolate Tarim Basin are uneconomic to drill, even with prices at $50/b. That does not mean China's robust economic engine is destined to grind to a halt. The country already suffers frequent power outages, but they occur because of insufficient power generation capacity, not a lack of fuel. The mainland meets more than two-thirds of its energy needs with coal. But to keep the increasingly oil-dependent economy racing ahead - and to ease some of the pollution that comes from burning coal for power - China's leaders are forced to seek ever-greater supplies of petroleum from overseas.

More than half of China's oil imports come from the volatile Middle East, making oil security a pressing concern in Beijing. China has begun building up a strategic oil reserve which it hopes to fill with at least 30 days' worth, and the country has several pipelines planned that would theoretically receive supplies from fields in Russia, Central Asia and Burma.

However, China's state-controlled oil industry, comprising four major companies - CNPC, CNOOC, Sinochem and Sinopec - as well as numerous overlapping bureaucracies, has yet to develop a clear, comprehensive energy policy. Leaders in Beijing want to avoid the fate of other oil-poor countries like South Korea, which buys all of its crude oil on the open market and is therefore exposed to sharp price rises. The way to do that is to invest in exploration and development (E&P) in countries that have large oilfields but lack the capital or technology to exploit them. Once Chinese companies have a stake in oil coming out of the ground, even if it originates abroad, they will have secured long-term supplies independent of the world's fickle prices. The process of overseas E&P began in 1997, when Premier Li Peng encouraged state-run oil concerns to look outside China's borders for investment opportunities, and in the past few years the search has ranged all over the world.

The first major E&P deal in 1997 was signed in Kazakhstan by CNPC. Later CNPC moved to Azerbaijan and the other Central Asian republics (see surveys of the CIS countries in the current volume's Nos. 1-17). Later it moved to Sudan and to Venezuela, where it paid a high E&P signature banus.

CNOOC, for another example, signed a deal in 2002 to extract 1m b/d of oil in Indonesia. In 2003 it signed a major contract to produce gas in Australia. In February, President Hu travelled to Gabon hoping to secure agreements in Africa. In June, he led a delegation from China's natural gas industry to Uzbekistan to build the mainland's presence in oil and gas rich Central Asia. Chinese oil executives have even begun courting Ecuador and Colombia in hopes of buying oil in the US's backyard. (Latin Americans feel frustrated that the US has virtually ignored the region, so turning to China is prudent and will pay financial dividends down the line. Venezuela has a plan to export oil to China on a big scale and for this it is negotiating with neighbouring Columbia for a pipeline to the Pacific - as the Panama canal cannot serve VLCCs.

Earlier this year, ONGC Videsh, the overseas investment arm of India's largest oil and gas producer ONGC, was on the verge of completing a deal that would have given it an 11% stake in a proven oilfield in Sudan. While the company waited for the necessary approval from India's cabinet, CNPC swooped in with an offer that was 17% higher, and snatched the oil deal for China. "The Chinese are definitely very aggressive in the price they are willing to pay", says R.S. Butola, managing director of ONGC Videsh.

Vietnam's leaders recently complained to visiting Chinese Premier Wen Jiabao about CNOOC's intent to conduct seismic testing near the Spratly Islands in partnership with the Philippine National Oil Co. The Spratlys, a mostly uninhabited archipelago in the South China Sea, are believed to contain commercial deposits of oil and gas, but sovereignty over the islands has long been disputed by Vietnam, China, the Philippines, Malaysia and Taiwan.

Undaunted by such diplomatic sensitivities, Beijing has demonstrated its willingness to focus first on protecting its energy interests. Recently, the UN discussed imposing sanctions on Sudan as a punishment for sponsoring human rights abuses in Darfur. China has invested $15 billion in Sudanese oil projects, and Sudan supplies about 7% of China's oil imports. China, which sits on the UN Security Council, threatened to veto the sanctions. The UN instead passed a watered-down measure. China has assured Tehran more recently that it would veto a UN Security Council resolution to impose sanctions against Iran (see News Service 17 in APS Diplomat of Oct. 25).

As assertive as China appears to be in its search for oil, however, it has fallen far short of its goal in energy security. Oil output from China's overseas investments supplies just 5% of its imports - the rest is purchased on the open market. Mainland oil companies have twice been foiled in their efforts to buy stakes in fields in Kazakhstan and an oil company in Russia. They have not secured any significant E&P rights in Central Asia or the Middle East, although Sinochem has a major gas E&P venture in Saudi Arabia in partnership with Saudi Aramco and Chinese companies have just signed a major oil E&P/LNG deals with Iran.

Most oilfields which Chinese companies have so far bought into are already mature, and many experts feel they have overpaid. They are trying to learn in a decade what it has taken multinational companies a century to master.

The failure to secure Moscow's approval to begin construction on a pipeline from Russia has especially frustrated China's leaders. In its absence, Siberian oil has been transported into China at great expense in trains and trucks; yet even this is no longer available as the supplier, Yukos, is facing serious trouble in Moscow and might go bankrupt next month.