State visits are known more for ceremony than substance. Chinese Premier Wen Jiabao’s trip to Abu Dhabi in January appeared to be no exception. Wen’s visit to the capital of the United Arab Emirates ended with the signing of typically vague agreements on further collaboration between the two countries. Much of the state media coverage focused on deals related to sustainable energy, since Wen also made a stop at the World Future Energy Summit during the Abu Dhabi trip.
But the real substance of the visit dealt with that old-fashioned fossil fuel, crude oil. China National Petroleum Corporation (CNPC), the country’s largest state-owned oil company, signed an agreement during the visit with the Abu Dhabi National Oil Company (ADNOC) to study oil fields in the Gulf Coast territory. It was China’s latest in a string of on-the-ground partnerships signed in the Middle East.
Not content as merely the Middle East’s next top customer, China has been eyeing a more direct stake in the region’s oil. The recent deals with the UAE – which provide about 3% of China’s oil imports, with the bulk coming from Abu Dhabi – exemplify China’s desire to move up the value chain by taking part in ventures such as oil exploration, production and storage.
The shift will solidify China’s influence in the region. Buyer-seller relationships involving oil can change almost overnight, but on-the-ground ventures are not easily cut off.
“I would find those on-the-ground kind of deals more significant,” said Robin Mills, an economist and head of consulting at Manaar, a UAE-based company that is also involved in oil and gas supply chain management. “Whenever you put real steel on the ground, it’s a more solid commitment.”
Fueling the economic engine
China’s precipitous economic growth has been accompanied by an almost equally rapid rise in oil consumption by both private consumers and industry. This year, China is projected to consume roughly 9.6 million barrels per day, an increase of 86% from one decade ago.
Chinese demand has a huge effect on global oil prices. According to Mamdouh Salameh, a London-based oil economist and consultant for the World Bank, Chinese demand accounts for about US$25 of the current price of an oil barrel (about US$118 per barrel as this issue of China Economic Review went to press).
If China’s oil consumption continues to grow at current rates, Salameh predicts it will reach 21.36 million barrels per day by 2022, surpassing the US. An even a more conservative estimate from BP predicts that China will reach 17.5 million barrels per day by 2030, surpassing the US sometime along the way.
China will be unable to meet this growing demand with increased domestic production. About 42% of Chinese oil comes from domestic sources, with most coming from three aging oil fields in the northeast, Salameh said. He estimates that, by 2030, domestic resources will provide only about 11% of China’s oil.
“[China’s] global oil diplomacy is geared toward making sure that China will never be short of oil, that’s a very, very important thing,” Salameh said. “China, for instance, is trying to get deals all over the world from Venezuela to Iraq and from Iraq to Saudi from Saudi to Burma, everywhere.”
The Middle-Eastern connection
China currently imports roughly half of its oil from the Middle East and about a quarter from Africa. But as China’s oil needs balloon, only the Middle East has the reserves and production capacity to meet them, Salameh said. He projects the region’s share of Chinese oil imports will increase to around 60% in 2020 and roughly 80% in 2030.
Abu Dhabi is one of the Middle Eastern territories where China has moved to secure future imports. Last year, CNPC signed a deal with ADNOC to increase oil imports to 200,000 barrels per day by 2014, double the amount Abu Dhabi exported to China in 2010 and roughly 10% of the emirate’s overall exports.
Abu Dhabi is unlikely to further increase production, which is nearly maxed out already, to meet these obligations to China, according to Salameh. Instead, the UAE will probably reduce exports to another country in Europe or Asia to meet the export goal.
The only logical reason for the UAE to do this is to build up a long-term strategic relationship with China, said Matt Parry, a senior economist at the International Energy Agency. Abu Dhabi and the UAE probably make smaller margins on their exports to China, based on discounts for the large volume and China’s strong bargaining position as the world’s second-largest economy. (Countries generally do not pay published oil prices but negotiate a price with the exporting country on a case-by-case basis.) Central planning also means China can more easily predict its oil needs, rather than paying for oil at market prices as needs arise.
Abu Dhabi may be willing to accept a lower profit margin to solidify its trade relationship with China, Parry said. After all, China will become an increasingly important customer while, for example, US oil consumption has already peaked and is now declining. Chinese companies do business based on relationships, as well as price and quality. Abu Dhabi may recognize this and be hoping that slimmer margins now will pay off in the future.
Import deals show China’s growing importance to the region, but on-the-ground ventures – whether in oil exploration, production, refining or storage – with-oil producing nations are a more meaningful sign of China’s influence, said Mills of Manaar.
In 2009, CNPC signed a major oil production deal for the Rumaila Oil Field in Iraq, the first major sign that China is moving further into oil production in the region. BP partnered with CNPC to win drilling rights to one of Iraq’s largest oil fields for the next 20 years. The partnership then awarded three drilling contracts, including one to China’s Daqing Oil Field Company (a subsidiary of PetroChina, which is in owned by CNPC).
Abu Dhabi could be the next place China inks such a production deal, if history is any indication. South Korea won production rights in three UAE oil blocks in March, roughly a year after entering an agreement to study oil fields similar to the CNPC-ADNOC deal signed during Wen Jiabao’s state visit, Mills said.
China could find further opportunities in Abu Dhabi as current oil concessions overseen by state-owned Abu Dhabi Company for Onshore Oil Operations (ADCO) begin to expire.
“The big question people are asking...is when the big current concessions start expiring, the first of those the ADCO onshore concession that expires in 2014, will the Chinese or other countries come in? On what terms? In what areas?” said Mills, the author of “Capturing Carbon” and “The Myth of the Oil Crisis.” “People are watching and thinking the Chinese might have a good chance.”
China could also become more involved in oil exploration by buying oil companies with existing contracts in the Middle East. At the moment, these companies are likely too expensive based on high oil prices for Chinese companies to consider buying them, said Parry of the IEA. But, thanks to the advantages of long-term central planning, Chinese authorities can afford to bide their time until oil prices fall, and then move in to acquire exploration companies. That could happen in the next two years or so, should the economies of the US or EU worsen.
Hedging its bets
International conflicts, an increase in oil prices or the growing adoption of alternative energy may slow China’s rising oil demand, but they are unlikely to reverse it. Most of the oil that comes to China from the Middle East is shipped by sea through two narrow straits. Both straits face threats that could cripple China’s oil supply chain. Iran has threatened to close the Strait of Hormuz, through which much Gulf Coast oil flows, in reaction to US-led sanctions. Alternatively, in a conflict between China and the US over Taiwan, the US Navy could blockade the Strait of Malacca, through which 80% of China’s oil flows.
Both scenarios are very unlikely, Salameh said. Still, China hawks could become alarmed by the country’s growing oil insecurity and take steps to lessen this perceived threat – perhaps by advocating the wider adoption of alternative energy sources.
In particular, a highly successful electric car could be a “game changer” for China, Parry said. “If the oil price continues to inch up the way it has been, then it makes more sense for authorities in countries like China to make more investments in free charging points in various cities for electric cars, and that’s not a good situation for the UAE to have,” Parry said. But electric car battery life would need to improve substantially for electric cars to succeed in China.
Oil producing nations in the Middle East will do all they can to prevent a major push toward alternative energy by ensuring that oil prices do not get out of hand. With few other economic drivers, these countries will undoubtedly seek to maximize the revenue they earn from the finite resource. That means finding customers and keeping them happy. For territories like Abu Dhabi, partnering with China is among the best ways to run out the clock.