By Yang Guang

Senior research fellow of IWAAS

yangguang@cass.org.cn

It is believed that China, while making a critical move in all respects towards a moderately prosperous society, will be more heavily relying on oil imports to cover its growing shortfall in fossil fuels for the first two decades of the 21st century. A primary energy source, obviously, flows from the Middle East. The growing number of oil imports from the region, however, poses a new challenge to which China must respond by seeking solutions to wisely identified problems on the basis of mutual benefits. It is only by this strategy that China will push ahead with its economic development and deepen its relationship with the oil exporters in the Middle East as well.

A Long-lasting Demand for Imported Oil

An inadequate natural reserve of domestic oil brings supply and demand further away from the equilibrium when there is a growing need of the fuel to support economic growth and optimize energy composition. That is how a demand arises for imported oil in China.

The first half of the 21st century is a critical time for China to grow into a middle-income country, resulting in a rapidly growing demand for energies. Economic growth and energy consumption are positively correlated in a constant fashion. Greater economic growth would definitely lead to more energy demand, as in the case with China, where the elasticity of energy demand has reached 0.7 on average and in some years even gone up as high as 1.0. As compared with developed countries, China receives a rather large proportion of GDP when energy is highly consumed as in transport, power supply, metallurgy, building, and production of raw materials, building materials, steel, and chemicals. One point added to the GDP means that China consumes more fuels than developed countries on account of low energy efficiency. Furthermore, in its structural reform of prime energy, China will be substituting coal for premium fuels, including oil, which accounted for 25% in 2000 and is expected to remain anywhere between 20% and 24% in 2020.

A big oil producer, China was ranked fifth on a global basis in 2007 with a staggering output of 187 million tons of crude oil, accounting for 4.8% of the world output, but for all that the country still finds itself short of petroleum reserves. By the end of 2007, there was only 2.1 billion tons of oil found underground in China, adding as little as 1.3% to the global reserve. As a result of this natural constraint, total domestic output falls far behind growing demand in the market. Since the late 1980s – particularly the 1990s, China has been experiencing a slowdown in its oil production, with the self-sufficiency rate plummeting from 102% in 1993 to 51% in 2007. The widening gap between supply and demand transformed China into a net importer of petro-products in 1993 and then of crude oil in 1996. 2007, as a result, saw China’s net oil imports rocketing from 2.92 million to 203 million tons.[1] A majority of foreign experts on Chinese oil issues predicate that by 2010, China will have reached the pinnacle of oil output; while Chinese specialists argue that the peak will be hit later, around 2015. In any case, the self-sufficiency rate will most likely start to fall on a steeper downward slope sometime in the 2020s. It is generally acknowledged that twenty years from now China’s oil output will only increase by 1.3%-1.5% annually. For a GDP growing as slow as 4.8% from 2000 through 2030, as conceived by the International Energy Agency (IEA), China’s oil consumption rate would still rise up to 3% per year on average.[2] At a possible GDP growth rate of 7.2% for the first two decades of the 21st century, as perceived by Chinese scholars, actual oil consumption may grow even faster than estimated by IEA.[3] As revealed by a generally agreed international predication, China will have to import 220 – 411 million tons of oil in 2020, supplying more than half – maximally 76% of national consumption.[4] Even though they did not show up in some other estimates that suggest the problem being less acute, these startling figures, nevertheless, offer a grim and yet more realistic view of the matter, reflecting the unexpected highs in China’s oil import quantum over the recent years.

The Middle East – China’s Primary Source of Petroleum

The Middle East, a region naturally abundant in petroleum and geographically facilitated for transport, has gained a strong foothold in the global petroleum market and will, inarguably, become an unrivaled and primary oil supplier for China.

The Middle East boasts such an abundance of oil that by 2007 in West Asia alone, there was discovered as much as 102.9 billion tons of oil, or 61% of the world proven reserve, which could last 82.2 years based on that year’s output. In addition, the region enjoys unprecedented advantages in terms of oil recovery with highly concentrated deposits, thick and shallow reservoirs, and a large number of gushers. The cost of production, therefore, drops to a minimum of $0.16-$0.50 per barrel and $2-$3 on average – far below the world mean of $9-$10. Nowhere else in the world possesses these attributes desirable for oil supply.

Increasingly, a bountiful natural resource combined with great suitability for exploitation boosts the Middle East’s capacity as a predominant oil supplier for the world. In three decades beginning from 2000, as estimated by IEA, OPEC members in the Middle East will steadily raise their daily crude oil output from 21 million up to 51.4 million barrels, over 80% of which will be exported, bringing the percentage of the world total supply from 28.1% to 42.9%.[5] The predominance of the Middle East, thereby, will very much likely be assured and strengthened in years ahead.

The Middle East, moreover, is in a geographic and economic position favorable for China. While maximizing the utilization of oil tankers available on both sides, sea routes to the region require less cost and time than to West Africa or Latin America. By contrast, Central Asia and Russia are geographically closer to China, but what might be saved from the shorter distance would be offset for the reason that, during the prolonged economic transition, there have not been set up oil pipelines or well-facilitated fiscal systems required for exportation. The situation will not be remedied anytime soon.

As justified by the foregoing observations, China has long placed reliance on the Middle East for oil imports. Table 1 shows that imports from the region have increased about tenfold by weight since China became a net importer in the 1990s – from 12.3459 million tons in 1994 to 145 million tons in 2006. Accordingly, the increase is reflected in the proportion to total oil imports, which has remained at 50% or thereabouts since the new millennium began. There were only six Middle East exporters to China in 1994, but the number has risen to 12 by 2006. Urged by a growing demand for fossil fuel, China will certainly continue to increase its imports from the Middle East as the latter gains further ascendency over the petroleum industry.

Table 1: 1990-2006 Import Quantum of China

(Unit: ten thousand tons)

Source: China Customs Statistics Yearbooks 1994-2006, General Administration of the Customs, People’s Republic of China

Challenges of Importing Oil from the Middle East

As discussed thereinafter, the way China develops reliance on the Middle East poses some challenges to the relationship between the two parties.

One of the challenges emerges when China is losing its trade balance with the oil exporters in the Middle East. On the whole, the increase in oil exports to China rapidly raises the value of trade for the exporter and the importer alike, but it also raises the latter’s expenditure on imported oil, which imposes an increasingly greater impact and pressure on efforts to keep the current account for international payments balanced. By 2007, China saw a total of 79.77 billion US dollars spent on imported crude oil – 12% of the total national import value.[6] The proportion would have gone larger had imported petro-products been included. The figures may well rise even higher at the prospect of a growing demand for oil imports in the country.

Table 2 shows China’s growing trade deficit with primary oil exporters in the Middle East, which rose to 27.1 billion US dollars in 2007. From a long-range perspective, it is very much likely that China will import liquid natural gas from the region, adding to an even greater weight on the respective proportion to the overall national spending on imports. Consequently, the surplus China has long maintained in its foreign trade will soon be depleted in a booming national economy where the demand for imports is dramatically rising, and where an increasing number of exports are being threatened with international protectionism as in anti-dumping. Since January 2004, a reformed export rebating system has revealed a generally declining export rebate rate. All these observations contribute to the difficulty in increasing the export quantum and thus in maintaining a balance of trade. It is therefore imperative to address the overriding issue regarding how to achieve a backflow of “Petrodollars” and keep the trade balanced with an increase in importing fuels from the Middle East – a considerable challenge that poses a threat to national economic security.

Table 2: Value of China’s Goods Trade with Primary Oil Exporters in the Middle East 2007

(Unit: ten thousand US$)

Source: Web information from Comprehensive Department, Ministry of Commerce, People’s Republic of China, July 2008

Imposed by China’s oil importation from the Middle East is yet another challenge that concerns the environment. Petroleum, as a fossil fuel, emits sulfur when burned, hence inflicting a major problem on Mother Nature. Oil recovered in the Middle East, unfortunately, contains a fairly high amount of sulfur. As shown in Table 3, the sulfur content in most categories is distinctly higher than Indonesian crude oil that was once exported to China in large quantities, as well as crude oil from the oilfield in Daqing, China. Emissions of sulfur have become a major pollutant in China, and particularly in megacities such as Beijing and Tianjin, where the air-borne SO2 content by cubic metre is higher than that in some other developing countries like India, Egypt, and Mexico.[7] Acid rain is a result common in many places around China. The persistent increase in the quantity of imported sulfur-rich oil, therefore, would cause more damage to the environment if there was little to be done with desulfurization. One solution to this problem would be to increase the desulfurizing capacity of oil refineries. Progress was achieved to a certain degree when China, by building and renovating oil refineries with supplementary petroleum wharves, pipelines, and storage tanks on a large scale from 1995 through 2003, raised its desulfurizing capacity so as to process approximately 40 million tons of sulfur-rich oil per year.[8] But it was barely sufficient for the crude oil imported from the Middle East in 2003, much less for the greater demand that followed. Obviously, it is due to the desulfurizing incompetence that many oil refineries in China find themselves to this day incapable of processing crude oil imported from the Middle East in large quantities. Worse, there are a great number of small-scale oil refineries that are impossible to desulfurize at low cost. The problem poses a great threat to China’s energy reliability and environmental safety. It is thus a prerequisite to invest substantial capital, monetary and technological alike, for an expansion of the oil refining scale to further increase desulfurizing capacity. As compared with developed countries, China has a relatively low standard for sulfur emissions.[9] In view of the scientific outlook on development adopted by the Central Government for sustainable national growth, it is necessary to introduce stricter regulations and improved facilities in order to refine sulfur-rich oil to an environmental standard drawn closer to that in developed countries.

Table 3: Sulfur content in some categories of Asian crude

                                           Category                           Sulfur Content (%)

                                           Kuwaiti Crude                  2.52

                                           Lower Zakum Crude        2.00

                                           Arabian Gulf Light           1.77

                                           Iranian Heavy                   1.73

                                           Arab Super Light              1.15

                                           Omani Crude                    0.94

                                           Murban Crude                   0.78

                                           Sumatran Light                 0.08

                                           Daqing Crude                   0.09

Source: Takeshi Hayashi: Diesel Fraction Desulfurization, Japan Petroleum Energy Center, March 2004.

As a major importer that relies on fair pricing and timely delivery of petroleum, China considers the political instability of the Middle East an impediment to oil supply. Global oil supply is highly prone to unrest in the world economy and political scene, and particularly in primary oil-exporting regions, where political disturbances have caused huge price fluctuations and interrupted part of the oil supply over the recent 50 years. As shown in Table 4, most of the major incidents that partially cut off oil supply took place in the Middle East.

Table 4: Major events that interrupted the global oil supply[10]

Political unrest has continued right up in the Middle East to the present day. Racial, religious conflicts and territorial disputes have not been eradicated in most regions where oil is produced and shipped. PLO-Israeli conflicts are set off constantly after the Middle East peace process suffered a severe setback in 2000. Even more uncertainty has been brought to the political stability in the Middle East when the United States invaded Iraq, hoping to establish a Western political model in the region. All these disturbances carry a risk to the reliability of oil shipment. By inflaming a widespread worry about what the future may hold for oil supply, wars and conflicts in the Middle East have also contributed much to a persistently high world price for petroleum since 2000. Capitalists around the globe would then seize the opportunity and, by speculation, stir up the price even though the market was basically in equilibrium. This challenge has made it essential for oil importers around the world to collaborate with Middle East nations in restoring their peace and reliability for an uninterrupted source of oil supply.

Contemplation on Cooperation for Mutual Benefits

While facing the emerging challenges discussed earlier, China, in its effort to develop relationships with Middle East countries, should focus its attention on what needs to be done as contemplated thereinafter.

First, to enlarge the scale of export. For a long-range balance of trade with the Middle East, China needs to increase its export to the region by orienting itself to the following objectives in particular. The first objective is to adopt an attitude towards what we call “large economy and trade,” in which coalescence is sought for development. In the Middle East, there exists not only a large open market for goods but also a substantial market for contracted construction projects and labor services. Since the 1980s, there has been a decline in the oil exporting revenue of the oil producers, bringing profound change to the market, where competition began to take the form of – in particular – a series of barter trade businesses, owner-financing contracts, and BOT projects. Chinese companies, having been disconnected from foreign trade and overseas economic cooperation, can rise to these new challenges only when they come out of autism to coalesce into “business tycoons” that associate themselves with trade, investment, contracted building, collaborative labor service, and mutual support. The coalescence, once established, will provide solutions to such problems of insufficient corporate funding, disorderly competition, and weak business management, by fostering collaboration among companies in industrial, agricultural, banking, and civil works contracting sectors. Interaction is thus created across industries and with overseas economies to gather strengths for an overall boost of competitiveness in the Middle East market.

The second objective is to promote free trade and avoid ">The third objective is to diversify the economy and trade by encouraging the participation of free enterprise. Economic and trade activities to this day, for the most part, remain in the interest of state-owned corporations in China and the Middle East. The trade as a whole, however, depends on free enterprise to advance further still. For this reason, it is necessary for the government to spur private companies by effectively providing them with incentives and services in terms of information consultancy, legal advice, quality control, brand certification, bank guarantee, loaning on credit, training, and more.

Secondly, to diminish the “Asia Premium.” The “Asia Premium” phenomenon has long been a concern among scholars from Asian major oil-importing countries. The phenomenon, as revealed by studies from Japan and Korea, is in effect a chronic condition in which the Middle East has been exporting crude oil to Asia at a price higher than that of the same grade to Europe and America.[11] From 1991 through 2003, the mean difference was $1.02 per barrel. The reason why the Asia Premium prevails, as concluded in the studies, is that since the 1990s, Asian demand for oil has drastically increased to a point where Dubai, a producer of crude oil, raised the price at the prospect of declining output and falling capacity to supply – the price taken as a baseline for export to Asia by the other oil exporters in the Middle East, resulting in an overvaluation and hence generally higher quote of oil exports to Asia. To solve this problem, studies suggest that the baseline be instead represented by Brent Crude, or crude oil for European and American markets, or even Arab Light Oil that holds a larger share of the sales with greater marketing potentials. The Asia Premium presents a chronically and technically thorny problem that imposes higher cost on Asian oil importers and hence a negative impact on their economic development and market competitiveness. As China continues to increase oil imports from the Middle East, attention, therefore, should be concentrated on prudent examinations and negotiations by both importers and exporters for a solution to this problem. The diminution of the Asia Premium should be included as one of the objectives in Asian cooperation for energy safety.

Thirdly, to drive collaborative investment on a wider scale. Collaborative investment in the petroleum industry presents a mutually beneficial approach to a secured trade of oil. As an oil importer, China needs tremendous investment to fill up its Strategic Petroleum Reserve, build or renovate oil refineries, and construct facilities for oil transport and marketing. Investment by primary oil exporters may provide a fundamental way for China to keep balanced on international accounts with a backflow of petrodollars. In the downstream industry, it may also offer investors a necessary means of securing their future shares in a highly competitive market that constitutes all major oil importers, including China. This two-way investment strategy is known in the Middle East as “global integration” among the OPEC members that, as in the case with China, need foreign investment as well – particularly in the upstream industry, where there is a rising call for a boost to production capacity to meet the increasing demand and competitiveness for crude oil in the foreseeable future. As estimated by the GCC, there would be as much as 400 billion US dollars invested for OPEC to raise crude oil output up to 60 million barrels per day by 2020 – two times greater than it is today.[12] In their eager pursuit of an outward-oriented policy designed to ensure business growth and the safety of oil imports, the Chinese oil corporations have a keen interest in increasing investment and setting up production-supply oil bases particularly in the Middle East. Benefits, as derived from two-party collaboration, may also be extended to a third party by joint investment. Thailand, for instance, recently brought up a proposal that foreign investment could be attracted to laying pipelines that traverse the Isthmus of Kra to reach the Pacific from the Indian Ocean – a substitution for the channel that passes through the risky Straits of Malacca, and a shorter route that requires less freight for oil supply from the Middle East. The attraction lies in the fact that the new pipelines, once built, may well serve as beneficial to importers and exporters alike in terms of safety. To sum up, investment-oriented collaboration between China and its oil suppliers in the Middle East should be given top priority in the petroleum industry as an effective strategy with which to gain benefits in a bilateral or even multilateral way.

Fourthly, to uphold regional peace. As discussed earlier, a drastic rise in oil prices and an abrupt interruption to oil supply are the undesired results of religious and political conflicts. To prevent them, China, undoubtedly, will pay more attention to issues with peace and stability of oil producers in the Middle East, with whom a bond of interests has been forged in the industry. As a permanent member of the United Nations Security Council holding to an independent foreign policy for peace, China, while maintaining a friendly and mutually trustworthy relationship with oil exporters in the Middle East and other countries around the world, may exert limited and yet noticeable influence on taking preventive or mitigating measures against frictions that plague the Middle East. Its influential actions involved emissaries, for many times since the 1990s, being dispatched for mediation in disputes between Palestine and Israel; a proposal addressing Iraqi issues widely appreciated by the other Security Council members for its solution to bringing peace to the gulf region; and a diplomatic approach devised in the 21st century to push the Iranian nuclear issue and the Darfur Crisis further down to an effective political solution. All these accomplishments show the more active diplomacy China has adopted in its contribution to upholding peace and stability in the Middle East.

Fifthly, to establish strategic dialogue. As an energy-driven relationship strengthens, on a broader plane, the reciprocal ties between China and the Middle East countries, it is more crucial than ever to establish a strategic dialogue mechanism for further advancement of cooperation. During President Hu Jingtao’s visit to Egypt this year, China and the Arabic League came to a significantly proactive strategy to develop the framework of a forum, within which dialogues may be facilitated not only among governments but also among regional organizations such as GCC or OAPEC. In addition to official dialogues, the forum may also provide a platform for civil communications particularly in the academic circles and think tanks. By strengthening oil-driven interaction between China and the Middle East countries, multilayered dialogue mechanisms create an instrument with which to discover, investigate, and solve problems in every aspect that seriously, chronically harm the interests of either party, hence pushing their reciprocal relationship to an all-time new height.