For Public Policy of
James A. Baker III Institute for Public Policy, Rice University
Before the Commission on U.S.-China Economic and Security Review
October 30, 2003
China has achieved remarkable economic progress over the past ten years, leading to speculation that it may rival the U.S. as a superpower in the 21st century. Discussion of this rivalry has led to speculation that China may compete with the United States for important global resources.
China’s energy sector is one of the key areas where dramatic change can be expected in the coming years. Cheap, readily available energy sources will be critical to China’s economic expansion, just as such resources played a major role in the industrial revolution and rapid economic development in the West.
Already, China’s economic expansion is being accompanied by a strong increase in demand for energy. China’s total energy use has risen steadily from 313.3 million tons of oil equivalent in 1975 to 910.80 million tons of oil equivalent (mtoe) in 2001, according to official government statistics. Coal use has dropped from 76% of the country’s energy mix in 1990 to 67% currently, replaced mainly by higher oil consumption and hydroelectric power. While the bulk of total Chinese energy demand will continue to come from industrial activities for the foreseeable future, the transportation sector is beginning to represent an increasing share of total energy use. In fact, at a per capita GDP growth rate of 5%, the Baker Institute projects that energy demand in the transportation sector could triple by 2015, fueling a sharp increase in oil and petroleum product use. This means that transportation energy demand can be expected to grow 50% faster than demand for energy in the remaining sectors of the Chinese economy.
Chinese oil demand has risen from 2.1 million barrels a day (b/d) in 1990 to over 5 million b/d currently. The Baker Institute projects Chinese oil use will grow to around 7 million b/d by 2010. China’s domestic oil output is averaging around 3.4 million barrels a day in 2003 and is likely to remain flat to slightly lower in the coming years. Therefore, China’s oil imports can be expected to grow significantly in the coming decade after nearly decades of complete self-sufficiency. This change has important implications for Asian energy security and oil geopolitics.
There has been speculation that China’s rising oil use would be a major factor driving international oil prices to new higher levels in the coming decade and that China will become a key competitor to the United States for vital oil supplies from the Middle East and elsewhere. However, this view presupposes that a shortage of oil and natural gas will emerge, and experts generally do not support this premise.
Short to Medium Term Oil Market Expectations: Supplies May Go Up, Prices Down
Analysis of scenarios for international oil market supply and demand for 2010 and beyond do not bear out the thesis that China’s rising demand will necessarily force oil prices to new, significantly higher levels or leave the world depleted of this important fuel. Many respected analysts are forecasting that oil market conditions may become oversupplied in the coming years if demand growth is held in check over the remainder of the decade. This will require concrete policies in oil consuming countries to discourage sharp rises in oil consumption, but implementation of such policies in many countries is under implementation or debate.
Under scenarios which posit a continuation of slow world economic growth, analysts suggest that oil demand may grow by no more than 4 b/d between 2002 and 2005, or roughly 1.3 million b/d a year, with about 60% of that growth coming from China and elsewhere in Asia. Non-OPEC supply, including production rises from Russia and the Chtmian Basin, is expected to total 3 million b/d over the same period. This development, should it occur, would only leave the Organization of Petroleum Exporting Countries (OPEC) with one million barrels a day in market share growth over the period to 2005. Since Iraq alone could take up to that volume, or even expected increases from Algeria and Nigeria, OPEC could have increased difficulty sustaining its current $25 oil price targets without shutting in substantial existing productive capacity.
Some analysts believe that OPEC will want Saudi Arabia to cut its production to make room for increases by other OPEC members, but it remains to be seen how much the kingdom will be willing to sacrifice of market share to defend oil prices. Saudi Arabia has also made public statements that it will not look on passively if Russia continues to grab market share away from OPEC, and any Russian government will have to move cautiously to avoid stimulating a price war among major oil producers. This pressure will be increased by 2007 and beyond, if Iraq is able to make significant headway in achieving some large-scale expansion of its production capacity.
Long Term Oil Resources: Are We Running Out of Oil?
There has been considerable debate in recent years about the determinants of future world oil supply. Some experts point to the declining average size of modern oil discoveries and the rate of depletion in conventional oil fields and conclude that steady growth in oil use could overtake available conventional resources in the coming years. Current high oil prices and the precariously low level of spare oil-production capacity worldwide have intensified these concerns. Others have highlighted advances in oil exploration and drilling technology that are expanding potential frontier resources and greatly reducing the costs of exploiting them. This technology can be used in areas that are newly reopened to the international industry, such as the former Soviet Union, China, and the Persian Gulf, to provide potentially higher supplies from those regions. The current environment of rising oil prices and worries about near-term supply conditions has made the issue of resources even more timely, although there is a need to distinguish between immediate oil availability, which is determined mainly by past efforts and current resources, and longer-term supply, where future efforts and the potential resource base are the key determinants.
Warnings that the world will soon exhaust the known base of hydrocarbon resources are not new. As far back as 1914, the U.S. Bureau of Mines forecast only a 10-year supply of oil left for the United States. In the aftermath of the 1970s oil crises, the Club of Rome concluded that the world would shortly run dry of oil. This extreme view, and others like it, failed to allow for the technological advances that have slashed the costs of finding and developing previously hard-to-tap reserves in deep ocean waters and improved the chances of new discoveries, especially in important terrain in Iraq, Libya and the former Soviet Union which were held back from benefiting from emerging technologies by politics. It also failed to recognize the falling commercial costs of exploiting unconventional resources such as oil shale, tar sands oil, oil sands-based synthetic crudes, and perhaps in the future, gas to liquids and methane hydrates. Similarly, technological advances, conservation policies, and consumer reactions to earlier price shocks have all contributed to shifting paces of demand growth, reducing the rate of depletion of the world’s resources.
The World Petroleum Assessment released by the U.S. Geological Survey in 2000 estimates that in areas exclusive of the U.S., a mean value of 649 billion barrels of oil could be added to reserves through new discoveries in the coming 30 years (1995–2025). This estimate is 20 percent higher than the estimate in their last assessment published in 1994. These findings represent a continuation of the long-term upward trend in ultimate reserve estimates, which may prove too pessimistic as new drilling in Russia proves up more resources than previously expected. The ratio of world-proven reserves to production currently stands at 42 years, substantially higher than it was in 1972.
Total estimates for the world oil reserves outside the U.S. of 2.66 trillion barrels represent a 5 percent increase over previously assessed totals. The assessment also estimates that as of the end of 1995, the world had used 539 billion barrels, or 20 percent, of its currently estimated total oil endowment. Of the remaining estimated oil endowment of about 2.1 trillion barrels, about 75 percent, which includes potential additions from reserve growth, has been found, and 25 percent remains undiscovered. But the report noted that 75 percent of undiscovered oil resources outside OPEC would be found offshore, lending credence to contentions that much of the “easy” oil has already been found. The International Energy Agency (IEA) assessment published in 1998 had similar assessments, arguing that there are 2.3 trillion barrels in ultimate recoverable reserves (that is, available at current prices with current technology) and well over 4 trillion barrels if unconventional tar sands and oil shale are included into the tally.
In summary, resource depletion is unlikely to be a factor in the future US-China relationship.
The United States and China and the Geopolitics of Oil
However, the question is not just whether there will be enough oil under the ground but whether the political, social, and economic environment in oil-producing regions will facilitate or hinder the development of future oil production capacity. In studying both the short-term, strained condition of the oil market and the prospects for the future, it is clear that political issues will loom large, possibly playing a more important role than even geological factors in determining the pace of resource development for at least the next 10 years.
One key political factor influencing the pace of resource development in the developing world is nationalistic or protectionist sentiment, which, in many countries, has created a political climate that promotes blocked access to oil resources by foreign investors. In recent years, political factors have far outweighed geological ones in limiting available supply to world oil markets. It is in managing these political factors that the United States and China have common interests that needs to be carefully nurtured through sound diplomacy and public policy.
As China’s oil imports rise to levels above 3 million b/d, it will be increasingly difficult for China to meet its crude oil import requirements without concluding large, long-term contracts for the supply of oil. Over the past few years, China has demonstrated a willingness to deepen its oil trading relationships with Iran, Sudan, and Libya, taking advantage of U.S. sanctions policy and leading to fears that Beijing will form oil-for arms, military-client relationships with nations under boycott by the United States.
As China pursues bilateral oil diplomacy, political pressures will build for Beijing to back positions popular with particular oil producers in forums such as the United Nations. This could pose new challenges for the West on a variety of issues, in much the way that Russian and French political opposition to military strikes against Iraq hurt U.S. efforts to create U.N. support for a coalition of the willing.
China has yet to consider seriously activities involving multilateral alliances on oil issues with other important oil consuming countries. The West is partially responsible for not making a sufficiently convincing case for an alliance. The U.S. has failed to push for a way for China to join the international emergency stockpiling system and is only now beginning to make significant efforts to transfer new, cleaner energy technologies to Chinese industry and to involve China in multinational energy research initiatives. For the U.S., energy cooperation could be key in building a cooperative relationship with China. Such cooperation could smooth the way for better coordination on weapons non-proliferation and environmental protection.
In the almost three decades since the 1973 Arab oil embargo, countries such as the US, France and the UK have realized the limitations to bilateral supply arrangements, even in light of the cases where such bilateral relations extended to extensive arms shipments and other forms of military cooperation. The impact, by contrast, of the International Energy Agency emergency stocks program has been quite successful, not only in calming markets such as seen in the early days of the US military campaign to remove Iraq from Kuwait in 1991, but also in serving as a deterrent to oil producer groups to exercise monopoly power in times of market crises or to impose politically-driven oil supply restrictions. The lesson of the IEA is that its members have been able to minimize the impact of supply disruptions from the Middle East by sharing resources in a coordinated fashion rather than by acting alone. The IEA serves other important critical functions as well, including promoting alternative fuels and developing market mechanisms to boost energy efficiency.
The continued effectiveness of the IEA system, however, will depend on oil market developments, including Chinese and Asian demand trends. The member countries of the IEA now represent a smaller portion of the oil market than they did at the time of the IEA’s formation in 1977. As oil demand growth in Asia expands in the coming decade, new strains could come to the international system if new policies are not put in place. The omission of key consumer countries like China from the global emergency stockpiling system will increasingly put pressure on the effectiveness of limited, existing stocks in the Organization for Economic Cooperation and Development (OECD) countries. Moreover, tensions created by Asian “free-riding” or possible “hoarding” actions during a crisis could hinder the IEA’s ability to stabilize international oil markets in the future.
The OECD countries comprising the IEA represented 42.3 million barrels a day (b/d) out of a total world oil use of 60.6 million b/d in 1977, or around 70% of world oil demand. The US alone consumed 30% of the world’s oil used in 1977. Asia Pacific at that time was a less critical component to the world oil use situation at 10.1 million b/d or roughly 16% of world oil demand.
By 2001, the OECD share of world oil use had declined to 62% of total world demand while Asia Pacific use had grown to 28%, overtaking the US share of 25%. Asian economic powers Japan, South Korea, Australia and New Zealand are OECD members and, as such, are part of the IEA system now. But other key Asian oil consumers such as China, India, Taiwan, Thailand, Philippines, Pakistan and others are not. As their share of world oil demand grows, this disconnect between Asia’s size and importance as a consumer region and its lack of energy policy coordination with other large oil consuming countries will create new problems and challenges for international oil markets and the international economic system.
As oil import levels for key Asian countries rise over the next two decades, the behavior of oil players from these countries during times of market crisis will increasingly matter. If a significant percentage of countries continue to hold little or no strategic oil stocks despite their rising oil import levels, then any rush to markets with panic buying by these countries at the first signs of crisis will thwart the joint, coordinated and constructive policies of the industrial countries to the detriment of all concerned. In addition, even without panic buying, industrialized countries are likely to resent “free-riding” by other large consumer countries over time since the level of stocks needed to stabilize markets will expand as world demand rises. The best possible win-win scenario would be for new links between the IEA and other large consumer countries like China.
Analysts of Asian energy security should make no mistake that China has concrete strategic interests in Asia’s sea-lanes linked to energy concerns among other issues, as well as a major commitment to its own military strength. But in light of the limitations on China’s own force projection capabilities, these interests are best served, at least for many years to come, through cooperation and strategic partnership. It is precisely the U.S. guarantee of equal access for all of Asia’s sea-lanes that allows China to fulfill its strategic energy requirements through free riding rather than military adventurism. A U.S. military asset drawdown in the Pacific, which might open space for security competition –for example, between China and Japan— to fill the vacuum --would be far more dangerous to Asian stability than the potential for a Chinese challenge to the status quo.
Environmental Issues
It is unlikely that China will be able to cope with rising dependence on oil resources in the short to medium term by leapfrogging to alternative technologies for the transportation sector. Environmental policies that forced industry to create cleaner engine systems for use the transportation industry in the U.S., Europe or Japan could eventually lead to commercial breakthroughs that could be applied to reduce pollution in developing countries such as China and India. Still even if a technological breakthrough or government policies could stimulate strong consumer demand, it would take many years before electric, fuel cell or hybrid vehicles would have significant impact on energy markets. Some pilot programs are being conducted to develop non-hydrocarbon-based energy technologies in certain industries including transportation sectors in China, and several cities in China have promoted natural gas vehicles as an alternative to gasoline fuel. Still, these programs are in their infancy and are unlikely to counterbalance the rise in gasoline-fueled vehicles in the short to medium term.
While growth in Chinese energy use in the transportation sector will likely be highest, demand for energy in both the residential and commercial sectors, as well as the industrial sector, may nearly double by 2015. Rationalization of energy use and increased energy efficiency may come with market reforms, denting growth rates as related to GDP gains but the expansion in the Chinese economy is still likely to bring major increases. Energy use in the industrial and other sector could expand from 545 mtoe in 1995 to 1291 mtoe by 2015. Residential and commercial energy consumption could see increases to 282 mtoe, up from 137 mtoe. In terms of oil, residential and commercial oil use could climb from 128,000 b/d to 270,000 b/d by 2015. Oil use in the industrial sector could rise from just over two million b/d to between 3.4 million b/d to 4.9 million b/d, depending on economic growth rates.
To the extent that the industrial, residential and commercial sectors are coal intensive, this will have considerable ramifications for the environment (coal emits 34% more carbon per British Thermal Unit (BTU) than oil and 81% more carbon than natural gas). For example, by 1992, China was already emitting 55% of the U.S. level of carbon emissions from industrial processes. China’s per capita CO2 emissions could rise from 2.44 metric tons to 3.77 metric tons by 2010. Forecasts for the increase in per capita emissions in China, India, Indonesia and Brazil imply that these four countries could produce as much as 2.0 billion tons of carbon annually in 2010, according to the Baker Institute.
Current international agreements on global warming will be substantially flawed unless they include major developing economies such as China, India, Indonesia and Brazil. Controls on the developed nations alone may be ineffective in reducing the accumulation of carbon dioxide in the atmosphere. The growing emissions from developing countries could dwarf proposed reductions for the industrialized world.
The costs of Beijing trying to limit this rise in emissions in line with the Kyoto agreements are prohibitive. In the year 2020, Chinese attempts to limit emissions in line with available production technology would result in GDP levels 27 percent lower than if emissions are not constrained. The cumulative loss of GDP for the period 1999 to 2020 by evaluating carbon dioxide emission would be about 24 trillion. This is more than twice China’s expected GDP level in 2020.
Given the other pressing social, economic and health challenges facing China, its leaders are unlikely to make control of greenhouse gases a major priority. In order for the developing countries like China to take effective action on global warming, they will have to be compensated until the net cost is acceptable. Given the relative unimportance of global greenhouse gas emissions when compared to China’s other more urgent pollution problems, as well as health, education and economic challenges, an acceptable cost to Beijing to participate in global warming accords is likely to be close to zero. Thus, the cost of any sacrifice that is demanded of developing countries is likely to fall on taxpayers of those countries whose politicians view the problem as a high priority. Since massive transfers in the billions or trillions of dollars would be required, this is not a practical solution to pursue.
Emerging technologies in the field of transportation and power generation could play a positive role in reducing emissions in emerging economies where major infrastructure investments remain to be made. Cleaner, more efficient emerging technologies in the automotive and power sectors could eventually help fill the gap that the Kyoto agreement leaves in reducing emissions from key developing nations. At the margin, China may try to lessen environmental consequences of rising coal use by switching to other resources where possible. While progress has been made in recent years in the development of alternatives to fossil fuels for power generation, these alternatives are unlikely to have significant impact on energy markets until after 2020.
China’s natural gas sector
Natural gas remains another viable alternative to expanding coal and oil use in China. Natural gas could rise from 2 percent of China’s current energy consumption to 8 percent by 2010 and 10 percent by the year 2020 if the Chinese government quickly gives priority to the natural gas sector.
China has significant potential resources of natural gas. There are 54 large and medium gas fields found over the past few years mainly in the Ordos, Sichuan, the Tarim, the Juggar, the Qaidam areas as well as in the western South China Sea. Exploration and production (E&P) activities from 1991 through 1998 resulted in newly added proven reserves totaling 853 billion cubic meters (bcm).
Natural gas demand in China has been restricted in the past. While liquefied petroleum gas (LPG) has been widely used in 600 cities, natural gas use has lagged other major economies. Major Chinese natural gas markets still remain most prominent around the Sichuan gas fields. Considering China’s current environmental situation and future economic goals, China’s natural gas use should be enhanced. High economic growth forecasted above will translate into at least 100 bcm of additional natural gas demand in 2010 and 150 bcm in 2020. But this level of natural gas use faces several obstacles including a possible internal supply deficit, massive infrastructure requirements and lack of expertise and institutional frameworks for commercialization of domestic natural gas markets.
In addition, a non-conventional source, Coal-bed Methane (CBM) resource is estimated 25 trillion cubic meters. There are several pilot CBM areas with 300 bcm reserves and 50-100 bcm production. Further development can be expected in the next decade.
The gap between demand and indigenous supply is projected to grow from 21-24 bcm in the year 2000 to 46-73 bcm in 2010 and to 60-111 bcm by 2020. The potential gaps between Chinese natural gas supplies and its demand by the year 2010 is roughly equal to the size of all annual liquefied natural gas (LNG) exports (23 bcm) from Australia, UAE, Qatar, and Libya in 1997 or 20 percent exports by pipeline from the Russian Federation. The level is also close to combined LNG imports of Belgium, France, Italy, Spain and Turkey and larger than LNG imports of both South Korea and Taiwan. China’s potential gas import requirements by 2010 could reach or even surpass current LNG imports of Japan. China’s southern provinces alone are expected to see demand for gas-generated power reach 11-18 bcm by 2005 and 20 to 35 bcm by 2010, according to a Baker Institute study.
About 50-bcm of natural gas imports have been planned to 2010 from neighboring countries such as Russia, both by pipelines and LNG tankers.
A prioritization of China’s natural gas segment could help enhance China’s energy security by diversifying available supplies to meet China rising energy requirements. It will also improve the living standard and air quality in most major cities. Reasonably, gas policy should be viewed as an imperative to securing Chinese sustainable development.
China sees itself as both an emerging market and as a land bridge for regional gas shipments and it views its gas import strategy as a means to secure and maximize various regional linkages. China has been vying with Japan over competing gas pipeline routes from East Siberia, with China favoring a route from Angarsk to Daqing, connecting to the Chinese port of Dalian and Japan pushing for a more expensive route that would bypass Chinese territory and remain instead inside Russia, exiting at the Pacific port of Nakhodka.
The Geopolitical consequences of China’s rising energy needs
Over the past few decades, China has had the luxury of choosing a neutral role towards events in oil geopolitics. Oil prices inside China were fixed by the state central planners and had no relation to world price levels. Internal supplies fairly evenly matched domestic requirements. Its economy was sheltered from the volatile international oil scene and therefore its leaders could be indifferent to conflicts in the Middle East or elsewhere. Oil disruptions neither hurt nor helped China substantially.
By contrast, the U.S. economy, as a major consumer and importer of oil, was vulnerable to sudden swings in international oil prices, dictating foreign policies that would promote stability in international oil markets. The U.S. navy defended Persian Gulf supplies while U.S. policy-makers worked to remove political and economic barriers to oil development outside the volatile region. The Soviet Union was a major oil exporter and its economy benefited directly from rising oil prices. Its interests in oil markets were diametrically opposed to those of the U.S. Soviet oil interests so diverged from America’s that policy theorists in the 1980s suggested the U.S. would benefit from events that could drive oil prices lower to hurt the Soviet treasury.
China’s rising oil import requirements and the physical constraints of its refining sector may mean China will become increasing dependent on the same energy sources as the U.S., Japan, and other industrialized economies. This could tie its strategic interests more closely with Western interests in the Middle East. A rising reliance on Persian Gulf oil and gas imports imply that China will suffer the same negative consequences as the U.S., Japan and Europe if military equipment it or others pass to regimes such as those in Iraq or Iran is used to interdict the free flow of oil from the Middle East or elsewhere. Continued political instability in Afghanistan or Central Asia will have similarly dire consequences for China’s chances of tapping Chtmian energy supplies.
However, it remains to be seen if China’s energy interests will be enough to alter China’s military’s perceptions of its own more general strategic interests, particularly on the issue of weapons non-proliferation. China may continue to perceive a benefit in diverting U.S. strategic engagement away from Asia. China’s leaders may view larger strategic interests in Asia –beyond the energy sector-- as better served by diverting U.S. diplomatic attention and military assets away from the Asian theatre to places like the Middle East. This latter interpretation of Chinese interests will depend greatly on Beijing’s perceptions of U.S. intentions –both in the short and long term-- and their potential risk to China.
To some extent, China’s economy could be shielded from the negative consequences of a temporary cut-off in oil supplies as a result of a major disruption by its heavy use of coal in vital industries. But it would still have to implement uncomfortable –and potentially destabilizing-- major consumer sacrifices.
The Chinese leadership’s freedom of movement on asking for major consumer sacrifices is likely to diminish over time as China’s middle classes gain a rising role in the economy. As media outlets expand inside China, awareness is growing regarding disparities within Chinese society and between PRC citizens and people living in Hong Kong, Taiwan, the United States, and other rich societies. The proliferation of television and other media forms is already ushering in vast social change and rapidly rising expectations of a more consumerist society.
Nearly 100% of homes in urban China and two-thirds of homes in the countryside own television sets. Advertising is targeted at middle class Chinese who might desire lavish vacations, air-conditioned homes, and private cars—all of which drive up the demand for energy almost exponentially.
The Chinese central government has fought back against this bombardment of foreign images by delivering competing messages of socialist values, but ultimately, Beijing faces a near impossible challenge to monitor and control the symbols being circulated at the local level throughout China. The net result could easily be a society increasingly unwilling to forego consumer goods and unlikely to conserve energy. This fact will make the imposition of curbs on energy use more costly politically and give the Chinese leadership pause to take adventurous military actions that could result in a cut-off in energy imports.
China does not yet have the military muscle to challenge successfully the U.S. and its regional allies in the Asian seas. China lacks the military capability and the basing facilities to close Asian sea-lanes for any extended period of time –should the U.S. Navy intervene to reopen them. Given its limited military budgets and current capabilities, China’s military is 40 to 50 years away from the type of comprehensive, across-the-board technological modernization of its naval and air forces that could challenge American power in the sea lanes.
The U.S. presently has a window of opportunity to pursue cooperative energy policies that help China feel more secure about its energy security, thereby reducing the stimulus to conflict. Initiatives that assist China in developing cleaner energy sources can also enhance Western environmental goals.
[1] Dr. Steven W. Lewis, Senior Researcher in Asian Politics and Economics, contributed to this written presentation.