China S Influence on the Price of Oil and on the Western Countries Oil Security

China’s influence on the price of oil and on the western countries’ oil security

By David Brasholt

Title of study: HA Almen

Supervisor: Jørgen Ulff-Møller Nielsen

Department: Department of Economics

2010

Summary:

This report aim is to cast light on the future development of China’s oil consumption to get an idea of how China will affect the future oil price and to explorer whether or not China will be a threat to western countries’ oil security. It does this by first presenting an overview of the oil market. It is found that the economic crisis has lowered oil companies profit and made it hard to obtain loans. This has caused a reduction in investments that will tighten supply. Furthermore oil production is set to become more concentrated in a few countries, causing oil producers to gain more market power. Then a historical overview of China’s oil consumption is presented. Along with that is a description of what China has been using its oil for. It is found that China has been importing more and more oil since 1993, the year it became an oil importer. The increase in oil consumption in China has primarily been caused by an increase in transport and heavy industry. Heavy industry has expanded due to increased need for housing and infrastructure and an expanding light industry that needs inputs from heavy industry. Transport oil use has become a much larger share of total oil use in the last 20 years. China has also had price subsidies in place which has kept crude oil prices from having their full effect on oil consumption. But these subsidies are gradually being removed. It is also found that China has implemented or is implementing several policies aimed at reducing oil use. China has also been increasing production of alternative fuels but it is expected to remain a small share of overall oil consumption. The two most comprehensive analyses of China’s future oil consumption are IEA’s and EIA’s analyses. Their analyses are therefore presented. They both project that China’s demand as a share of total world oil demand will increase from 9.5% in 2008 to about 15% in 2030. A regression analysis is made of China’s oil consumption between 1980 and 2008 to see which and how large an effect variables such as GDP and oil price have. GDP, oil price, percentage value added from the industrial sector, FDI and the preceding year’s oil consumption are found to be influencing China’s oil consumption. A projection to 2015 was made using the regression model based on the historical relation between the aforementioned variables and China’s oil consumption. This projection is compared to EIA’s and IEA’s projections and it is found that EIA and IEA are underestimating China’s future oil consumption. However, the historical relation between the variables in the regression model and China’s oil consumption are unlikely to hold, since China’s economy will change a lot in the coming years. But it does cast some doubt on IEA’s and EIA’s projections. The last part of the report attempts to determine whether or not China is a threat to western countries’ oil security. It is found that China overseas involvement is growing quickly. But China is not found to be a threat as China is not found to be locking up the oil resources. The increased demand for oil by China on the other hand does provide oil exporters with an alternative destination for their oil imports. This reduces western countries bargaining power. It should also be noted that the Chinese government still holds some power over the Chinese oil companies.

Index

Introduction 5

Problem Statement 7

Methodology and structure of this report 7

Definitions 9

The oil market 10

China’s oil production and consumption 14

Determinants of China’s oil consumption 16

Alternatives to oil in China 21

The International Energy Agency and the U.S. Energy Information Administration analyses of China’s oil demand 22

Comparing GDP per capita to Oil consumption per capita 24

Regression Analysis of the causes of China’s oil consumption 26

China’s influence on western countries oil security 33

Conclusion 39

Reference list 42

Introduction

China is the world’s most populous country and now has one of the biggest economies in the world. Up until 1978 China was a poor country with a command economy. But in 1978 China began its economic reforms and started to move towards a market oriented economy. Since then China has experienced very high growth rates and millions have been lifted out of poverty. China’s average annual growth rate from 1980 to 2008 was 12.26% (World Bank, 2009). One of the highest in the world. In 2008 China’s GDP in PPP terms was 7903 billions (World Bank, 2009). Today most Chinese in the urban areas are able to live modern lifestyles. However this economic growth has not been without its costs. Rapid expansion of industry has polluted China heavily. And great wealth disparities have arisen between urban Chinese and rural Chinese.

In spite of the move towards a market oriented economy, private property rights are not yet fully protected and the Chinese government still has the power to influence and even control any company if it wishes. Some enterprises remain state-owned.

China suffered less from the economic crisis than major western economies. China’s GDP grew by 9% in 2008. While the US, the UK, France and Germany enjoyed only a growth of 1.1, 0.7, 0.4 and 1.3 respectively. (World Bank, 2009).

Through the size of its economy China is gaining more and more influence in the world. And because of its “going global” policy, which is a strategy of encouraging Chinese companies to invest abroad, this influence is increasing fast.

As China’s GDP grew so did its demand for oil. For some years China was able to satisfy its demand for oil through domestic production but in 1993 China became an oil importer for the first time and since then its import has only increased. China is now the world’s third largest importer of oil after the USA and Japan. And in IEA’s projection to 2030 China is predicted to account for 42% of the demand growth in oil (IEA, 2009). This means that China will have a strong influence on the oil market now and in the future.

As all major western countries are oil importers except Canada the oil price have a significant influence on their economies. IEA is of the opinion that although the financial crisis played the main part in causing the economic crisis the steady increase in oil prices from 2003 to 2008 further exacerbated the crisis through weakening industrialized countries’ trade balances and reducing their income. As an example IEA mentions that US household spending on energy doubled over the five years up to the economic crisis. Reducing their consumption of other goods and services and increasing their debt. (IEA, 2009). As China’s emergence as an oil importer will drive up prices if supply is not expanded sufficiently, China will potentially have a negative influence on western countries’ economies. It is therefore important for western countries to have an idea of how large China’s oil demand will be in the future and how China influences the oil price.

As a consequence of the financial crisis and later the economic crisis, oil companies have had a hard time obtaining credit for investments. Their income has also plummeted as demand for oil has shrunk due to the economic crisis. This has left them with little cash for investment. China’s oil companies have used this opportunity to secure oil through large investments abroad.

China’s largest oil company “China National Petroleum corp.”(CNPC) is now involved in 65 gas and oil production and development projects abroad. An example is that CNPC and the Russian Transneft are building a 300000 barrels per day pipeline from East Siberia to China. Through many years as a net exporter China has built up an immense holding of foreign reserves. China is now using these reserves to secure long-term oil and gas contracts by offering loans to oil producing countries, including Kazakhstan, Venezuela, Brazil, Bolivia, Ecuador and Turkmenistan (Paula Dittrick, 2010). In a “loans for oil” deal, China lend Russian Rosneft and Transneft $25 billion in exchange for an additional 15 million metric tons of oil export to China per year for 20 years (David Winning, Shai Oster, & Alex Wilson, 2009).

These deals and investments are often described as China locking up resources and western countries are concerned that China’s oil companies will not act independently but serve China’s national interest. China has also been investing in Iran, which the western countries have sanctioned economically to prevent it from acquiring nuclear weapons. If Iran manages to acquire nuclear weapons the region, which holds the bulk of proven world oil reserves, could be further destabilized. China is one of the 5 veto-wielding members of the UN Security Council, so western countries fear that China will veto any sanctions against Iran aimed at stopping Iran from developing nuclear weapons.

So some see China as a threat to western oil security. The USA for example blocked a Chinese company from acquiring the American oil company Unocal. Since US politicians feared that such an acquisition would be a threat to national security. And a threat to oil security is a threat to a country’s economy in general since oil plays a central part in the economy and there are no readily available substitutes for oil. So this is a central concern to western countries.

Problem Statement

As described above China will influence the oil prices in the future and the oil prices have a strong influence on western countries’ economies. As a result western countries are in need of more information on the strength of China’s influence on the oil market. Western countries also need an assessment of whether or not China is a threat to western countries’ oil security so that if this is an issue it can be dealt with before China grows too strong.

Therefore, this report will attempt to offer insight into the following questions:

How large is China’s import of oil likely to be in the future?

How is China likely to influence oil prices in the future?

Is China a threat to the western countries’ oil security?

Methodology and structure of this report

Two respected agencies have attempted to predict how China’s oil demand is likely to evolve in the future. One is the U.S. Energy Information Administration (EIA), which releases the report “International Energy Outlook” once a year. This report contains a projection and an analysis of future developments in the energy markets. The other agency is the International Energy agency (IEA), who release “World Energy outlook” each year. As the International Energy Outlook, this report contains an analysis and a projection of the future energy markets. As these two reports are the two most comprehensive analyses of the energy markets they offer the best estimation of how China’s demand for oil is likely to develop in the future. However, since they do not specialize in China’s oil demand, and IEA’s projections have been criticized (Nel & Cooper, 2008), it would be sensible to review their projections and analyses. This report will attempt to do this through use of the literature on China’s oil demand and through an analysis of the historical relation of China’s oil consumption to predictors such as GDP and oil price. This relation will be modeled through regression analysis. China’s influence on the oil price will depend on their net import. So the answer to this question will also be answered through the aforementioned analysis.

To answer the last question it is first necessary to establish what oil security means.

IEA defines energy security as “access to adequate, affordable and reliable supplies of energy and lists “the most important indicators of energy security” (IEA, 2009, p. 115):

The extent of imports (especially from politically unstable regions)

The distance from production to consumption

The vulnerability of physical supply chains to disruption

The degree of fuel substitutability

The diversity of the fuel mix

The degree of concentration of market power

The extent of imports depends on a country’s consumption and production, so China can’t have a direct influence on this. But if China somehow monopolizes some sources of oil, China will reduce western countries supplier diversity making imports more unreliable. In this way China might also force western countries to source more oil from more unstable regions. China could also destabilize or keep western countries from stabilizing an oil exporting country. This would cause western countries oil import from that country to be less reliable. This is what some western countries believe China is doing in Iran.

China might extend the distance from production to consumption for some western countries. By importing oil from countries close to western countries forcing western countries to import oil from countries further away. In the same way China could force western countries to import oil through supply lines that are more vulnerable to physical disruption.

China can’t have an influence on the degree of fuel substitutability and the diversity of the fuel mix as these are determined internally in each country.

The larger China’s demand for oil imports are the stronger China will influence the market power of exporters and importers. How much change China will cause to the current distribution of market power depends on how quickly China’s demand for oil will grow and whether oil producing countries can keep up with the growth in China’s oil demand.

China’s growing demand can also potentially push up prices so much that importing an adequate amount of oil would not be affordable to some western countries. Another way that China can influence the western economies negatively is through creating price volatility in the oil markets. This is bad for western companies as it imposes on them the risk of suddenly having their costs increase from an unexpected oil price hike.