Beijing’s Responses to Falling Oil Prices

Publication: China Brief Volume: 9 Issue: 3

Zhang Guobao, deputy minister of the National Development and Reform Commission

Oil and other commodity prices have been declining as major economies of the world go into a recession, but the Chinese are now more convinced than ever that their country had very little to do with the sharp climb and subsequent nose dive of oil prices in the past five years. [See Table 1., world oil price started to climb in a sustainable manner since 2003 at an average price of $31 per barrel that year, reached its peak in the middle of 2008, and then plunged to $35 year end. It took only 5 months for the price of oil to plummet from $150 to under $40.] Chinese officials and energy company executives instead maintain that China was a victim of increasing oil prices, and that a large amount of its $1.95 trillion foreign reserves have to be used to import more than 40 percent of its daily consumption [1]. While China’s intensified domestic energy development program and its “go-out” strategy were designed to cope with a prolonged period of high oil prices, the recent drop in the global energy market has presented new sets of challenges to Beijing’s energy security.

New National Energy Administration

The booming Chinese economy was confronted with a severe energy shortage shortly after entering the 21st century. Yet the Energy Bureau, under the National Development and Reform Commission (NDRC), was under-staffed and overwhelmed by day-to-day administrative tasks. With the worldwide rise of energy prices, there were growing calls for the Chinese leadership to strengthen its government institutions to deal with the mounting challenges in the energy sector. A major study published jointly by the World Bank and China’s State Council (the cabinet) urged the establishment of the Ministry of Energy [2].

However, the long-anticipated Ministry of Energy did not materialize in China’s overall “super ministries” reform program last year. Although it has been argued that an independent and strong Energy Ministry is crucial to China’s long-term energy security, experts suggest that those with vested interests in the status quo have sufficient influence to thwart such development. Among them are the top three Chinese national oil companies and various government bodies which currently manage the country’s different energy sectors [3]. In balancing the complex relationships involving many ministries and agencies regarding energy and resources, China’s new energy bureaucracy is named the National Energy Administration (NEA). Under the dual leadership of the State Council and the NDRC, NEA does not have full ministry status but is headed by the deputy minister of NDRC with a ministerial ranking, Zhang Guobao. This energy management reshuffle not only expanded the administrative scope of the NEA by absorbing a number of functions from other agencies but is also in the process of setting up nine director-general level bureaus with almost four times the size of the original Energy Bureau personnel under the NDRC [4].

The new functions of the NEA were re-defined in important ways. First, it will take more responsibilities for research on key energy issues and macro-control at the policy level. Second, it will undertake day-to-day supporting duties assigned by the newly established National Energy Commission, a high-level strategic and coordinating body that replaced the National Energy Leadership Group, the latter was established in 2005 headed by Premier Wen Jiabao and was in charge of formulating mid- and long-term national plan for China’s energy development [5]. Third, it will emphasize energy conservation, new energy technology and clean energy development. Fourth, it will take over the management of China’s Strategic Oil Reserves, enhance international energy cooperation, and secure energy supply. Finally, it will participate in domestic energy price reform [6].

Domestic Policy Implications

The most significant sign of NEA’s assertiveness was the publication of a detailed account of China’s new strategic thinking on energy authored by Zhang Guobao, head of the NEA, at the end of 2008. Euphemistically describing the current energy situation as “opportunities” within “crisis” (wei zhong zhi ji), Zhang outlined the challenges and opportunities associated with the global financial crisis [7].

Zhang identified the symptoms of the crisis as the decreasing demand in the energy sector, such as oil and coal; declining prices of oil, coal and related products; and the deterioration of operating conditions of energy enterprises such as electricity generation, petro-chemical and coal plants. These new developments, as conditioned by the international financial crisis, demand new thinking and new adjustments. And Zhang clearly sees more opportunities as he elaborated how China will proceed with a series of new energy policy measures.

First, China’s energy strategy will be in concert with the broader $600 billion stimulus package that Beijing had already announced. This means boosting domestic demand and further building up China’s energy infrastructure: three new nuclear power plants ($17.5 billion), the second West-East gas pipeline of 5,300 kilometers (km) and related projects ($44 billion), plus a range of other coal, electricity generating and transmission projects.

Second, China will speed up the re-structuring of its energy mix: expanding large electricity generating plants while reducing the number of small ones; re-organizing coal mining by focusing on 13 large national coal mining areas with large-scale, modernized operations; increasing the share of electricity generated from nuclear power plants; putting more resources into the renewable energy development; and encouraging the development of large energy enterprises.

Third, China sees the lower energy and commodity prices of late as providing breathing space for the much-needed but complicated on-and-off domestic product oil price reform. Despite the fluctuations of oil prices, the government seems committed to an “indirect and controlled connection” between domestic and international product oil prices.

Finally, China is likely to take advantage of the low oil prices not only for importing more oil but also for filling up its strategic petroleum reserves (SPR), a task that was delayed by the persistence of high energy prices in recent years. Zhang indicated that China’s first phase of SPR, already in place, has a stockpile capacity of about 100 million barrels of oil, and the second phase now under construction will accommodate 170 million barrels (Huanqiu Shibao, January 8).

Reuters reported that China was filling nearly 40 percent of its third strategic reserve base of SPR Phase I in Huangdao in the last two months of 2008, with more filling expected for January 2009. State-owned Sinopec and PetroChina have also been stockpiling their commercial reserves as well (Reuters, December 29, 2008; January 12). But statistics released by the Chinese customs show that in both November and December, Chinese imports of oil decreased substantially (Caijing, January 15).

There is no official confirmation that the first phase of stockpiling has been completed but as current regulation stands, it would still only meet less than 30 days of China’s need in case of an import cutoff. In contrast, the United States and most Western major economies have up to three months of reserve storage. There are also doubts on the wisdom of rushing to stockpile more oil. Zhou Dadi, former director-general of NDRC’s Energy Research Institute, agues that there is no consensus on what should be the right amount of SPR a country should hold. As the cost of storage is high and the utility is low, China may not need to have a huge SPR (Caijing, December 26, 2008).

Impact on Go-out Strategy

Speculation that China’s move to stockpile more oil for its SPR may drive up oil prices have not materialized. In fact, the U.S. Department of Energy also announced in early January the addition of 12 million barrels to its own SPR due to low oil prices, and so far the market has not responded with any clear trend either [8].

China is also working hard on a number of pipeline projects that began last year. China and Russia reached an agreement last year that a Russian oil pipeline will be built to China’s Northeast. But most notable is the beginning of the construction in July 2008 of a natural gas pipeline starting at the border of Turkmenistan and Uzbekistan, running through Uzbekistan and Kazakhstan, and finally connecting with China’s second phase of West-East Pipeline in the Northwestern Xinjiang Autonomous Region. This ambitious project has gone through multi-year, multi-country negotiations with large Chinese investments. The first component is the 1,818-km, $7.3-billion pipeline outside China, in Uzbekistan and Kazakhstan; the second is a natural gas production sharing agreement that will satisfy part of the pipeline’s capacity; and the third part is a second West-East gas pipeline inside China [9].

This project is important to China’s overall energy strategy in many ways. First, it will increase the share of natural gas in China’s overall energy mix (currently at 2.8 percent in contrast to the global average of 23 percent). Second, it will reduce China’s growing dependency on the Mideast and African energy imports (currently at over 80 percent) [10]. Third, the use of natural gas will decrease the use of coal, thus reducing the country’s overall greenhouse gas emissions.

What is less clear is how Chinese energy companies will re-adjust their acquisition activities in other parts of the world given that they, like other companies, have all been caught off guard by the sharp decrease in oil prices in recent months. The dilemma facing both the Chinese energy policy makers and large Chinese oil companies today is exemplified by Sinopec’s recent purchase of Tanganyika Oil, a Canadian company with its main assets in Syrian oil blocks [11].

When Sinopec International Petroleum Exploration and Production Corporation, through its wholly owned Mirror Lake Oil and Gas Company Limited, offered RMB $2.5 billion  ($2.1 billion) to acquire Tanganyika Oil last September, the oil price was hovering around $90 per barrel. But by December, the price had dropped to about $40. Yet there was no revision of the deal and both the State Council and NDRC went ahead with the required government approval (Wall Street Journal [Chinese edition], December 22, 2008)

Many see such a commitment, especially in the face of large financial losses, as a move for the sake of credibility. Others, one of which being the chairman of China’s State-owned Assets Supervision and Administration commission, question the wisdom of putting so much money abroad without immediate benefits when there is so much need for cash in dealing with the domestic economic downturn (Caijing, December 15, 2008). Yet others, represented by China Petroleum and Chemical Industry Association, view the purchase as a healthy long-term investment in the expectation that the oil price will go back up again in the near future. The latter camp seems to have the upper hand. Only days after the Tanganyika acquisition, Sinopec reportedly offered $130 million to Urals Energy, a London-listed oil-producing company with a Russia focus. The price tag is supposed to be five times higher than the firm’s market value, and the news also generated a 100 percent increase in the shares of Urals Energy (China Daily, December 28, 2008).

Nevertheless, such debates demonstrate that China’s energy policymaking process is far from being a monolithic bloc. Chinese officials, business leaders and their foreign counterparts are all exploring the implications of China’s “go-out” strategy at the moment of economic crisis and oil price uncertainty [12].

Notes

1. “China Sees 1st Annual Growth Slowdown in Forex Reserve in 10 Years,” China Daily, January 13, 2009; “China to be the world’s second largest oil consumer,” China Chemical Reporter, November 26, 2003.
2. Noureddine Berrah, Fei Feng, Roland Priddle and Leiping Wang, Sustainable Energy in China: The Closing Window of Opportunity, Washington D.C.: World Bank, 2007.
3. “New China Energy Ministry Unlikely in 2008,” Platts Oilgram News, February 1, 2008.
4. Jing Fu, “Energy Management Reshuffle Starts,” China Daily, July 7, 2008.
5. “China Sets up National Energy Leading Group,” People’s Daily, June 4, 2005.
6. Author’s interviews in Beijing, November 2008. See also, Tong Chunhui, “Guojia Nengyuan Ju ‘Sanding’ Fangan Gongbu, Yi Xinmianmao Yidui Xinxingshi” (National Energy Administration’s “three assignments” made public: Facing new situation with new setup), http://www.china5e.net/www/dev/newsinfo/newsview/viewnews-200807310054.html.
7. Zhang Guobao, “Dangqian de Nengyuan Xingshi: “Wei” Zhong zhi “Ji” (The current energy situation: “Opportunities” within “crisis”), The People’s Daily, December 29, 2008.
8. “U.S. DOE to Restart Purchasing SPR Oil in 2009,” Reuters, January 2, 2009.
9. Wang Zhen, “China-Central Asian Pipeline: Implications for China’s Energy Security,” Geopolitics of Energy, August-September 2008.
10. Author’s own calculation based on data from Chinese Customs.
11. “Sinopec Buys out Canadian Oil Company,” China Daily, December 26, 2008.
12. Based on the author’s observations as the organizer of the 4th Canada-China Energy and Environment Forum in Beijing in November 2008. And the author’s surveys of Chinese press, interviews with Chinese officials and business leaders in the past few months.