China’s Strategic Petroleum Reserves in Sino-Venezuela Relations

After inviting two Russian strategic bombers capable of carrying nuclear weapons to land in Caracas as part of a joint military maneuver—whose significance was downplayed by the Russian authorities—Caracas expelled U.S. Ambassador Patrick Duddy on September 11. Venezuelan President Hugo Chavez has since embarked on a whirlwind diplomatic tour that took him to Beijing and also includes stops in Moscow and Havana, with the obvious intent to throw salt in Washington’s eyes by cozying up to U.S. competitors and adversaries. After holding talks with his Chinese counterpart Hu Jintao in Beijing on September 25, 2008, Chavez told journalists that he was committed to further strengthening Venezuela’s energy cooperation with China. Apart from tripling Venezuela’s oil exports to China to one million barrels a day by 2012, other plans include joint projects to build three oil refineries in China capable of processing Venezuela’s heavy and sulphur-laden crude oil, the construction of four oil tankers, and even a military contract for the purchase of 24 K-8 aircraft from China in 2009. Though Chavez claimed that Venezuela would not immediately suspend crude exports to the United States on increased supplies to China, closer Sino-Venezuelan ties sweetened by military deals is a cause for legitimate security concern from Washington (International Herald Tribune, September 10; September 23; BBC News, September 25; Press TV, September 25).

China’s Energy Cooperation with Venezuela in Sino-U.S. Relations

China’s thirst for oil and resources fuelled by the country’s breakneck economic growth has been the primary driver behind its proactive engagement in forging ties with Venezuela and other regimes with troubled relations with the West. Though oil exports had long been an important source of the Chinese government’s revenue since Beijing began exporting its crude to Japan, the Philippines, and Thailand in the wake of the 1973 Arab oil embargo, China eventually lost its long cherished status of energy independence in 1993. Since then, China’s net oil imports including crude and refined petroleum products increased rapidly at an astonishing rate of 22 percent annually, reaching 197 million tonnes (Mt) in 2007. China’s 93 Mt increase in petroleum imports between 2002 and 2007 accounted for 19 percent of world oil trade growth during the same period, and is widely regarded as one of the primary reasons behind the recent oil price spike from around $25/barrell in 2002 to a critical level that has hovered around $100/barrell [1]. With an unprecedented crude output of 3.7 million bbl/d in 2007, China is also the fifth-largest oil producing country in the world. However, China’s domestic crude production could not keep pace with its economic growth. After China overtook Japan as the world’s second largest oil consumer in 2003, China’s nominal GDP grew at 16 percent annually, but its crude production only increased marginally by 2.4 percent on a year-over-year basis. According to the International Energy Agency (IEA), China’s dependence on oil imports will rise from about 50 percent today to near 80 percent in 2030 [2].

While a sustainable world economy requires a steady flow of crude oil, the small absolute value of price elasticity in the global demand for crude oil means that even modest reductions in supply can result in dramatic price shocks, which will lead to adverse economic disruption to net oil-importing countries like China. Not surprisingly, securing oil supply from offshore sources has long become a priority for Chinese policy makers. As Daniel Yergin, chairman of Cambridge Energy Research Associates, observes, “If there was a single overarching principle (for energy security), it was the importance of diversification” [3]. Two years before China’s crude imports reliance on the politically unstable Middle East peaked at an “unacceptable” level of 61 percent in 1998, CNPC won the tender for the “Block 1/2/4” project in Sudan. In 1997, CNPC acquired 100 percent holding of the Intercampo Oilfield on Maracaibo Lake and the Caracoles Oilfield in the East Venezuela Basin [4]. These two single events highlighted both Beijing’s desire of diversifying its oil supply and the beginning of China’s aggressive oil diplomacy.

China’s heavy reliance on oil imports has made China vulnerable as other industrialized nations to oil supply disruption. Being a net oil-importer should, in principle, bring China’s national interests closer to those of the oil-dependent West. However, in practice, China has so far acted as a pariah courting major oil producers for exclusive rights to supplies while defying economic sense. Beijing’s political and monetary support that include military sales to Sudan, Angola, Iran and Venezuela has especially undermined the West’s agenda of pressing these regimes for political changes, thus attracted criticism from the West. Meanwhile, though China has reaped short-term benefits by defying the West’s sanctions on countries like Sudan and Iran, Beijing’s uncoordinated oil diplomacy nevertheless has increased geopolitical risks to the long term stability of the world oil market, which may contradict with its long-term interest as a net oil-importer.

China and the West largely played a zero-sum game in their oil diplomacy during the decade. For instance, no matter how Iran’s nuclear threat and the Darfur Crisis are perceived by the West, China always chooses to stick to its economic bottom line. In comparison, a number of events—such as the British Gas group’s existing partners’ (all established international oil companies) decision to exercise their rights to pre-empt CNOOC and Sinopec’s bid for the North Caspian Sea Project in 2003, the U.S. Congress’ vehement intervention on CNOOC’s unsuccessful Unocal acquisition in 2005, Chinese national oil companies’ failure to access Canada’s vast oil sands resources partially due to the Canadian government’s indifference in terms of diversifying its oil demand—have reinforced the mistrust between China and the West. Not surprisingly, a deeply insecure Beijing has tried every available method to improve its energy security including the establishment of a strategic petroleum reserve (SPR).

China’s Strategic Petroleum Reserves

Strategic Petroleum Reserves (SPR) are quantities of crude oil or petroleum products held either to facilitate draw-downs to reduce the economic impacts of crude oil supply disruptions or to deter purposeful reductions in crude oil supply for political ends. According to an official from the State Development and Reform Commission (SDRC), the development of China’s SPRs is based on a three-phase schedule: about 10 to 12 million tonnes for phase one, and 28 Mt for both phase two and three [5]. Though the preparation and evaluation for China’s SPRs began as early as 1993, the official approval of the establishment of the SPRs did not pass through China’s largely ineffective bureaucratic energy decision-making process until March 2004. The first phase includes four stockpiling facilities at Zhenhai (Ningbo), Aoshan (Zhoushan), Xingang (Dalian) and Huangdao (Qingdao). A combined storage capacity of 103 million barrels has been developed: Zhenhai by Sinopec; with 33 million bbl; Aoshan by Sinochem, 31 million bbl; Xingang by PetroChina, 19 million bbl; and Huangdao by Sinopec, 20 million bbl (Reuters News, April 2, 2007).

The IEA set a stock requirement for its members based on levels of imports. Specifically, each country is required to hold petroleum stocks, exclusive of military stocks and oil in transit at sea, equivalent to 90 days of net petroleum imports. After China’s remaining three stockpile bases in phase one were completed between 2007 and 2008, the storage capacity of China’s SPRs represents an equivalent to 24.7 days of China’s net oil imports in 2007 (or 12.6 days of China’s oil consumption in 2007). Coupled with industrial stocks, China’s total oil reserves would allow the country to operate as usual for more than two months without oil imports (or more than one month of China’s oil consumption). Moreover, 28 Mt of storage capacity is planned to be added both by and beyond 2010 under the second and third phases. According to the IEA’s projection, China’s net oil imports will rise sharply from 3.7 million bbl/d in 2007 to 7.1 million bbl/d in 2015 and 13.1million bbl/d in 2030. If so, the total capacity of China’s three-phase SPRs could only cover slightly over 70 days of China’s net oil imports in 2015. Nevertheless, the ultimate aim of China’s SPR plan is to meet the IEA standard, and Beijing is using a hybrid approach to establish its SPRs—while the government and state energy companies shoulder one-third and two-thirds of the financial burden to build the public SPRs, respectively. The industry also needs to meet the shortfall between the three-month net-imports criteria and the public oil stock, though much remains to be done in defining public, quasi-public and quasi-private roles in establishing and maintaining the oil reserves.

Due to its potential impact on the world oil market, the filling schedule of China’s SPRs has caught the attention of the international community. On October 10, 2006, the stockpiling of 3 million bbls of Urals oil from Russia to the Zhenhai base marked the beginning of a massive SPR buildup in China (Shanghai Securities News, October 11, 2006). However, apart from sporadic anecdotes like this, the lack of transparency is the main characteristic of China’s SPR filling strategy. To build a stock to meet the IEA standard by 2015, China needs to import 220 thousand bbl/d of crude oil, which translates into 0.24 percent of world crude output between 2007 and 2015. If China is willing to build up its SPRs at a longer time framework, meeting China’s SPRs requirement by 2030 only represents 0.14 percent of world crude output during the same period. Given the relatively small percentage of China’s SPRs to the world oil output, an appropriately designed and transparent filling schedule could minimize impacts of China’s SPRs on the international oil market, especially considering Beijing’s close ties with major oil-producing countries.

Similar to oil-importing countries, major oil-producing nations also need to observe the overarching principle of diversification. Given the enormous potential of China’s oil demand in terms of the scale of its economic growth, many oil-producing nations are keen to maintain close ties with Beijing, which explains why Saudi Arabia, Iran, Kuwait and Venezuela have all shown strong interest to help China fill its SPRs. Saudi Arabia, the swing producer of the Organization of Petroleum Exporting Countries (OPEC), so far possesses the greatest potential of producing significant amounts above its OPEC quota to fill Beijing’s SPRs without disrupting the market. If Riyadh supplies an extra one million barrels per day for Beijing, it would only take less than two years to build up enough of a reserve to last China three months by 2015. To minimize market speculation, China should rely primarily on Riyadh or other oil-exporting countries’ spare capacity to fill its SPRs with long-term contracts. Unfortunately, even after the State Oil Reserve Office was created under the former Energy Bureau of NDRC on December 18, 2007, there was no sign that China has adopted such a strategy. To make matters worse, Beijing currently holds a strange view that filling SPRs with domestic supply or oil obtained from state oil companies’ overseas production sharing contracts could alleviate the impacts of China’s rising demand on the international market. Based on such an assumption, on December 6, 2006, Xu Dingming, deputy director of the former National Energy Leading Group Office at NDRC revealed that China had already started to fill the Zhenhai base with oil primarily from the domestic sources, which was widely regarded by policy analysts in Beijing that China will largely use domestic oil to fill its SPRs (Xinhua Net, December 8, 2006). However, as it is the volume of China’s net oil imports that really matters, sending contradictory signals can not achieve the intended goal of calming down market speculation, which is evident by the continuous oil price spike since then.

Sino-West Energy Relations at a Crossroads

In the past, Sino-West energy relations have been tainted by mistrust. As a result, the level of coordination between China and members of the IEA in the international oil market is significantly lower than it otherwise should be. As China quickly gains international political clout through multilevel engagement with third-country suppliers, continuing hostility toward China is unconstructive and may backfire sooner or later. Therefore, engaging China should serve the interests of the international community better; one good example is the IEA’s continuous dialogue with China on energy-related issues. Given the common interest of both as an oil importer, much could be done to coordinate China and the West’s moves in the international oil market. Therefore, admitting China into the IEA is an idea which warrants serious deliberation.

When China first decided to establish its SPRs in 2004, the economic assessment was based on a world oil prices of $30 – $40/bbl, with the underlying political driver of a potential conflict with the United States over the Taiwan Strait. However, after world oil prices skyrocketed to a level above $100/bbl, the economic net cost-benefit of developing China’s SPRs became increasingly unbearable. Moreover, after Taiwanese President Ma Ying-jeou’s victory at the polls in March 2008, ending 8 years of pro-independence Democratic Progressive Party rule, the danger of a Sino-U.S. military clash over the Taiwan Strait has diminished for the near future. Since there is no endogenous solution for China to fix its vulnerability toward oil supply disruption, this is an opportune time for the West to explore Chinese membership in the IEA in exchange for Beijing’s positive political and economic compliance to international norms. Currently, Chinese admission to the IEA faces several roadblocks, chiefly the prerequisite of Organization for Economic Cooperation and Development membership and the requirement of a three-month oil stockpile [6]. However, with China looming ever larger as a petroleum consumer and importer, if Beijing is not brought into the fold of major oil importing countries, its pariah-style responses in an energy crisis could potentially disrupt the coordination efforts of the major Western powers.

As an emerging power in an increasingly multi-polar world, China’s economic stakes—which are critical for regime security—may be best served if it maintains the condition of assisting the West in preserving world order when necessary, while keeping the United States at arms length and avoiding direct conflict over access to oil. Furthermore, with sufficient economic and political incentives such as a special status in the IEA, the West may open a window of opportunity to shape China to Western oil-importing countries’ advantage. Continuous engagement with Beijing is likely to foster cooperative Sino-Western energy relations in the years to come; otherwise, a deeply insecure China may form much closer strategic ties with whichever country offers it oil.

Notes

1. China Customs, various years; BP Statistical Review of World Energy June 2008.

2. National Bureau of Statistics of China, various years; World Energy Outlook 2007: China and India Insights.

3. Daniel Yergin, “What Does ‘Energy Security’ Really Mean?” Wall Street Journal, July 11, 2006.

4. China Customs; CNPC corporate website at https://www.cnpc.com.cn/eng/cnpcworldwide.

5. https://www.dayawan.gov.cn/xdocweb/eip/display.asp?articleid=5128.

6. Flynt Leverett and Jeffrey Bader, Managing China-U.S. Energy Competition in the Middle East. The Washington Quarterly, Winter 2005-06, pp. 187–201.