Mission Mostly Accomplished: China’s Energy Trade and Investment Along the Silk Road Economic Belt

Chinese President Xi Jinping’s efforts to build the Silk Road Economic Belt (SREB)—a network of transportation infrastructure across Eurasia—are unlikely to drive a step change in China’s energy trade with and investment in Central Asia. This is not only because of the already robust energy linkages developed over the past two decades, but also because a primary objective of the SREB is not to increase China’s imports of energy and other goods. Rather, the SREB is intended to spur the export of excess capacity in industries hurt by China’s economic slowdown. That said, the SREB will reinforce the geopolitical logic that underpins China–Central Asia energy trade. Moreover, the SREB is likely to encourage China’s national oil companies (NOCs), especially China National Petroleum Corporation (CNPC), to make more investments in Central Asia. This is because the high priority the Xi administration attaches to developing the SREB makes it a politically safer destination for China’s NOCs to step up their international mergers and acquisitions after a year of largely sitting on the sidelines due to the ongoing anti-corruption campaign.

China’s Interest in Central Asian Energy Predates SREB

Nearly twenty years before President Xi proposed the creation of the Silk Road Economic Belt in Astana, Kazakhstan, in September 2013, CNPC made its first foray into Kazakhstan in search of upstream assets. The company had initially set its sights on Russia because of the country’s abundant oil and natural gas resources and the experiences of CNPC executives, including former president Wang Tao, studying there. However, after having its efforts to enter the Russian upstream sector rebuffed, CNPC turned its attention to Kazakhstan. In 1996, the company made a bid for Uzen, one of Kazakhstan’s largest oil fields, where production had plummeted from 340,000 barrels per day (b/d) to around 4,000 b/d, after Russia withdrew personnel and capital following the collapse of the Soviet Union. CNPC assessed that it could raise production using its own technology and drawing on its experiences at China’s Daqing oil field due to some geological similarities between the two fields. One condition of CNPC’s winning bid was the construction of an oil pipeline from Kazakhstan to China, which CNPC’s then–vice president, Wu Yaowen, had promised to build during pre-bid negotiations. However, China’s State Council did not approve the pipeline proposal. Although the government of Kazakhstan subsequently decided not to privatize Uzen and CNPC lost its $500 million signing bonus, the experience paved the way for the company’s subsequent expansion in Kazakhstan and neighboring states in Central Asia (Energy of China, December 2014).

Over the next two decades, CNPC established itself as a dominant foreign producer in Kazakhstan and the dominant foreign company in Turkmenistan. CNPC currently accounts for about one quarter of Kazakhstan’s oil output (International Oil Daily, December 16, 2014). Meanwhile, the 600,000 barrels of oil equivalent per day (boe/d) that CNPC pumped in Kazakhstan in 2013 accounted for one quarter of the company’s overseas production of 2.46 million boe/d in that year (International Oil Daily, January 20, 2014). CNPC occupies a more privileged position in Turkmenistan, where it is the only foreign company to have been awarded an onshore production-sharing contract (at Bagtyyarlyk). In addition, CNPC currently has a technical services agreement to help develop Galknysh, the world’s second largest natural gas field.

More than a decade before President Xi spoke of how he could practically hear the camel bells and see the smoke in the desert along the old Silk Road, CNPC started to establish, albeit on a small scale, the type of continental connectivity that the SREB envisions through the construction of oil and natural gas pipelines (Xinhua, September 22, 2013). The first project, put into operation in 2005, was the Kazakhstan-China oil pipeline, for which CNPC dusted off its earlier plan and that, this time around, received a green light from the State Council. Next was the Trans-Asia Gas Pipeline (TAGP), which stretches from Turkmenistan to China (via Uzbekistan and Kazakhstan) and began deliveries in 2009. The pipelines, especially the TAGP, have played a role in deepening economic linkages in one of the least economically integrated regions in the world.

The Silk Road Economic Belt Will Reinforce the Geopolitical Logic of China-Central Asia Energy Relations

A strong geopolitical logic underpins both projects, which were built when Beijing was much more anxious about energy supply security than it is today. During the mid-2000s, China’s energy demand grew much faster than most people inside and outside of China had projected, and China found itself increasingly dependent on a global oil market that officials did not fully trust or understand as well as they do today. Pipelines were—and still are—viewed in Beijing as enhancing China’s security of supply by diversifying not only the countries from which China imports oil and natural gas but also the routes by which those imports reach China (Yangcheng Evening News, September 18, 2014; 21st Century Business Herald, August 31, 2004). While both pipelines have furthered such diversification, the TAGP has contributed more. China’s oil imports from Kazakhstan were less than 26,000 b/d in 2004, the year before the pipeline went into operation. Last year, the pipeline delivered 240,000 b/d to China, accounting for just 4 percent of China’s total crude oil imports. In contrast, China imported 997,000 b/d—19% of its total crude oil imports—from Saudi Arabia (China Customs, January 21). In contrast, Turkmenistan is by far and away China’s largest supplier of natural gas, delivering 44 percent of China’s imports last year (China Customs, January 23).

The pipelines and Chinese upstream investments have also paid geopolitical dividends for Central Asian countries by providing them with an outside power to balance against Russia. Turkmenistan is a case in point, having traded economic dependence on Russia for economic dependence on China. The TAGP has been praised by analysts, including this author, for increasing Turkmenistan’s independence from Russia by providing Ashgabat with a non-Russian outlet for its natural gas exports. But now that Gazprom is reducing its purchases from Turkmenistan—the Russian firm recently announced it would cut its imports from 10 bcm to 4 bcm this year—Turkmenistan is finding its economic fortunes increasingly tied to China (IHS Global Insight Daily Analysis, March 10). Ashgabat is heavily in debt to Beijing thanks to at least $8 billion in natural gas export-backed loans borrowed from China Development Bank since 2009.

The SREB underscores the geopolitical logic of China–Central Asia energy relations by explicitly linking cross-border pipelines and oil and natural gas investments made by Chinese firms to a broader Chinese national strategy aimed at forging tighter economic links between China and the rest of Eurasia. To be sure, the connectivity Beijing seeks to forge with the SREB covers a much larger geographic area and is largely driven by the transportation projects. That said, the oil and gas pipelines linking Central Asia to China are a microcosm of this grander vision. For example, the fourth line of the TAGP, which will run from Turkmenistan through Uzbekistan, Tajikistan and Kyrgyzstan to China upon completion in 2020, is considered part of the SREB, even though the project was conceived before the SREB (Ministry of Foreign Affairs, September 20, 2014; Nefte Compass, March 7, 2013).

The High Priority Xi Attaches to the SREB Provides Political Cover for Investment Along Route

The SREB is also likely to make Central Asia a politically attractive place for CNPC to resume international mergers and acquisitions after a quiet year in 2014. Last year, China’s NOCs largely sat on the sidelines due to the Xi administration’s ongoing anti-corruption campaign, which took down more than two dozen managers at CNPC (see China Brief, January 23). Uncertainty about who might be targeted next paralyzed decision making within CNPC and its domestic peers as management went into self-preservation mode. Indeed, China’s NOCs only closed four major deals last year with a combined value of $5.4 billion, compared to an annual average of $21 billion in 2010–2013. This reluctance to make big international investment decisions has spilled over into this year. CNPC and CNOOC are part of the group of 26 state-owned enterprises currently being inspected by China’s top anti-graft body, the Central Commission for Discipline Inspection. [1] Once the NOCs return to acquiring assets abroad, Central Asia might be viewed as a region where their investments might be less scrutinized for corruption—or even simply failing to maintain or increase the value of state assets—because the NOCs can link their deals to the broader national strategy of building the SREB. Indeed, Chinese oil and natural gas investments in the region so far appear to have escaped being harshly criticized for graft. However, the pace of China’s overseas oil acquisitions will be slower than it was in the past decade and the NOCs will be more selective shoppers due to the deceleration of China’s oil demand growth, decreased profits from lower oil prices and a greater emphasis on returns over growth, in line with the Xi administration’s objective of making China’s state-owned enterprises more efficient.

SREB Focused More on Domestic Excess Capacity, Less on Energy

That said, from Beijing’s perspective, facilitating the import of oil and natural gas is not as high a priority for the SREB as driving the export of aluminum, cement, rolling stock, steel and the products of other industries in which there is excess capacity in China (Securities Daily, January 14). China’s overseas investments are shaped by China’s growth model (Rhodium Group, June 2012). The dominant role that China’s energy and mining companies played in the country’s outbound investments in the 2000s—and the resulting acquisitions of assets and construction of pipelines in Central Asia—were the product of China’s energy-intensive investment and export-led growth model. Today, the drivers of economic growth are shifting toward consumption and efficiency gains. Moreover, China’s economic growth is decelerating. Last year’s GDP growth rate was 7.4 percent—the slowest since 1990—and the Chinese government has set a new target of “around 7.0 percent” for 2015 (Xinhua, March 5). Consequently, there is less anxiety in Beijing about securing energy supplies to fuel rapid economic growth and more concern about finding new markets abroad for companies in industries hard hit by China’s economic slowdown. As a result, Chinese firms involved in building railways, roads and ports are likely to receive more encouragement—both political and financial—for seeking business opportunities along the SREB in Central Asia and beyond.

Notes

1. Sinopec was part of the inspection round that concluded in late December.