The Iraq Energy Factor in Sino-Japanese Relations

Iraq could soon emerge as an important new focal point of intensifying Chinese and Japanese commercial diplomacy and energy rivalry, in spite of their extensive overlapping interests and mutually beneficial economic ties. It is difficult to determine whether friction over energy-related matters is a symptom or an additional cause of the strained relationship between China and Japan. What is indisputable, however, is that these energy concerns have become foreign policy priorities in both Beijing and Tokyo, spurred by the debate over “peak oil,” the spike in world oil prices and heightened concerns about possible supply disruptions. Chinese and Japanese anxiety about energy insecurity stems from the predicament that they face in common, namely, exceedingly high degrees of energy import dependence.

Energy Insecurity

Even though Japan has reduced its oil dependence by a third since the 1970s, it remains the world’s third largest consumer of oil as well as the world’s largest importer of liquefied natural gas (LNG), accounting for 40 percent of total world imports. While its energy consumption growth is expected to plateau, Japan will continue to import vast quantities of oil and gas. China, which has now become the world’s second largest consumer of oil, imports about 3 million barrels of oil per day (bpd), or roughly 50 percent of its total consumption. In 2006, China’s oil imports grew 14.5 percent over the previous year, and the International Energy Agency estimates that China’s petroleum imports are likely to rise fourfold from 2003 to 2030 (Xinhua, January 12; International Energy Outlook, 2006). China’s imports of LNG, which began in 2006, are expected to grow rapidly as well. It is therefore not surprising that securing stable energy supplies from overseas has become a major preoccupation for Chinese and Japanese policymakers alike.

Such a dependence upon energy imports, coupled with energy price and supply volatility as well as high geopolitical risk, has sparked a debate about energy security in China as well as in Japan. On one side are analysts and strategists in both countries who view oil and gas as strategic goods, regard the current circumstances as permanent and therefore view energy competition in zero-sum terms, arguing for more active government intervention. On the other side are those who continue to view energy resources as commodities and confidently assert that market forces will balance supply and demand. In Beijing and in Tokyo, however, it appears that those who are mistrustful of market forces have gained the upper hand, if only temporarily.

In Japan, of course, this debate is hardly new. The 1970s oil shocks led the Japanese government to undertake a number of measures to reduce its energy vulnerability. What has changed and is new is the Asian energy and geopolitical landscape, marked especially by the rise of China. Since 1993, China has been a net oil importer, and unlike in the past, it is now a major force in regional and global economies, with an increasingly sophisticated and proactive diplomatic apparatus and advancing military capabilities.

The additional concern in Japan is that China has shifted in the direction of resource nationalism—a concern that is hardly unfounded. Beijing is actively using state-owned oil companies to buy or invest in energy assets in Russia and other resource-rich countries in Central Asia, Latin America and Africa. Japan’s concerns about the impact of Chinese resource nationalism upon its own energy security are manifested not just in discourse, but also in its policies. A report issued by the Japan External Trade Organization (JETRO) in 2005 warned of intensifying global competition for oil and gas. Japan’s New National Energy Strategy document, promulgated in May 2006, expressed worry about “market disturbance factors.” The strategy called for, among other things, increasing the proportion of “Hinomaru oil” (i.e. oil developed and produced by domestic companies) from 15 percent to 40 percent of total imports by 2030. These concerns have thus caused Japan to follow China into the ranks of those countries that have shifted away from open markets and toward increased government intervention.

To be certain, the hunt for energy resources was a source of tension in Sino-Japanese relations even before this shift in emphasis toward greater state control over upstream resources by China and Japan. Two notable examples are the dispute in the East China Sea over the Shirakaba/Chunxiao gas field and the contending claims to the Senkaku/Diaoyutai Islands. Both countries have also been competing head to head over the untapped East Siberian oil fields—a rivalry that Russia has sought to exploit for its own purposes.

The Iraq Energy Factor

Both China and Japan rely heavily upon Middle Eastern oil, with the former drawing 40 percent of its oil imports from the region (and this figure is expected to significantly rise in the coming years) and the latter, 90 percent. Yet Iraq’s oil reserves, the third largest in the world, have been relatively untouched by either country for the past decade and a half. Following the 1991 Gulf War and the sanctions imposed by the UN Security Council that prohibited foreign companies from investing in Iraq’s energy sector, neither China nor Japan was a leading export destination for Iraqi oil. While China’s oil majors did not contravene these sanctions, Beijing was an advocate of lifting these sanctions and Chinese firms were involved in the high-stakes bargaining for “pre-contracts” on the future development of Iraqi fields that took place in the late 1990s. In fact, Beijing initiated the drive to explore and develop overseas oil and gas fields at virtually the same time that Saddam Hussein embarked on an energy diplomacy campaign in 1997 aimed at undermining the UN sanctions regime.

By the time that the U.S.-led coalition launched “Operation Iraqi Freedom,” Iraq contributed less than one percent of China’s total oil imports. Indeed, all Chinese business activities in Iraq came to a standstill. Following the invasion, Beijing pledged $25 million in reconstruction assistance and agreed to cancel a portion of Iraq’s multi-billion dollar debt as a humanitarian gesture. In February 2004, ZTE, China’s largest telecommunications supplier, became the first Chinese company to win a reconstruction contract. The Chinese embassy in Baghdad reopened four months later. For the next two years, however, Sino-Iraqi energy cooperation was limited to oil trade and the training of Iraqi personnel (China Brief, May 24, 2005).

Tokyo’s support for the U.S.-led invasion was no doubt aimed, at least in part, at reestablishing Japan’s presence in Iraq. Japan deployed nearly 1,000 troops to assist the U.S.-led operation, cancelled 80 percent of Iraqi debt and pledged and disbursed $1.5 billion in grant aid. In 2003, Mitsubishi signed a contract to purchase oil from Iraq’s State Oil Marketing Organization. For the most part, though, Japanese firms such as Arabian Oil Company and Japan Petroleum Exploration Company (JAPEX) have limited their involvement to providing technical assistance to the Iraqi Oil Ministry.

Yet over the past several months, the competition for access to the Iraqi energy sector seems to have intensified. While Iraq is still plagued by violence and the country’s energy infrastructure continues to suffer from frequent acts of sabotage, Chinese and Japanese companies have reportedly begun maneuvering to expand and secure their respective stakes in Iraq’s future energy development. At the same time, Iraqi authorities have been aggressively wooing them in hopes of attracting new foreign investment in the country’s energy sector.

When Iraq Oil Minister Hussain al-Shahristani embarked on an Asia-Pacific tour last October, both China and Japan were, unsurprisingly, on his three-country itinerary (Asia Times, November 7, 2006). During his visit to China, the Iraqi delegation briefed Chinese energy officials and companies on the possibility of reviving the Ahdab oil field deal (AFP, October 28, 2006). While in Japan, the Iraqi delegation obtained a pledge by Tokyo to train 1,000 Iraqi petroleum engineers in the next two years and to consider financing three oil and gas projects. Iraq and Japan also agreed to set up a joint steering committee to coordinate bilateral energy-related projects (Kyodo News, December 6, 2006; Alexander’s Gas & Oil Connections, December, 2005).

While these developments seem to suggest that China and Japan are preparing to stampede into Iraq and are fiercely vying with each other to lock in a privileged relationship with Baghdad, there is little evidence that this is in fact the case. To the contrary, the initiative has come almost entirely from Iraq, which is desperately in need of foreign technical assistance and investment in order to invigorate its energy sector.

Until now, attacks by insurgents on foreign contractors and oil pipelines have kept Japanese companies from Iraq, even though recent setbacks suffered elsewhere have created some pressure for them to dive into Iraq in spite of these risks [1]. Japanese companies are reportedly interested in the Gharraf, Tuba and possibly Nassiriyah fields, but have thus far been unwilling to undertake any substantial actions (Asia Times, November 7, 2006). Chinese firms, though regarded generally to be less risk averse than their Japanese counterparts, have also proceeded somewhat cautiously and conservatively in Iraq. The priority for China National Petroleum Company (CNPC), for example, seems to be regaining its development rights (obtained as a $700 million pre-contract in 1997) to the Ahdab field, a medium-sized oil field (far smaller than Bin Umar, Majnoon, Nassiriyah and Ratawi) that is located in close proximity to pipelines and refineries (Reuters, September 28, 2006). Rumors of an imminent breakthrough on the development rights have surfaced from time to time, though negotiations continue. Iraqi officials have reportedly also invited Sinopec to build refineries; however, no specific proposals have been made (Alexander’s Oil & Gas Connections, October 28, 2006).

Renewed Interest—Changing Fortunes?

It is possible, perhaps even likely, that if and when the final version of Iraq’s oil law is passed, Iraqi authorities will offer preferential access to Chinese and Japanese companies in exchange for generous infrastructure financing schemes, development aid, low-interest loans and export and investment credits. Beijing and Tokyo would be hard pressed to demur. Under such a scenario, it is conceivable that China and Japan will soon be bidding directly against each other for energy development deals in Iraq. Yet, if this were to occur, the costs and risks might prove greater than the rewards. Ownership does not ensure price or supply, and projects in Iraq might be nationalized, as they have been in Russia. Indeed, the investment experiences of the Japan National Oil Corporation (JNOC) in the 1980s were not encouraging. Most projects operated at a loss and, overall, contributed little to the flow of oil. Worse, a race between China and Japan for ownership or preferential terms in Iraq—if it were to occur—could create a spiral of misperception and insecurity.

Paradoxically, by avoiding risk in Iraq, China and Japan could find themselves vying more intensely with each other elsewhere. A further decline in the global market price of oil might alleviate, if only temporarily, some of the anxiety over their energy insecurity and mistrust of one another. The overall climate of Sino-Japanese relations is nevertheless bound to condition and be conditioned by their respective dealings with Iraq, its neighbors and other energy suppliers for many years to come.

Notes

1. In 2000, Japan’s Arabian Oil Company lost its concession rights, which it had held since 1957, to the Khafji oil field in the Saudi-Kuwaiti Neutral Zone. In 2006, Japan’s Inpex Corporation agreed to renounce its status as the operator of the Azadegan oil field in Iran and to have its stake reduced from 75 percent to 10 percent.