Global Policy Forum

China's Demand for Energy is Reshaping


By Adam Wolfe

Power and Interest News Report
February 25, 2004

China's Gross Domestic Product rose at a rate of 9.1 percent in 2003, and surpassed Japan to become the world's second-largest oil importer after the United States. Domestic energy production is rapidly expanding, but China continues to rely on imported fuel to keep its economy growing. The expectation that China will continue to demand more and more oil from foreign countries is beginning to reshape the relationships between oil producing countries, and has even had an effect on the U.S.' "war on terrorism."

China plans to spend 200 billion yuan, or U.S. $24.2 billion, this year to build power plants that generate three times the electricity used by New York City in an effort to prevent blackouts. The rapid ascent of China's economy has happened on the back of an outdated and chronically failing power grid and production system. China is now faced with the daunting task of repairing the current system and expanding production to accommodate future growth, all while privatizing industries that are currently state controlled monopolies -- cooperating with large multinational companies such as General Motors and SVA Group. Demand for electricity is expected to expand 11 percent this year.

The seemingly endless demand for energy has persuaded China to focus much of its attention on finding foreign sources of oil and gas. China sits on major deposits of coal, but the government is trying to move towards cleaner burning sources of energy for environmental and health concerns. Chinese crude oil imports rose by 31 percent in 2003, at an increased cost of 55 percent. The higher prices that Beijing was forced to pay last year have helped to focus China's efforts on establishing a reliable and steady source of oil.

China had hoped to build a pipeline from Russia in order to avoid the cost of shipping the oil through the Black Sea, but Russia's prosecution of the Yukos Oil Company has stymied this effort. The deal seems to have been put on the back burner until the circumstances of Mikhal Khodorovsky's arrest are straightened out; in the meantime, China has acquiesced to an agreement in which oil will be shipped from Russia to China via rail. This is a less attractive deal for the Chinese because the fixed costs of shipping by train are higher than a pipeline; also, Russia will be able to maintain greater control over shipments under the agreement. Beijing will continue to pressure Moscow to allow the building of a pipeline into China; how Moscow reacts will in large part be dictated by forces in the Middle East.

As the Northern Hemisphere eases out of winter, demand for oil and gas falls. In this situation China's purchasing power increases. China prefers to purchase its oil from Russia because even though the shipping route is twice as long as the route from the Middle East, the cost of Russian crude oil is still below the market price of OPEC. This has helped to draw down the prices of Middle Eastern oil, and those countries have begun to seek ways to prevent any more slippage in price.

Russia and Saudi Arabia are jockeying for position as the global leader in crude oil exports, with each country hovering around 8 million barrels per day. The importance of oil to each country's economy has forced the leaders to change their diplomatic strategies in reaction to China's demand for energy. Because China's need for oil is so great, neither country is interested in pursuing an aggressive strategy to weaken the other. A Brunswick UBS analyst, a leading bank in Russia, sums up the situation: "We believe that growing demand far in excess of Russian production offers the most realistic and probable outcome that would alleviate OPEC of the need to confront Russia dramatically, although the risk is present."

As long as the Chinese economy continues to expand, Russia will persist on working with the Middle Eastern producers, but Russia has not forgotten the lessons of 1985 when the Saudis used excess production capacity to drive down oil prices to $12 a barrel, which wrecked any hopes of a Soviet survival. Russia is demanding far more for its cooperation with OPEC during this cycle of increased demand.

In September 2003, Crown Prince Abdullah bin Abdul Aziz of Saudi Arabia visited Russia and signed a five-year cooperation agreement. Then, in January 2004, Akhmad Kayrov, the pro-Moscow president of Chechnya, visited Riyadh. The Saudis agreed to halt all funding for Islamic rebels in Chechnya and recognize his government. These major concessions will have a huge impact on global affairs. Greater cooperation between the two largest suppliers of crude oil will leave producing countries in a better position to keep prices at higher levels, which will affect the bottom line of nearly every industry in practically every country. Saudi Arabia's recognition of the Chechnya government has made it a target for Islamic militants and will only stoke the fire that keeps al-Qaeda and similar organizations full of willing recruits.

China's economic rise has already begun to reshape the world in many ways, but perhaps its greatest effect will be on the global market for energy supplies. While Asia purchases nine out of ten barrels of oil from the Middle East, China has actively pursued Russia as its major supplier. As the purchasing power of China increases, this simple act of pursing oil at the best price available will reshape the global energy market; every industry and every country that relies on foreign fuel supplies will feel the effects.

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