China s Energy Issues Increasing Impact on the Global Economy

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1 VOL.1 NO.13 August 26 China s Energy Issues Increasing Impact on the Global Economy China s energy issues have become a global hot topic interest on the issue is rising both domestically and globally. This is because the rapid rise in energy demand under the country s high growth and its aggressive moves to obtain overseas supply combined with the uncertainties on the supply-side reflecting the political instability and rising resource nationalism of oil producing nations is one of the factors that are heightening concerns for global tightening of energy supply and demand. The influx of speculative funds further added to the surge in global oil prices. There has also been a paradigm shift in the view toward energy-related products, in which they are being increasingly viewed as strategic resources concerning national security rather than commodities. These changes in the international energy situation have a large effect on Japan as the world s second largest petroleum importer. This report looks into the current state of China s energy issues and how it is dealing with them. 1 Energy issue calls for government s sense of crisis China is an energy-rich nation as the worlds largest producer of coal and sixth largest in crude oil as of 25. However, in the medium to long term, there is a risk that its supply cannot keep pace with rising demand as standards of living rise further, including the widespread ownership of automobiles. This is leading to the government s growing sense of crisis on the matter. China s primary source of energy is coal, representing 68.7 percent of energy consumption in 25, and has so far been self sufficient in it (Figure 1). Oil consumption only accounts for 21.2 percent. Nonetheless, China s total crude oil consumption exceeded Japan s in 22 and became the world s second largest oil consumer after the United States, despite its economy being only one-third of Japan at the time. The country was already a net oil importer in 1993 and imports jumped to grow at over 3 percent for two straight years in (Figure 2). China s dependency on oil imports (the percentage of net imports in total domestic consumption) increased rapidly, reaching 45 percent by 25. Further dependency is unavoidable as domestic oil production has already hit the ceiling. In addition, around 4 percent of total imports come from the Middle East with strong uncertainties in supply. The 1

2 government has reinforced its recognition on the vulnerability of its energy security and plans to take further steps to address the issue. Figure 1 Energy Consumption in China (M illion tons oil equivalent 1,6 1,4 1,2 1, Source: Compiled by the Economic Research Office, Bank of Tokyo-Mitsubishi UFJ based on CEIC. Hydro power Natural gas Oil Coal (Year Figure 2 Oil Production and Trade in China (Million tons Production of Crude Oil Exports of oil Imports of oil Net exports of oil Notes: Oil consists of crude oil and petroleum products. (Year) Source: Compiled by the Economic Research Office, Bank of Tokyo-Mitsubishi UFJ based on China Custom's Statistics etc. 2 China s full-scale efforts to secure its energy supply 1 State-owned oil companies pursuing foreign oil The Chinese government started efforts to establish a stable, long-term resource supply system as early as the 199s when it first became a net crude oil importer. According to the government's intention, procurement of overseas resources was carried out by the state-owned oil companies which had already been converted from the oil divisions of government agencies. China National Petroleum Corporation (CNPC) was originally responsible for upstream onshore matters (exploration and development), China Petrochemical Corporation (SINOPEC) for downstream onshore matters (refining and processing), and China National Offshore Oil Corporation (CNOOC) for marine exploration and development, each holding both administrative and corporate functions. Through the 1998 reforms, the administrative functions were segregated and each company entered various areas of the business, competing against each other. Still, the companies maintain their competitive edge in their respective roots, and have made their overseas advancements accordingly. CNPC, China s largest oil company, was the first to go abroad by obtaining rights to develop an oil field in Alberta, Canada in 1992 and continues to lead the industry in overseas advancements. CNOOC followed by acquiring a 32.5 percent ownership in the Malacca mining block in Indonesia in 1994, and takes advantage of its strength in marine exploration and development on its pursuits abroad. SINOPEC lagged behind, with its international operations fully starting only from 21, as it originally specialized in downstream and lacked know-how on exploration and development. These three companies now operate in the Middle East, Africa, Central and South America, Southeast Asia, Central Asia/Russia, pursuing over 1 projects combined all together. In the 199s, the Chinese companies used to favor independent exploration of new oil fields, but more recently they have shifted to acquiring rights to existing oil fields. This reflects the oil companies improved financial position, being well funded by profits from rising crude oil prices and their increased ability to raise large amounts of capital by listing 2

3 on overseas stock exchanges. As a result, they are more active in obtaining rights of existing oil fields rather than new oil field exploration rights with higher risk and return, and there have been projects involving billions of dollars. The amount of crude oil supplied from directly-owned oil fields reached million ton in 24, which was 15 percent of total crude oil imported. This already clears the target set in the 1th Five-Year Plan (21-25) of acquiring million tons of overseas equity oil. 2 The achievements of China s resource diplomacy Chinese oil companies have made progress in the ten years since starting their foreign pursuits in the early 9s. Resource diplomacy was a factor that played a major role behind this. Chinese presidents and prime ministers have exchanged visits with oil producing countries in the Middle East, Africa, Central and South America, Asia, and former Soviet nations and have strengthened ties going beyond energy-related matters, establishing comprehensive cooperation which include economic assistance and offering of military weapons. As oil resources are generally state-controlled in most oil-producing countries, strengthening ties with these countries governments is thought to have been highly effective in obtaining rights and upon exploration and development. Resource diplomacy has also contributed to the diversification of oil-supplying countries, and unlike Japan, China has been able to avoid overdependence on Middle Eastern nations (Table 1). Table 1 Oil Exporters to China and Japan 25 Million tons From China Japan Imports Share Imports Share Middle East Africa Asia Pacific Former Soviet Union South & Central America Europe North America Other Total Source: Compiled by the Economic Research Office, Bank of Tokyo-Mitsubishi UFJ based on BP statistics. China continues to actively pursue its resource diplomacy in 26. In January, Saudi Arabia s King Abdullah visited China to meet with President Hu Jintao. In addition to an agreement on oil and natural gas development, four other agreements were signed on strengthening trade relations and enhancing cooperation in culture, science and technology. In April, President Hu Jintao visited Saudi Arabia. Upon his meeting with King Abdullah, the two agreed on increasing crude oil trading volume, and several other agreements were signed including the cooperation between SINOPEC and Saudi Arabian Oil Company (Saudi Aramco) on exploration of oil and natural gas. It is extremely rare for top-level meetings of this rank to be held in such a short period of time. When Russian President Putin visited Beijing in March to meet President Hu Jintao and signed joint cooperative agreements on fifteen areas including the economy, finance, and environment, they stated that energy matters were central to their strategic partnership. The two countries agreed for CNPC and Russia s Gazprom to build a pipeline to bring gas from Siberia to China, and also that CNPC will form a joint venture company with another 3

4 Russian oil company to refine crude oil and sell gasoline and other products. In April, President Hu Jintao flew to Africa following his US-China summit meeting at the White House and met with Nigerian President Obasanjo. While China offered to extend.5 billion dollars of export credit from the Export-Import Bank of China for developing Nigerian infrastructure, it was agreed upon that Nigeria will offer CNPC priority bidding rights to four of the mines to be placed for international bidding in May and that China will purchase the Kaduna refinery. On May 31 and June 1, China invited foreign ministers and representatives from the 22 Arab states and regions to attend a meeting of the China-Arab Cooperation Forum in Beijing. The talks ended with a resolution to hold a China-Arab Oil Cooperation Meeting by 28 and to double the trading volume between the two sides to 1 billion dollars by 21. They also adopted its action plan which includes promotion of building a communication mechanism for energy cooperation issues. 3 Concerns of the global community Being backed by the governments resource diplomacy, Chinese oil companies quickly increased their global presence; so much that recently they are referred to as the Chinese oil majors. While some have given credit to the comprehensive approach of government working hand-in-hand with the state-owned companies, there are some aspects that are alarming other nations. One concern is that Chinese oil companies are intensifying the competition for oil by bidding at prices noticeably higher than others, and driving up the market for oil-related interests. Japan also received such criticism in the past but China s divergence from market rates is far beyond Japan s case. Crude oil prices projected by Chinese oil companies appear to be considerably higher than the 2-3 dollars per barrel rate assumed by Western oil majors. On the other hand, as the paradigm shift continues in which markets increasingly view oil as a strategic resource than as a general commodity, this approach would not seem so illogical especially if crude oil prices continue rising. The next concern is the fact that the countries that China has approached to obtain resources include countries in the Middle East and Africa that have been sanctioned by the US as terrorist-supporting nations or by the UN for threatening international peace and security. For Chinese oil companies which lag behind in exploration technology and know-how, it has been easier to focus on regions where western oil majors hesitate to enter. However, these moves combined with Chinese governments resource diplomacy that involves the offering of military arms have been criticized by the international community for decreasing the effect of the sanctions imposed. Just recently in June, Iran s President Mahmoud Ahmadinejad, currently under mounting international pressure on his country s nuclear programs, made an observer appearance at the annual summit of the Shanghai Cooperation Organization. The meeting commemorated the fifth anniversary of the regional energy and security bloc formed by China, Russia and the 4 Central Asian nations (Kazakhstan, Kyrgyzstan, Tajikistan and Uzbekistan). The official joint statement announced after the meeting included claims that differences in political systems should not be permitted as a reason for foreign intervention in domestic affairs; in addition to confirming further cooperation in regional security and energy matters. These moves have raised concern among Western states, the US in particular, and there have been cases where it has barred China s acquisition of energy-related interests. In June 25 when CNOOC bid to purchase the US oil company Unocal for 18.5 billion dollars 4

5 against US major Chevron s bid for 17 billion, US Congress strongly opposing to this transaction citing national security concerns enacted an energy bill the following month including a clause that effectively blocked the CNOOC takeover, thus forcing the company to withdraw its offer. 3 China s ambitious energy conservation policy The fact that the tightened supply-demand from rising energy consumption surfaced in the form of power shortages has alarmed the Chinese government, and led to further efforts in developing energy strategies which look into the mid to long term. As a part of this strategy, energy conservation was the first of eight major policies listed in the Medium and Long-Term Energy Development Program (24-22) issued by the State Council in June 24. The plan states that saving energy continues to be the highest priority and also that comprehensive and rigorous energy-conserving measures will be implemented in order to drastically improve energy efficiency. 1 Poor energy efficiency In addition to the rapid growth of the economy, China s low energy efficiency is also a large factor in the surge in energy consumption. China s energy consumption per real GDP was four times greater than the US, eight times Germany s, and eleven times Japan s in 25 (Figure 3). These figures apply the actual market rates for the dollar-yuan conversion (as of 1995 when the China s current account was mostly balanced), and some may view that China s energy usage per production would be much lower if the absolute purchase power parity released by the World Bank were used. Even then, much room for conserving energy remains compared to developed nations. (Tons oil equivalent/million dollars of GDP) 3,5 3, 2,5 2, 1,5 1, 5 Figure 3 Energy Consumption in China and Developed Nations Per real GDP Per capita First oil shock Second oil shock 25 figures in parentheses China(934) USA(228) Germany(116) Japan(87) (Tons oil equivalent per capita) Year Notes: GDP is based on 1995 prices. Source: Compiled by the Economic Research Office, Bank of Tokyo-Mitsubishi UFJ based on BP statistics Year Furthermore, China s energy usage per real GDP, even though it had declined through the two energy crises, reverted to an increase from 2. One of the factors was that the investment boom was concentrated in the energy-intensive basic material industries such as steel, non-ferrous metals and non-metals industries. It also reflects the general improvement of living standards such as the start of motorization. 5

6 2 Various energy conservation measures In light of the Medium and Long-Term Energy Development Program placing energy saving as its top priority, the National Development and Reform Commission (NDRC) announced China s first Medium and Long-Term Energy Conservation Plan in November 24. According to this plan, if China s energy consumption increases at the current pace, it will grow from 1.5 billion tons coal equivalent (Note) in 22 to 4 billion tons coal equivalent in 22. The plan aims to cut this down to 3 billion. Note: 1 ton coal equivalent =.7 ton oil equivalent In terms of industrial policy, the plan will promote the development of the service and IT industries which uses relatively less energy. In addition to strengthening supervision and inspections for the energy-intensive industries, more specific standards for energy use will be set. In the private sector, there are plans to establish mandatory energy efficiency standards for household electric appliances, lighting, and automobiles. As a first step, mandatory indication of a five-scale energy efficiency rating has been introduced for household refrigerators and air conditioners. The 11th Five-Year Plan (26-21) also sets a goal for 21 of reducing per GDP energy usage by 2 percent from the level at 25. Measures to curb energy usage are being promoted in the industrial, transportation and private sectors toward this goal. In the industrial sector, excess capacity has become a serious issue in energy-intensive industries as a result of the recent investment boom, and its adjustment was an urgent matter. In December 25, the government designated 399 types of production technology, equipment, and products to be eliminated. In March 26, in addition to identifying the steel, aluminum, alloy iron, cokes and automobile as industries with clearly excessive capacity, the cement, coal, power and textile industries were identified for potentially excessive capacity all to be subject to stricter standards for market new entrants and consolidation of small sized enterprises. In April, industry-specific restructuring plans were announced establishing quantitative targets that would promote the advancement and consolidation of the industry while eliminating small-scaled companies and outdated equipment. For the highly resource and energy intensive metal products, controls on exports were enhanced by raising the tax burden, and this measure also aims to relief trade frictions at the same time. Policies in the transportation sector centers on preferential treatment to compact vehicles as a countermeasure to motorization. Until recently, local governments took measures which benefited large vehicles which have higher profit margins, partly due to the promotion of local manufacturers such as banning small automobiles from city centers and highways or placing minimum requirements on engine capacity for taxis. In January 26, six administrative bodies including the NDRC, Ministry of Construction and State Environmental Protection Administration (SEPA) issued a joint directive to regional governments instructing them to remove restrictions imposed on compact vehicles by March and instead implement measures to promote their use. The vehicle tax system was also modified in favor of compact cars. In March 26, the Ministry of Finance announced a major change in the scope and rate of the consumption taxes which were mainly imposed on luxury goods. The three tax scales for vehicles were further divided into six: while taxation on vehicles between 1, and 1,5cc were lowered from 5 to 3 percent, the rates on vehicles between 2, to 2,2cc were raised from 5 to 9 percent and the rates on vehicles with 2,2cc and over was raised further to 9~2 percent 6

7 from the previous 8 percent. Construction of energy-efficient building seems to be the key in the private sector. At a press conference in February, Qiu Baoxing, Vice Minister of Construction stated that one third of China s existing buildings require improvements at a cost of over 2.6 trillion yuan. The 11th Five-Year Plan set a goal of constructing energy-efficient buildings by a total of 2.16 billion square meters and save energy equivalent to 11 million tons coal equivalent. As this would be about 5 percent of the total energy used in 25, if the plan were to be realized, it will considerably contribute to the key initiative raised in the Five-Year Plan to reduce energy consumption per real GDP by 2 percent of the level in Incentives crucial to grow energy-conscious minds While the government set forth these various polices to address the issue, the goal of cutting total energy usage by 2 percent is considered rather ambitious. It has been criticized for some time that one of the root causes of energy overuse is due to the low energy prices under government control. The government has already proposed a policy to revise the pricing mechanism for petroleum products reflecting international prices and also to introduce a new fuel tax. These measures have also been included in the 11th Five-Year plan, but implementation is being put off with the international crude oil prices surging to unexpected levels. The price of petroleum products are required to be within a range of ±8 percent from the base price that the NDRC determines in reference to prices in the Singapore, New York, and Rotterdam markets. The base price was raised twice so far this year (in March and May), resulting in an 18 percent increase, but this still seems about 25 percent cheaper than international prices and inadequate to become an incentive for saving energy. On the other hand, the rising petroleum costs are heavily burdening low-income consumers, and the government has already drawn measures to pay out 8.5 billion yuan of subsidies to the fishery, forestry, and public transportation industries. Fuel tax was expected to be introduced from early this year at 3-5 percent of gasoline retail prices but as of June, the State Administration of Taxation has expressed its view that the timing was premature. Moreover, merely raising petroleum product prices would not be enough to seriously address the issue of conserving energy. Further expansion of incentives such as subsidies for energy-saving facilities or preferential treatment in taxation and financing are urgently in need. 4 International Cooperation must be enhanced As discussed above, China is making a wide range of strategic efforts in order to avoid facing mid- to long-term constraints on energy resources. Though the efforts on the supply-side such as using resource diplomacy to leverage the acquisition of overseas supply had started earlier when the country became a net oil importer, China is starting to take major steps to control its demand. In addition, the country s first drafting committee on energy-related laws was established earlier this year to put the various energy related policies into context and draw up a comprehensive framework. The committee is calling for input from the public and the press aiming for legislation in the next two years. Among the various energy policies, its aggressive efforts to secure overseas interests is proving to be effective especially as the international energy market enters a new paradigm where energy resources have become a strategic product concerning national security. Even 7

8 in Japan, a target for independent development of oil reserves has been reintroduced to the new national energy plan after once being removed in 2, with a goal of raising the proportion from the current 15 percent to 4 percent by 23. However, China s overseas strategies have had negative side effects such as becoming the source of soaring resource prices and being criticized or alarming other countries for hindering international security and human rights. There also are deep running issues which continue to plague the country in reducing energy usage: in addition to the delay in introducing market mechanisms to energy prices, factors like its inability to eliminate inefficient enterprises are curbing other positive measures. In order to facilitate the resolution of these diverse energy issues, international cooperation especially from within the Asian region is called for. While the strategic value of its approach to oil-producing nations have been somewhat proved, China may also end up paying a higher price if the intensified competition for energy resources consequentially lowers the overall bargaining power of countries that purchase oil. In addition to China, the Asian region includes consumer-heavy countries like Japan and India (Figure 4), and there would be much significance in working to enhance bargaining power or to establish a regional energy reserve and emergency response system through mutual cooperation. Figure 4 World's Leading Oil Consumers 1, Million tons USA EU China Japan India Year Source: Compiled by the Economic Research Office, Bank of Tokyo-Mitsubishi UFJ based on BP statistics. China is also looking for ways to use new or clean energy, and there are many aspects where Japanese technology and know-how can contribute to this initiative. This is a significant business opportunity for Japanese firms, and would also benefit Japan by lowering China s energy and environmental risks. In this regard, both countries seem to fully recognize the merits, even as the so-called politically cool, but economically hot relationship continues. When both governments hosted the China-Japan Forum on Environmental Protection and Energy Saving in Tokyo on May 29, Minister of Commerce Bo Xilai spoke in his speech that the Forum should serve as an opportunity for a new kind of bilateral cooperation. In June, it was reported that Japan s Ministry of Economy, Trade and Industry will take on a project to transfer coal-liquefaction technologies (refining gasoline and light oil from coal) to China. Although conflicts exist regarding the oil and gas resources claimed by both countries in the East China Sea and over the oil pipeline route from Russia, it is hoped that the two countries cool-headedly seek a mutually beneficial path in energy cooperation, including the resolution of these existing disputes. (Yoko Hagiwara, July 11, 26) 8

9 The Bank of Tokyo-Mitsubishi UFJ, Ltd. Economic Research Office 2-7-1, Marunouchi, Chiyoda-ku, Tokyo , Japan This report is intended only for information purposes and shall not be construed as solicitation to take any action. In taking any action, each reader is requested to act on the basis of his or her own judgment. This report is based on information believed to be reliable, but we do not guarantee its accuracy. The contents of the report may be revised without advance notice. Also, this report is a literary work protected by the copyright act. No part of this report may be reproduced in any form without express statement of its source. 9