On a map of Beijing, Chang’an is referred to as a street, not an avenue and not a boulevard. Yet this highly congested “street”, traversing the Forbidden City, Tiananmen Square, and Wangfujing shopping district, has no fewer than 16 lanes, making it one of the world’s widest and busiest inner-city thoroughfares. Until about a decade ago, Chang’an looked like an endless river of bicycles. But those have since been banned—except for bikes powered by an electric motor—to make way for automobiles. Compact European-style cars are rarely seen there. For millions of Chinese moving up the socioeconomic ladder, a car is more of a status symbol than it is a four-wheeled conveyance, and so the larger and more luxurious it is, the better.Major cities like Shanghai, Guangzhou, Chengdu, and Dalian all have their own Chang’ans, massive traffic arteries that symbolize the challenges associated with China’s growth spurt. At the heart of the Chinese Dream, an elusive term often used by China’s leaders to describe enhanced material prosperity, stands car ownership. The growth of China’s vehicle population has dazzled even the most bullish analysts. In 1995, the Chinese government predicted that by 2010 private car ownership would reach 15 cars per thousand people. The actual number exceeded thirty. Since then, the number has more than doubled, standing now at around seventy cars per thousand people (compared to 800 in the United States). China’s automobile market, the world’s largest, grows today at 12–16 percent annually, with car sales hovering around twenty million, ten times more than India’s. At the current growth rate, in less than a decade China will have more cars on its roads than the United States.China’s vast coal reserves and system of hydroelectric dams, as well as eighty nuclear reactors currently under construction or planned, will enable it to provide for its electricity needs, albeit with some non-trivial environmental consequences. Transportation fuel is a completely different story in China, as it is everywhere else. All these cars, not to mention other modes of transport (ships, trains, and planes) require gigantic quantities of oil, and China is already the world’s number one importer, with 60 percent of its oil needs coming from abroad—a level of dependency almost twice as high as America’s.Obtaining the crude will become an increasingly difficult task, considering the potential for economic growth China still harbors. Consider this: So far, China’s economic miracle has mainly benefitted the sliver of land along its coast, where per capita GDP has surpassed $10,000, and where most of China’s one million millionaire households reside. But for most of the inland provinces, where per capita GDP ranges between $3,000 and $6,000, the economic boom has yet to arrive. If all of China is to “rise”, by 2025 it will need an additional volume of petroleum equivalent to Saudi Arabia’s current production. But turmoil in the Middle East, mounting tension between the West and Russia, and the recent fall in oil prices are making the task of adding so much crude increasingly difficult.This probably means that China will be ever more willing to compromise its “peaceful rise” policy in order to meet its energy security needs. Indeed, in classical Chinese the word Chang’an means perpetual peace, but barring a new and creative approach to Asian energy security, one in which the United States plays a critical role, the change it symbolizes might herald the exact opposite. Japan went to war against the United States in 1941 largely for fear of being starved of energy. Can we learn anything from that tragedy?Nearly ten years ago, in August 2005, after a nine-month drama, CNOOC, China’s third-largest national oil company, succumbed to strong opposition in Washington to its $18.5 billion bid to purchase Unocal, then America’s ninth-largest oil company, withdrawing its offer. The collapse of the deal was a national humiliation for China. The message from Washington to the Chinese was clear: Go hunt for oil wherever you like, but stay away from our backyard because we don’t really believe in pure capitalist competition. And this they did.Since 2005, ten Chinese companies, spearheaded by the three national oil companies, have set up operations in 42 countries, of which half are in the Middle East and Africa. But the past three years have delivered a strain of bad news for China’s overseas energy investments: the so-called Arab Spring, the rise of the Islamic State, the sanctions imposed on Iran and Russia, the escalating conflict between Sudan and the newly independent South Sudan, and the Ebola crisis too. All of these have put some of China’s top foreign investments at risk. The worst blow may be coming from Iraq, where 26 percent of China’s foreign oil assets are concentrated. As late as June 2014, an International Energy Agency report predicted that “Iraq is set to become one of the main pillars of global oil output, and will also become the largest contributor to global oil export growth.” Days later, the Islamic State took control of parts of the country, and China’s assets remain at risk of being consumed by another round of civil war.Further, Nigeria’s scheduled February elections could sink the country into turmoil, threatening China’s second-largest investment. In the rest of Africa, China’s oil companies and their deep pockets are no longer as welcome as they used to be. Fed up with what they perceive as Chinese environmental negligence and resource grabs, countries like Niger, Gabon, and Chad are showing a newfound assertiveness in dealings with the Chinese, and in Angola, Ethiopia, Sudan, Libya, and Cameroon rebels have already targeted Chinese interests.With so many setbacks to its “go out” energy policy, China is reorienting its resource hunt toward its various backyards. And this shift from the global to the more local will have considerable implications for Chinese foreign policy, as well as for relations with the United States.First among China’s nearby energy suppliers is Russia. China is already the third-largest customer of Russia’s oil, and it is already connected to its northern neighbor through an oil pipeline. In recent months the world’s largest energy exporter and the world’s largest energy importer have grown increasingly close. China increased its participation in the giant Yamal LNG project in northwestern Siberia, concluded a $10 billion deal to develop a large Russian coal deposit, and inked a $400 billion gas deal to supply China’s northeastern provinces with 38 billion cubic meters of East Siberian gas per year through a pipeline called Power of Siberia. Described by Vladimir Putin as “epochal”, the deal marks the beginning of a marriage of convenience between two of the world’s three most troublesome revisionist states.The Chinese market is critically important to Putin. In the face of growing international isolation, China can provide Russia with the security of demand it lacks in Europe. And this is why Putin was not content to stop there. This past November Russia and China signed another mammoth gas pipeline deal, this time connecting Western Siberia’s fields to China’s Xinjiang province, and from there to China’s existing West-East pipeline system, which feeds population centers like Shanghai and Guangdong. This deal could potentially supply three times the volume of gas offered by the Power of Siberia pipeline. The same energy corridor could also transport oil.Russia is much more of an oil exporter than a gas exporter, exporting 70 percent of its crude production but only 30 percent of its gas production. Its oil revenues are almost five times larger than its gas revenues. With a fiscal breakeven oil price of $105 per barrel, Russia must focus on selling more oil to meet its budgetary needs. Hence, aside from being a sizable market for Russia’s oil, China can also be a land bridge to the 1.2 billion-strong Indian market. Russia and India have been negotiating for some time the construction of a $30 billion oil pipeline, the most expensive ever, to connect western Siberia to Xinjiang and from there to northern India. If the project were to move forward, China would likely exact a high diplomatic and economic price from the Russians (not to mention a portion of the oil) for serving as a land bridge to India.To be sure, there has never been much love lost between Beijing and Moscow, nor will there ever be. Yet, engulfed in pollution, bewildered by domestic unrest spreading from Xinjiang to Hong Kong, and disenchanted about the prospects of replicating the American shale revolution, China is increasingly inclined to bet its energy future on its giant neighbor rather than on more distant and less reliable suppliers. This growing dependency will undoubtedly complicate the West’s efforts to isolate Russia. It will also make U.S. exportable gas uncompetitive in the Chinese market as piped gas is almost always cheaper than LNG, jeopardizing America’s hopes of becoming a major gas exporter to the Asian market.If China is counting on Russia to supply its northern region, it is becoming increasingly reliant on Myanmar to fuel its southwestern provinces of Yunnan, Guizhou, and Sichuan, which are home to 160 million Chinese. Those three provinces will be increasingly reliant on a newly created energy corridor connecting Kyaukphyu, a deep water port on the Bay of Bengal, to Kunming, the capital city of Yunnan. A gas pipeline has already been inaugurated, in 2013, and an additional one for oil is under construction. The sleepy and still largely isolated Myanmar may thus soon become a key to China’s energy security as it provides China with a solution to what former Chinese President Hu Jintao called Beijing’s “Malacca Dilemma”: its over-dependency on the congested and vulnerable Strait of Malacca.With the completion of the new corridor, China will be able to receive oil and gas shipments from the Persian Gulf and Africa directly to its heartland without having to worry about a U.S. Navy blockade in Malacca. Myanmar’s strategic value for China will be further elevated if more oil and gas is discovered beneath the waters of the Bay of Bengal, which is likely. This will also require Beijing to manage its diplomatic and economic relations with the soon-to-be-elected post-junta government in Naypyidaw, not to mention the Burmese people, in ways different from the exploitative style it has exhibited in Africa.Here too there may be strategic implications for Washington. China’s maritime forces have so far focused on securing Beijing’s interests in the South and the East China Seas. Myanmar’s opening to China will entail a greater Chinese naval presence in the Bay of Bengal and the Indian Ocean, creating a new security dynamic with India, Sri Lanka, Bangladesh, and Pakistan. In all but the first China has already established footholds: a fueling station on the southern coast of Sri Lanka; a naval facility in Chittagong, Bangladesh; and two ports on the Arabian Sea coast of Pakistan. China’s presence in the Indian Ocean, a launching pad to the Arabian Sea and the Persian Gulf, will not be well received in New Delhi, which is already preparing its navy to rival China’s. This will add a new layer of complexity to America’s interests in South Asia and the Middle East.China’s interest in the Bay of Bengal does not imply diminishing interest in its surrounding waters of the South and the East China Seas. To the contrary, the reorientation from the global to the local will make China more assertive on all matters related to what it defines as its “blue national soil.” The standoff with Vietnam over the contested waters around the Paracel Islands and the highly flammable dispute with Japan over the uninhabited Diaoyu Islands, or Senkaku as the Japanese refer to them, to a large degree already revolve around access to offshore oil and gas.Estimates vary as to the size of the reserves in the waters surrounding China, but in a climate of historical animosities and territorial disputes in which the presence of an offshore oil platform could ignite a regional war, no meaningful exploration and production activity can take place to validate the scope of the reserves, and none of the sides involved can enjoy the resources. With so many of its investments abroad turning sour, Beijing has two choices: It can either drive down regional tensions and encourage cooperative methods to get at the energy, or it can seize the resources and develop them unilaterally, as a committee of one, so to speak. The former option is daunting, and it would deprive the government of the nationalist rhetoric it uses to keep its public supportive or at least off balance. The latter option, however, would put China on a collision course with the United States—or would it?Recent U.S. indecisiveness exhibited in its dealings with allies and friends in the Middle East and Europe may encourage Beijing to test America’s commitment to its allies in the Pacific: Japan, Vietnam, Taiwan, and the Philippines. This has already happened twice in the past year and a half: first with China announcing in November 2013 the establishment of an air defense identification zone in the East China Sea, and later with the controversial May 2014 deployment of an oil rig in what Vietnam considers to be its economic waters. The U.S. Administration was quick to reaffirm its commitments to the status quo and more specifically its longstanding policy that Article V of the U.S.-Japan Mutual Defense Treaty applies to the Senkaku Islands. But its responses, not to mention its lack of muscle in its treatment of Russia, Iran, and Syria, have failed to persuade Beijing that Washington is ready to back up its diplomatic rhetoric with force should China decide to unilaterally grab the region’s energy.If, in the current climate of perceived American softness, China is tempted to pull the pendulum of power in the Asia-Pacific back in its favor, where it was for many centuries, its upgraded relations with Russia will help it to do just that. This new energy alliance will inevitably unnerve Japan, whose relations with both Russia and China have been historically troubled, driving Tokyo closer to Washington and potentially dragging the United States, after President Obama leaves office, into a prolonged and potentially explosive power struggle in the Pacific.All of this is to say that China’s energy predicament is nearly as much an American problem as it is a Chinese one, and not only because energy security concerns tend to breed belligerence. The supply of affordable energy will determine China’s ability to maintain a healthy growth rate, on which much of the global economy has grown dependent. For all the complaints about China’s environmental practices, it is worth remembering that plentiful and affordable fossil fuels allowed China in just four decades to lift its citizens’ life expectancy by twenty years and its per capita GDP thirtyfold. Without affordable electricity and transportation fuel, the locomotive pulling the global economy, including America’s, will run out of steam, reducing China’s ability to finance America’s debt.China’s energy security challenge is not only about providing for the physical supply of its energy, but also about ensuring that this energy comes at affordable prices. In the foreseeable future, China must subjugate its foreign policy to its economic needs, but no less important will be its ability to execute domestic reforms and cooperate with its allies and neighbors in efforts to better manage the resources it has, to keep energy demand growth under control, and to diversify energy supply all while striking a healthy balance between its energy security concerns and its serious environmental problems.So far China’s response to its growing domestic demand for crude has typically been to do to cars essentially what it has tried to do to humans: population control. Most major cities have introduced schemes to control the number of new cars. Shanghai auctioned in 2014 only 100,000 license plates at about $13,000 per tag. Beijing adopted a lottery system, offering only 150,000 new plates. It also instituted no-drive days based on the last digit of the owner’s license number. Guiyang, capital of Guizhou province, also declared a lottery but only for special plates that allow driving in the city. The rest of the drivers can only drive outside the first ring road. In Guangzhou, the capital of Guangdong, a hybrid system now exists: Half of the annual quota of license plates is available for auction, and half is provided free of charge through a lottery.But just as China is slowly realizing the unintended consequences of its One Child policy, it will soon discover that attempts to control the number of cars are worse than useless. Indeed, they are likely to guarantee that those lucky or affluent ones who can acquire a car buy the largest and most gas-guzzling vehicles possible in order to maximize the value of their plate. As long as car ownership remains the pinnacle of the Chinese Dream, and as long as subsidies and price controls keep China’s motor fuel prices 30 percent cheaper than Japan’s, it is hard to see how oil diets can stave off demand in more than a marginal way. The only way for China to address its oil challenge is to begin to diversify its transportation sector away from oil. And this is exactly what it is doing, though not without an ignition problem or two.In 2010, after visiting the Tianjin battery facility of electric car maker Coda Automotive, New York Times columnist Thomas Friedman lamented that America is lagging behind what he called “China’s moonshot”: electric vehicles. He was not alone in his lament. But the many pundits who pictured millions of Chinese hopping straight from bikes to Volts were actually projecting onto China what they wished to see in the United States. The problem is that the moonshot never happened.The Chinese Five-Year plan stated a target for 500,000 battery-electric and plug-in electric vehicles by 2015, and five million by 2020. It even provided subsidies that in some cases went as high as $20,000 per car. But so far the attempts to popularize electric vehicles in China have been a colossal failure. For the most part, Chinese motorists lack access to charging infrastructure, and affluent Chinese prefer traditional luxury cars to eco-friendly ones. Furthermore, China’s electricity system is not developed enough to manage the simultaneous charging of numerous electric cars. As a result, fewer than 40,000 electric vehicles were purchased in China in 2014, less than 1 percent of new vehicle sales. With such weak sales, automakers have insufficient incentive to dedicate their production lines to manufacturing battery-powered vehicles. Unsurprisingly, Coda Automotive filed for bankruptcy protection in 2013.Since the moonshot failed to materialize, China is now putting its faith in moonshine. Also known as wood alcohol, methanol fuel can be made from coal, natural gas, and biomass, which make it much more scalable than ethanol, its corn- and sugar-derived cousin used in the United States and Brazil. As with ethanol, the use of methanol requires minimal adjustments to vehicles and fueling infrastructure. China is the world’s biggest producer and user of methanol, primarily from coal. Due to its low cost compared to gasoline, this fuel is already used widely in millions of cars in several provinces, and Chinese automakers are rolling out cars that can run on it.There is also a large market for aftermarket conversions of standard gasoline-only vehicles to run on alcohol fuels, with conversion prices of roughly $100 per vehicle. But China’s shift to coal-derived methanol is approaching a limit due to the transportation bottlenecks and environmental problems associated with coal shipment and use. If China is to successfully introduce fuel choice at its pumps, it must find a way to both increase the availability of coal as well as to introduce natural gas, and the panoply of fuels made from it, especially methanol, into its transportation sector. In these two efforts, the United States, being both the Saudi Arabia of coal and a new fracking empire, can be tremendously helpful.Because China is poor in conventional gas reserves, natural gas today makes up less than 5 percent of the country’s energy portfolio, compared to the 25 percent average in the industrialized world. Most of China’s gas is used in industry and electricity generation; almost none as automotive fuel. Two things must happen in order for natural gas to play a role in powering cars: It must be more abundant domestically, and it must be cheaper to import.Between the provinces of Sichuan and Shandong lies the world’s largest reserve of shale gas, 50 percent larger than America’s. But the current fracking technologies used in North America are insufficient to unlock this gigantic reserve. China’s shale gas formations are twice as deep as America’s, far costlier to tap into, and, by and large, concentrated in arid areas not conducive to the water-intensive extraction methods currently in use. There is also inadequate access to pipelines, and government price controls make shale gas development financially challenging.Nevertheless, developing its shale reserves has become a Chinese national obsession—driven not only by the desire to reduce coal pollution but also from a deep sense of technological inadequacy: If the Americans can frack, why can’t we? While so far the results demonstrated by the Chinese natural gas industry have been underwhelming, it is never a good idea to underestimate Chinese doggedness and ability to emulate others. With growing Chinese investment in the North American shale boom, and with joint Sino-American efforts to enhance investment and technical cooperation aimed at accelerating shale gas development in China, in the long run China will learn how to exploit its unconventional hydrocarbons.Until then, gas must be imported. But at what price? China may be surrounded by gas-rich neighbors like Russia and Turkmenistan and can import large volumes from more distant suppliers in the form of LNG, but due to structural distortions in the way gas is traded in Asia the gas comes at a vastly inflated price. Today, China’s spot price for LNG normally ranges between $13 and $15 per million btu, roughly four times the price a similar unit of energy would sell for in the U.S. market. The reason for the disparity, liquefaction and transportation costs aside, is that throughout the Asia-Pacific region the price of LNG is mostly indexed to oil or a basket of oil products, and therefore the higher oil prices get, the more expensive gas becomes. In other words, Asia buys natural gas but pays for oil, which in the United States is three to four times more costly on an energy equivalent basis. This would be akin to buying water at Champagne prices. The indexation to oil also pushes the price of piped gas up, giving neighboring suppliers stronger bargaining power. This legacy system imposes a hidden tax on Asian economies, effectively preventing natural gas from competing against both coal and oil.In order to facilitate competition and lower prices, natural gas should be indexed to spot prices that are tied more closely with supply and demand fundamentals in the region (gas-to-gas competition). However, despite the fact that the Asia-Pacific is the second-largest gas market in the world, it lacks a single natural gas trading hub to facilitate the transparent exchange of the commodity and provide more competitive prices. It is past time for the largest gas users of Asia, supported by the United States, to join forces to delink the price of gas from the price of oil through the establishment of at least one regional trading hub in Asia. By acting as a buyers’ club for gas—as well as for oil—Asia can leverage its size and purchasing power in future price negotiations with the world’s leading gas exporters.An even easier way for the United States to ease China’s energy crunch is to avail more of its surplus hydrocarbons to the Chinese market. Much attention has been focused on America’s potential contribution to global energy security with respect to LNG exports. Indeed, provided that multibillion dollar liquefaction infrastructure is put in place and all U.S. exports go to Asia, the United States could potentially supply Asia an amount of gas more or less equivalent to what Germany currently imports. But the chance that any of this gas would reach the Chinese market is slim.Coal is a different story, however. American electric utilities are shifting rapidly from coal-fired power generation to natural gas-powered turbines due to cheap gas prices, a process helped along by the EPA’s war on coal. The United States, then, is left with gigantic reserves of under-demanded coal that cannot be utilized domestically but could be utilized by China. The United States is by far the world’s largest reserve holder of coal, with 27 percent of the globe’s total. However, it accounts for only 13 percent of the world’s coal supply, far lower than its reserve base permits. Increasing this level will not only benefit the embattled American coal industry but also provide China over the long run with additional feedstock from which oil substitutes like methanol can be produced.Last but not least, the United States and China share a common agenda in opening their vehicles to fuel competition. The two countries are home to 38 percent of the world’s automobile manufacturing capacity. Adding the other Asian manufacturing hubs of Japan, South Korea, Thailand, and Indonesia brings the figure up to 60 percent. By ensuring that vehicles sold in these markets are no longer captive to oil products but rather can run on fuels made from various energy commodities that can be arbitraged against petroleum fuels (remember, it costs only $100 per vehicle to enable liquid fuel choice), the United States and China can give rise to a competitive market in fuels and lead the world in placing the best price damper on oil: competition.If the shale revolution has taught us anything, it is that the world’s energy endowment is large. Unforeseen technological innovation has expanded the world’s pool of technically available energy, deeply reducing U.S. energy imports in just a few years. The fact that North Dakota, a state that until a decade ago played no role in America’s energy system, is now the second-largest oil producing state in the country, surpassing Alaska and California, should serve as a cautionary note to the Malthusians who for decades have warned that the world lacks sufficient resources to support the rise of a developing Asia. That said, China’s size, the pace of its growth, its regional and global aspirations and its complicated relations with its neighbors, beg for a more managed approach to its energy security, one that is part and parcel of a regional energy security architecture for the entire Asia-Pacific region.Today, energy security, particularly as it relates to oil and gas, is Asia’s potential unifying factor, just as concern about competition over coal and steel was Europe’s unifying factor post-World War II. The path to European unification started in 1951 with the establishment of the European Coal and Steel Community, which served to neutralize competition over resources in Europe. A similar process should take place in Asia.But while Europe’s joint market was able to grow organically by countries worn out by two world wars, in Asia the process would require an outside broker to help coalesce China, Japan, South Korea, and the ten nations of the Association of South East Asian Nations (ASEAN) to work together. The portfolio would have to have several parts: sharing energy infrastructure, attaining stronger bargaining power with respect to energy exporters, reducing price volatility, creating strategic energy reserves similar to the stockpile system managed by the International Energy Agency, cooperating on the development of offshore and unconventional energy sources, and breaking oil’s monopoly over transportation fuels by opening vehicles to fuel competition.A Pan-Asian “energy club” could also address the deeply destabilizing disputes in the South and East China Seas. Under the current international legal framework based on the United Nations Convention on the Law of the Sea, one country can claim all the resources in its economic waters while its neighbors receive nothing. This all-or-nothing approach lends itself to perpetual conflict, perhaps even regional war. But if a mechanism for joint multinational investment and shared development of the region’s resources were created, enhanced exploration activity would enlarge the regional energy pie, with all parties enjoying increased supply and lower prices.Since the United States maintains close relations with most Asian countries, it is the ideal midwife for such a regional initiative. Instead of focusing on further militarizing the Asia-Pacific region, a policy the Obama Administration calls the “pivot to Asia”, the U.S. government should assume the role of “community organizer”, a job President Obama knows something about.China would welcome such an American involvement in recreating the region’s energy security architecture. Chinese thought leaders often sentimentalize the Tang dynasty (618–907) as a golden era of harmonious Chinese hegemony in Asia, one in which China experienced unprecedented openness to the world and free exchange of goods and ideas enabled by the new and secure Silk Road. The Tangs not only exerted political sway but also cultural influence over neighboring states, including China’s current day antagonists Japan and Vietnam. A Tang-style model is essentially what Beijing needs and is rooting for. But such a vision can only materialize if the region learns to overcome historical animosities and address the energy challenge though a new Pan-Asian energy cooperation mechanism, which, evidently, only the United States can facilitate. It is only fitting that the capital of China during the Tang Dynasty, the world’s most populated city of the time, was called Chang’an.
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Appeared in: Volume 10, Number 4
Published on: February 3, 2015
Published on: February 3, 2015
China's Game of ThronesStrategic Implications of Chinese Energy Policy
As China’s far-flung energy acquisition strategy comes a cropper, the geopolitics of China’s ‘near abroad’ is getting dicey.