Fuelling China’s Development

31 August 2006 (Last Updated August 31st, 2006 18:30)

In a globalised world, energy security can only be achieved through international cooperation. Dr Gary Dirks, group vice president and Asia regional president at BP, highlights the key issues and solutions that will bring China greater oil security.

Fuelling China’s Development

Energy security is about ensuring energy supply whenever and wherever it is needed to fuel national economic growth and social development. Energy must be available, affordable and compatible with consumers’ needs and environmental requirements.

Energy security is not only about oil, it also involves electricity, natural gas and coal. Oil security has the strongest international aspect because it is the largest traded commodity. Electricity is the most important because it is closest to people's lives and has the widest impact while gas needs attention because its supply network is very rigid.

"Scale and geographic considerations make it very difficult for a country as large as China to improve security through equity ownership."

However, for a country like China, where coal provides about 70%
of primary energy supply and is the foundation of the energy system, long-term coal security and its clean use are vital. Worldwide discussion of energy security has focused on oil, but we should not forget the importance of other sectors.

OIL SAFETY

Focusing on oil, we can consider what it really means for a country like China, with a growing import dependency, to have energy security, both internationally and domestically. The international aspect means securing reliable, reasonably priced and low-risk supplies of crude oil for the country’s refineries.

On the domestic front, individual and industrial consumers need the right kinds of oil products without shortage or interruption at a reasonable price and that meet product specification and environmental requirements.

It is important to recognise the integration between the oil market and the financial market, as the majority of oil transactions are carried out through the financial markets. Trading and risk management skills are very important to a country's energy security.

The efficient operation of the domestic market is also vital. If domestic refineries cannot process the kinds of crude oil that are abundantly available on the international market, or if the distribution system cannot provide a reliable supply to consumers, there will be an energy security failure.

A FEELING OF INSECURITY

A high oil price is one of the main causes for people to worry about energy. People are also concerned about the continuing availability of energy resources to meet the growing demand in the future.

Even more worrying is the regional imbalance between production and consumption, with a growing concentration of supply in a smaller number of regions, particularly the Middle East.

There are geopolitical uncertainties surrounding Iran, Iraq, Nigeria and other oil-producing regions, which lead to concerns about the risk of major supply disruptions. Spare oil production capacity is at a historically low level, meaning any major disruption could cause strong price spikes. In addition, environmental concerns narrow the choice of fuels to meet growing demand.

CAN CHINA SECURE ITS ENERGY?

The intuitive reaction to increasing oil import dependency is to secure supply by owning the resource. China became a net oil importer in 1993 and has since seen its import volume grow rapidly.

At the same time, Chinese companies have been investing in overseas oil and gas projects, covering more than 30 countries. Their total equity oil production is around 30 million tonnes a year.

According to the China National Petroleum Corporation, only about 10% of the total Chinese overseas equity oil production was shipped back to China in 2003, the rest was sold on the international market.

The scale of resources secured by Chinese companies is still small in comparison to China's needs, largely serving the global market and contributing to global energy security.

This is consistent with a US Department of Energy (DOE) study assessing the implications of China's energy requirements, in particular its overseas investments, for US interests. The study concludes that Chinese overseas investment in oil and gas projects is either economically neutral or positive to the world market.

"High oil prices, local instabilities and low spare production mean that international energy security is essential."

Scale and geographical considerations make it very difficult for a country as large as China to improve security through equity ownership.

For Chinese energy companies the strategy may be fine; it is understandable that these very large companies want to pursue resources internationally, provided that the projects are economically viable.

However, there are risks, particularly when oil prices are very high; the oil industry has seen many boom and bust cycles in oil prices and there is no guarantee against another cycle.

WHAT WILL SECURE OIL?

There are many avenues China can pursue to secure its oil supply. It has already been implementing programmes such as energy saving, expanding domestic energy supply, diversifying energy sources, building a strategic petroleum reserve, promoting the development of renewable energies and developing oil substitutes. All of these are sound elements of an energy policy.

Given that China relies on a limited number of national oil companies to secure crude from the international market and provide oil products to the domestic market, it is important to develop these state-owned energy companies to improve their capabilities and efficiency in the international arena, in oil and gas exploration, in risk management related to oil trading and in the domestic market.

DIVERSITY, OPENNESS AND PARTNERSHIP

Winston Churchill said that the key to oil supply security is with diversity and diversity alone, and this is still true today. Diversity needs to be applied to the following areas:

  • The supply structure, to encourage the development of alternative fuels
  • The technology structure, to encourage the development of new and innovative solutions
  • The infrastructure, to minimise dependence on any single channel or hub
  • The sources of imports, to reduce reliance on any single country or region
  • Product imports, which should include different types of crude and final oil and chemical products
  • Import contracts
  • Market participants, including domestic and foreign companies, can play a significant role in China's energy security

Diversity is the foundation of energy security for China as well as for any other country. Only a diversified group of market participants can bring distributed supply sources and energy contracts, the basis for any competitive market.

Since 1979, the open-door policy has made China what it is today and the Chinese Government has wisely adopted this policy as the country's basic national policy for the 21st century. However, to tackle the country's energy security challenges, China needs to open its door wider to mobilise international resources and technologies more effectively and efficiently.

At a time of high oil prices, governments in energy-exporting countries are tightening control over the energy sector because it is their main source of revenue underpinning development. While this is natural, they should open up their energy sector to international investment because this contributes to global energy security.

"Energy-producing countries should open up their energy sector to international investment because this contributes to global energy security."

As an energy-importing country, China is at the other end of the spectrum, along with the USA, Japan and Europe. What an energy-importing country looks for is the ability to absorb energy resources worldwide in the most efficient way to fuel its economic growth and meet people's needs. This is only achievable by opening, rather than controlling, the energy sector for all eligible participants.

Opening the domestic refinery sector would allow world-class refineries that can process a greater variety of crudes to be built. Opening the shipping and logistics sector can create a modern and efficient transportation system while opening the wholesale and retail activities can make the distribution sector more competitive.

In a globalised energy market, security is a world problem and China cannot be isolated from the rest of the world. Moreover, the solutions to China's energy problems could also be the same as those needed for the rest of the world. Thus, international partnership is essential to tackling common challenges.

Partnership can be at several levels. A global energy organisation is required that includes China as an active member. This could be achieved by extending the scope of the International Energy Agency to include new consumers, such as China and India, and to bring in the key suppliers – including the OPEC members and Russia.

International cooperation also needs to be carried out at company level, where new forms of partnership and collaboration are needed. In the case of China, we see the need for closer collaboration between the Chinese oil sector and other international players – sharing views, jointly building energy infrastructure projects, carrying out technology research and development and co-investing in energy projects worldwide.

Long term, a mutually advantageous partnership will improve not only China's energy security, but also that of the whole world.