Wither China ?

from  Lewis L. Smith

The biggest “wild card in the oil deck” is no longer some yet-to-be-commercialized technology. Nor is it a country harboring nests of terrorists. Nor it is a producing country like Iraq, Iran, Qatar or Saudi Arabia.  It is China, a net consumer.

In part, this is because of China’s economic, energy, environmental, military and political importance. Howwever, the main reasons are two  —   the uncertainty surrounding the country’s  future and the undertainty as to future actions of its government in the international sphere.

At $4.2 trillion [2008] , China’s economy is the third largest in the world, after the USA and Japan. By 2020, it will be the second largest.  From 1988 to 2008, its gross domestic product grew at extraordinary average annual rate compounded, almost 10%. It has the second largest army in the world.

Its surplus on current account from international trade was $400 billion for the year 2008, and its reserves of foreign exchange at the end of the year were some $2.0 trillion !  A large portion of these reserves are invested in US Treasury paper, which makes China the largest single creditor of the USA.  Before 2010, China will become the world’s largest exporter of goods.

China’s records for economic growth and for the reduction of poverty are unprecedented in world history. This record is even more impressive when one considers that there are some major factors working against success. These include China’s immense size, a shortage of arable land, large and growing environmental problems, widespread corruption at the local and regional levels and certain “oddball” features of its economy. We mention only two of the latter.

For several decades a significant percentage of government-owned factories have been losing money, but have been kept going by loans from government-owned banks !  Some 25% of the country’s electric-generating capacity has been constructed ilegally by local and regional governments, often in violation of national environmental regulations. We know of no precedent for either of these features in world history.

A good part of China’s success has been due to the fact that early on, the regime made a decision to move towards some still undefined hybrid economic system of markets and Marxism and to do so in a way that is ad hoc, decentralized, experimental and gradual,  and that allows for individual, enterprise and low-level public-sector initiatives. At the same time, the regime has not given up political control. Nor has it abandoned economic development as the nation’s central goa

In a sense, both the desired economic structure and the means of achieving it are supposed to grow out of the very process of discovering both, hopefully without destabilizing the regime. And success in economic development is more important than the economic structure which is evolving to achieve it.

This is in stark contrast to Russia and Eastern Europe, where the governments and their Neoclassical [mainstream] economic advisors tried to move from a Stalinist-type command economy to some clearly defined version of a pseudo-capitalist one, all in fell swoop and all at the direction of the goverments concerned. A sort of “command transition”, if you will, instead of the “feeling our way” one which has characterized China.

In the Slavic cases, these attempts almost uniformly generated corruption, unjustified concentrations of income and wealth, recessions, unemployment et cetera and ended up with something that fell far short of the goal that had been established in each case, even though per-capita foreign investment was much greater than in the case of China, and foreign advice was both abundant and well received.

However, China’s spectacular achievements rest, like an upside down pyramid, on a very narrow base, rapidly increasing oil imports. From 1998 to 2008, China’s consumption of petrofuels increased at an average annual rate of 9%, net imports of petroleum at more than 15% and domestic production of crude oil at less than 2%. The result was that at the end of the period, imports supplied more half of consumption. This dependence is expected to increase to 85% by 2030 ! Already China is already one of the largest consumers of petroleum in the world, accounting for nine percent of global oil consumption in 2008.

[In 2009, consumption was running about eight million barrels of 42 gallons per calendar day. Consumption excludes inventory changes, which can be substantial in any given period but which are not published for reasons of “national security”.]

Some  16% of these imports come from Saudi Arabia through the Strait of Hormuz, between Iran and Oman, a passage which handles some 20% of the world’s oil trade. This body of water is only 21 miles wide at its narrowest point and contains an island occupied by Iranian Revolutionary Guards, supposedly equipped with Silkworm guided missiles. It would be easy to block the Strait by sinking two or three supertankers at the right locations.

Some 80% of Chinese imports come through the Strait of Malacca, between Indonesia and Malaysia. This body of water is 625 miles long and only two miles wide at its narrowest point. Near the northwestern end are two islands with Indian military facilities and at its southeastern, a US naval base at Singapore. Many Chinese leaders are old enough to remember when China fought wars with one or the other of these two countries !

Until recently, the main aim of China’s foreign policy has been to support its economic development, and often guided by the precepts of the late Deng Xiaoping  — observe developments soberly, remain free of ambition, never claim leadership, never attempt to be a hegemon, never practice power politics, never be a threat to neighbors or to world peace.

However, China’s growing dependence on oil imports is beginning to create a noticeable sense of “energy insecurity” among its leadership and in turn, a marked change in its behavior. The Chinese are clearly concerned about the possibility of oil shortages and/or price spikes of such magnitude that they would endanger economic growth, job creation and “social cohesion” and even the very existence of the regime. And a few daring souls have raised the possibility that that the fall of the current regime might be followed by a breakup of the country, undoing centuries of struggle to restore the national territory to its historic maximum.

For example, by the Central Government’s own admission there were 70,000 “public disturbances” in 2007, mostly directed against local and regional authorities. But if growth were to slow down, most of this anger might very well be redirected against the Central Government. And a full-blown recession could easily increase unemployment to at least 50 million, within six to nine months. The question would then become, Can the vaunted People’s Liberation Army of four million handle the resulting social turmoil ?

Faced with this threat, the Chinese have taken vigorous measures, such as investing large amounts of money in Canadian, Sudanese and Venezuelan oil. China has also become Iran’s top customer for gas and oil. And it appears to have established a long-range goal of obtaining most of its oil from Central Asia and Iran, via a combination of pipelines and “safe ports” on the Indian Ocean. Last but not least, China has become the largest manufacturer of wind generators in the world, and may soon reach that status with some other sources of renewable energy.

Two important links in the future transport chain are a port under construction in Pakistan [with 80% Chinese financing] and another in Myanmar.

For example, Iranian oil might travel by pipeline to the port in Pakistan, from there by tanker to the port in Myanmar and from there by pipeline to Yunnan in China, paralleling the Burma Road over which the writer’s uncle escaped from house arrest in Mao’s China many years ago. Still another option under consideration is a deepwater canal across the thinnest part of Malaysia, to bypass Singapore.

Unfortunately some of these oil activities have created points of conflict with the Russia, the West and/or the UN. And successive US administrations have upset China further by pressing it to [a] recognize and protect civil rights and [b] increase the rate of exchange between China’s currency and the dollar. This latter move comes at a particularly inopportune time, since both China’s exporters and the volume of its exports have recently become sensitive to the level of the exchange rate.

Last but perhaps most important of all, the Chinese are concerned about how the USA would react if China decided to invaded Taiwan, which they are determined to get back “by hook or by crook”. All of the foregoing is aggravated by the recent US sale of arms to Taiwan and by jingoists in China and the US Congress, who seem to be “spoiling for a fight”.

As a result, despite the “vigorous measures”, the Chinese do not appear to feel either happy or secure. One senses, in fact, that they are both angry at and mistrustful of the USA. For example, they have begun to threaten economic aggression, such as a rapid selloff of China’s vast holdings of Treasury paper, or the use of China’s vast holdings of dollar currency reserves as “a political weapon”. Such measures of course could easily backfire on China, but the fact that its officials are willing to engage in such bombast notwithstanding is not a good sign at all.

Fortunately the USA appears willing to talk to China about everything and to work with it on common problems, such as Global Warming, while simultaneously arguing about other issues, such as Taiwan.  Moreover, while not ceding America’s role of “number one”,  the Obama Administration is willing to play it with much more consideration for other’s feelings than was the Bush Administration. But whether any or all of this will be acceptable to the Chinese remains to be seen.

As a result, we have a situation in which there are now “two bulls in the same field”, a  “face-off” is possible and we have to keep them from “going at each other” and “tearing down the fence” in the process. This is going to take some skillful maneuvering on both sides. And whatever the outcome, it will have a significant impact on the future of the oil industry, as will the success or failure of China’s economic development program.

The foregoing is based primarily on two sources >>

[1]     Articles in the latest forum of the International Association for Energy Economics  >>

Click to access 2010WinterEnergyForum.pdf

[2]     Jakimowicz, Aleksander  [Oct 2009]  >  “[The] interdisciplinary matrix in economics  :  two applications to the transition from socialism to capitalism”, Nonlinear dyanamics, psychology and life sciences  13/04, pp. 393-422. ###