An excerpt from our Belt and Road Initiative: Risk Insights report for 2018. This section covers China’s energy outlook and general approach to energy investments.
Energy Security Investments
China’s general approach of hedging against over-dependence on maritime routes via the Straits of Malacca or else on any one supplier of oil and gas has not shifted. The two should be assessed separately, given that oil volumes are fungible and natural gas volumes have not yet reached that point.
Natural Gas
The country faces a growing diversity of options in coming years. Some expressed concerns over a decision to cancel Line D of the Central Asia-China gas pipeline network. The pipeline would carry 30 billion cubic meters (bcm) of natural gas from Turkmenistan were it completed, adding to the current 55 bcm of capacity that have been built. But that 55 bcm is not fully utilized and China is now negotiating for greater exports via Lines A, B, and C to cover winter shortages. China is also set to import 10 bcm from Kazakhstan.
The Power of Siberia pipeline being built by Russia’s Gazprom will come online some time in late 2019, built to a capacity of 38 bcm. Once it does, China will have successfully gained access to piped gas volumes from competing overland suppliers. However, the country’s pricing schema for consumers and geographic concentration of industry make LNG a better bet to maintain diversity of supply and keep prices lower. The concentration of capacity is borne out by the fact that China’s LNG imports hit record highs last November since they can more flexibly meet fluctuations in demand.
Production from Russian Novatek’s Yamal LNG – a China-invested project that has weathered sanctions – has finally come to market. Australia’s Gladstone port is now providing record volumes to China and Beijing’s interest in investment into Australia’s LNG production will most likely only grow despite back and forth between businesses over projects. A recent deal to jointly build an LNG plant in Alaska was reached in broad strokes, though the project is questionable economically. It’s likelier that China was trying to send a message to Gazprom to push it lower prices or else speed up construction. By and large, LNG is more flexible and affords many opportunities for competition as the market is facing a glut for the foreseeable future.
More broadly, LNG prices in Asia have hit three-year highs on spot markets due to winter demand. China is looking into projects in Mozambique and Tanzania as it expands its ownership over international production. Given that only Japan imports more LNG than China now, the geographic location of LNG investments will be largely irrelevant for major investments. The most important goal for Chinese policymakers will be making markets more liquid and interconnected, which entails increasing production anywhere possible and applying various levers to end destination clauses or oil-indexation for contracts.
Oil strategy
China’s import dependence is large now – 65-66% of needs are met by imports – and are set to rise to as much as 80% by 2030 due to falling domestic production and economic growth. Energy investments are increasingly important to ensure access to supply as China slowly expands its international presence. These investments will take on greater salience this year as the oil market tightens. Prices have edged above $70 a barrel as production has collapsed in Venezuela and demand has beaten expectations. Schlumberger, the world’s largest oilfield services provider, predicts a 5% increase in international spending on the oil sector, likely in the upstream if prices remain higher. But most higher prices are a particular boon to U.S. production with the same report predicting a 15-20% increase this year for investment into the American oil sector. Growing security concerns over Chinese investments will prove an important narrative for 2018 if China wants to further diversify its energy assets in the U.S.
Despite the appearance of the U.S. on the horizon, China has two dominant vectors for its oil diplomacy: Russia and Saudi Arabia. Private group CEFC China Energy bought a $9.1 billion stake worth 14.16% of Russia’s state oil giant Rosneft. Rosneft has also agreed to supply CEFC China Energy with 61 million tons of oil over the next 5 years, providing CEFC roughly 244,000 barrels per day.
Russia and Saudi Arabia have competed to be the largest provider of crude oil to China’s growing market. This year, Russia has held off Saudi Arabia to maintain the top spot, selling an average of about 1.19 million barrels a day through October. Pipeline capacity from Mohe at the border of the two countries will enable further import growth as Russia pivots its oil supplies eastward where markets are growing. China’s acquisitions in Russia will largely run through Rosneft, which means they’ll be shunted away from oil fields and into gas fields the company owns. Most recently, the Russia Direct Investment Fund has approached Chinese banks and companies in search of investment to expand oil pipeline capacity for Russia’s pipeline monopolist Transneft. Rosneft’s rising deliveries to China are straining existing infrastructure, which remains dominantly oriented towards Europe due to Soviet legacies and foreign investment is likely needed to smoothly meet domestic and Chinese demand longer-term.
Saudi Arabia has courted Chinese investment, reportedly signing deals worth $60 billion with China in late August. The two countries are seeking to expand cooperation on industrial projects. As Saudi Aramco transitions its revenue model to focusing on petrochemical projects and value-added parts of the supply chain, China will be a focus to lock in market share for petrochemical projects. Barrel counts don’t capture Saudi Arabia’s export strategy. Further, Saudi Arabia is looking to make up ground on Russia and other resource-rich states to play a bigger role on commodities markets. China’s steadfast support of Riyadh amidst its current anti-corruption campaign is partially aimed at turning memoranda of understanding into brick and mortar work on the ground.
Perhaps more important than any one project, China is now launching yuan-backed oil futures traded on the Shanghai International Energy Exchange. In doing so, Beijing is carving out a space in the international economic system to have some control over oil prices. Investors will likely be hesitant given China frequently intervenes in the market and has implemented strict capital controls, but the symbolism is in keeping with the broader attempt to use BRI and related initiatives as scaffolding for alternative multilateral institutions dominated or else principally organized by China. Sinochem and other Chinese firms are also looking to reopen U.S. trading desks to capitalize on growing shale production as oil prices have risen.
Energy Outlook 2018
Chinese firms will continue to buy up assets to guarantee access to resources. Look for China’s commodities traders to focus on deepening direct access to and control of supplies in Russia and Central Asia while China’s petroleum sector hopes to draw in Saudi investment and broadens its trading reach. It’s also likely that China will begin seeking export opportunities for nuclear power projects, a move that would free up more oil for export in states like Saudi Arabia. At the edges, China Inc. will also buy up downstream projects in Eastern Europe and the Balkans to slowly expand network of energy assets to establish beachheads in the EU.
Changes in the geopolitical shape of the oil markets – the potential for the U.S. to export greater volumes in coming years – should be watched closely as fears of a slowly developing U.S.-China trade war escalate. Growing space for oil trade would be a logical area of cooperation between the two countries, one that Russia and Rosneft will watch warily. Higher prices seem set to sustain for at least a considerable part of this year given stronger than expected demand. Expect greater interest and appetite in upstream investments from China’s oil majors so long as the projects do not rely on longer-term high price projections like those in the Arctic’s offshore.
