Mar 2005

This article is part III of a series. Click the following for part II, Ensuring Food Security. For part I, click here .

While food is necessary for survival, energy is necessary for growth… and the dragon is ravenous. China’s oil demand has doubled over the past decade, and the pace is only increasing. There will be ups and downs along the way; when the current infrastructure boom and flood of foreign investment slows, energy demand will slow for a time also. But in the long run, the trend is inexorably steep.  Consider this excerpt from The Economist:

In around 20 years’ time, China’s income per person could be close to South Korea’s today. If its energy consumption per person also rose to current South Korean levels, its energy demand would quadruple. The increase alone would be greater than America’s total consumption today, yet China’s energy use per person would still be only half that in America. At present there is only one car for every 70 people in China, against one car for every two Americans. If car ownership were eventually to rise to American levels, there would be 650m cars on Chinese roads- more than all the cars in the world today.
- “A Hungry Dragon,” The Economist Sep 2004

How is China going to ensure energy security with such a tall order to fill… let alone building the power-generating capacity for such incredible demand?

First, China will develop strategic ties with key energy producers who prefer an alternative to the “Bush doctrine” of the United States. Second, China will invest in local production and alternative energy sources that reduce reliance on imports over time.

Bush doctrine = China window

As spelled out in President Bush’s inaugural address and State Of The Union speeches, the Bush doctrine is essentially the mandate of Iraq writ large. Under the current administration, the US has literally expanded its moral ambitions to the sky, seeking “freedom”--that is to say, the workings of American-style democracy--for “everyone, everywhere.” 

Some think President Bush is merely engaging in grand rhetoric, building an emotional case for legacy with elections in Afghanistan and Iraq as a backdrop. For good or ill, others believe him quite serious in his efforts to impose America’s version of democracy on the world. Whether the Bush doctrine is morally justified makes no difference; whether it is more than just rhetoric is of secondary importance also. By declaring an aggressive enthusiasm for moral intervention, the United States has given China a window of opportunity.

The perceived self-righteousness of the United States has always been a sore spot for quasi-democratic countries; especially the ones with rough spots that could do for a little patching up.

In the case of Russia and Venezuela, you have two quasi-democratic countries who are also key players in the global energy game. The Bush doctrine has practically driven them into China’s embrace. America lectures Russia on human rights abuses, too firm a hand in Chechnya, too much Moscow influence in regional affairs etcetera; China simply smiles and shrugs. America lectures Venezuela on tainted elections, dictator style reforms, and over friendly relations with Cuba; China just smiles and shrugs. You get the idea.

With the Bush doctrine, the US has gone from muted criticism to grand moral pronouncements that, to quasi-democratic leaders, sound like , intrusive meddling at best, veiled threats at worst.  China, meanwhile, smiles and shrugs: do business with us, Beijing seems to say, and your quirks will not be criticized. Judge not, lest ye be judged. 

The apparent success of the Chinese model, in fact, runs directly counter to the Bush doctrine. Why absorb the risks of full-blown democracy, when you can enjoy economic prosperity and relative political stability at the same time… by doing it China’s way?

Moral or otherwise, this stark choice between criticism and laissez faire plays to China’s gain.  As American influence over quasi-democratic countries deteriorates rapidly, China‘s strategic energy ties become almost a virtual lock.

Hostility in America’s backyard

Consider Venezuela. As the fifth largest producer of petroleum in the world, Venezuela exports 60% of its product to the United States, representing approximately 13% of US oil consumption. As far as location goes, Venezuela is in the US’ backyard and halfway around the world from China… yet China and Venezuela have established firm footing for a long term partnership, while Venezuelan ties to the US are all but destroyed.

Venezuelan President Hugo Chavez is so incensed with the Bush doctrine, he has all but declared economic war on the United States. Chavez has announced his intention to sell eight highly profitable US oil refineries, mainly out of desire to cut ties with the US.  Venezuela’s energy minister, Rafael Ramirez, has said his country would be reviewing more than 30 operating agreements dating back over the past decade to examine their “viability” for Venezuela… shorthand for further divestment of US business ties.

All this plays into China’s hands quite nicely, and there is more. With Chavez openly antagonizing Venezuela’s major customer, that source of revenue must be replaced by another major customer--and Chavez is willing to sacrifice Venezuela’s OPEC ties to make it happen. Earlier this year, Venezuela missed an OPEC meeting… to sign a series of partnership agreements with China!

This past January, Chavez signed 19 agreements with Chinese Vice President Zeng Qinghong, a number of them directly involving the Chinese National Petroleum Corporation. The rhetoric was thick and rich. “Each agreement will turn into a thousand things,” Chavez said, “…we are absolutely sure of the great will of the Chinese government and I ask that all of the members of my government, ministers, presidents of institutions and companies, put forth our maximum efforts so that not one of these agreements remains just on paper, but instead all become reality.”

Meanwhile, what has the US done to maintain South American ties and stabilize a key petroleum source? So far, next to nothing. With a focus on the middle east abroad and domestic policy infighting at home, US geopolitical alliances are crumbling. Not only has Venezuela declared strategic allegiance to China and open hostility to the United States, they are purchasing arms from Brazil and Russia in a bid to defend themselves against a US invasion.  The Brazilian order: a dozen Super Tucano light attack aircraft. The Russian order: 50 Mig-29 SMT warplanes, 100,000 Kalashnikov rifles, and 40 helicopters. 

Does Chavez really think he is in danger of American invasion? Maybe he’s crazy enough to believe it… or maybe it’s just political theatre to strengthen his position at home. Regardless, China wins and America loses once again. The more China’s new friends engage each other in vigorous trade hostile to US interests, the more America’s influence slips away.

The state of Putin’s soul

While there was never much love lost between Chavez and the United States, Bush should perhaps take Russia’s defection more personally. In the past, President Bush and Putin had enjoyed a cautious friendship; on one of Putin’s relationship-building visits with the President, Bush had famously “looked into his soul…” and pronounced him a good man.

Those days are gone now, as Kremlin policy has distinctly shifted east. Whether or not Putin is still a good man in Bush’s eyes, he can no longer be seen as a clear United States ally.

While China is planning its rise to dominance, Russia is fighting a slow slide into internal chaos. The West is seen as ignoring Russia on the one hand, yet actively seeking to weaken Russia’s regional influence on the other; it is hard to say which is more offensive to Moscow. By establishing a strategic partnership with China, Russia ensures attention from Washington and a continued presence on the world stage.

All of Russia’s recent moves indicate realignment towards China and away from the United States. The destruction of Yukos and jailing of the fallen oligarch, Mikhail Khodorkovsky, has allowed for a concentration of energy-producing assets in state hands. As Vladimir Milov reports in the Wall Street Journal, renationalization of Russia’s energy industry was followed up by the abandonment of a key Russia-US project: an oil pipeline from West Siberia to Murmansk that would have facilitated major commercial exports--one million barrels per day--to the United States.

With this pro-US project abandoned, what did the Kremlin choose to pursue instead? A “controversial pipeline,” as Milov describes, “to pump western Siberian oil more than 3,700 miles to Nakhodka in the far east.”  Russian minister Yuri Tutnev confirmed the western freezeout on February 10th, with an announcement that foreign firms are banned from bidding on all future natural resource projects.

The Kremlin must act in line with Russia’s strategic interest, and right now open-market capitalist development does not fit with that interest. An growing alliance with China, however, fits the bill quite nicely.

As with Venezuela, the story only gets worse from an American perspective (or better, from a Chinese one). Russia and China have arranged for high level security talks, arranging communications between Russia’s security council and China’s Politburo. And this is more than just talk: joint military training exercises are tentatively scheduled for late 2005. In discussing mutual threats, there is only one nation that could be at the top of the Sino-Russian list: the United States.

Of course, energy links are quickly solidifying; Siberian outposts with hard to pronounce names like Krymskaya and Zaibalkalsk are being outfitted to handle a five-fold increase in transport capacity as quickly as possible. Conservatively, Russia seeks to increase total oil exports to China five-fold over the next few years, with further increases of similar magnitude to follow.

How can America reverse this turn of events? Now that Russia’s realignment is in play, it is hard to see any way to turn the course. The pro-Western influence on Russia’s European flank cannot be undone; the pro-Western victory in Ukraine cannot be taken back (nor should it be). Distracted by pressing affairs in the middle east and at home, Bush has little to offer his hemmed-in friend Mr. Putin. And in fact it is not hard to empathize with Mr. Putin, at least a little: faced with the prospect of a crumbling empire too sprawling and choatic to control, what choice does he really have? With China offering resurgence and new horizons, versus America offering little more than distracted rhetoric (and the veiled threats of the Bush doctrine), did Putin really have a choice of allegiances at all?

As with Brazil and Australia, Venezuela and Russia are merely two vivid examples of Chinese maneuvers on the energy security front. Similar policy will apply elsewhere on a smaller but broader scale. Net energy exporters in quasi-democratic regions will be attracted to China’s laissez faire, “judge not” attitude, while the flattery card will be played for full value wherever it holds appeal. China could practically run a television commercial:

Tired of being overlooked and underappreciated by the United States? Tired of being lectured at and talked down to because your political ideals aren’t up to snuff? Consider an allegiance with Dragon Inc. We’ll treat you with the respect you deserve.

Oh, Canada

Last but not least, China is even looking to America’s northern neighbor for long term energy security. Canadian Prime Minister Paul Martin visited China in January, bringing more than 350 trade and government representatives with him. High on the agenda: Chinese investment in Canadian oil sands infrastructure and development projects.

Alberta’s oil sands account for nearly 179 billion barrels of oil-equivalent energy--second only to Saudi Arabia for proven reserves. For the moment, the Alberta deposits are not commercially viable on a mass scale, due to the intense processing required to extract and refine the product. Though investment capital is plentiful, significant bottlenecks of labor, machinery, and energy all mean the scaling-up process will be painfully slow. 

But China is looking to the future, when its current energy demand has trebled or quadrupled. At that point, the economics of Alberta’s oil sands will not only be highly attractive, they will be downright sexy. In that spirit, Prime Minister Martin and Chinese Premier Jiabao signed close to a dozen bilateral agreements to conclude the January visit, cementing Canada’s willingness to overlook human rights concerns and ink a lucrative investment deal with the dragon. For America, Canada’s turn has a special bite to it; perhaps because America’s polite northerners have always been so vocal and visible about taking the idealistic high ground.

Other alternatives

With strategic ties to key producers like Venezuela and Russia in place, exploration and development efforts underway, and Canada as a longer-term energy source, China’s other focus is alternative energy. Through development of local resources and investments in cutting edge technology, China can further close the energy gap and thus reduce dependence on outside partners.
To this end, China is upgrading its nuclear power capabilities and investing heavily in advanced technology that will turn coal into petroleum products. It is in this area where western investment opportunities remain; while it is not feasible to invest in Venezuelan or Russian governments, China cannot avoid partnering with western companies when access to technology is required.

Nuclear power is a natural choice for China. The standard “green” objections to nuclear power simply do not exist in the middle kingdom. Furthermore, China has awful problems with water shortage, air pollution, and acid rain; a nuclear alternative could remedy some of these issues by substituting nuclear energy for fossil fuels and removing stress from the environment. Nuclear power has another green aspect as well: it produces virtually zero carbon dioxide, and thus does not contribute to global warming.

China has plans to develop a new type of reactor design known as the PBMR, or Pebble-Bed Modular Reactor.  The pebble-bed reactor is theoretically cheaper and easier to build than traditional PWR (pressurized-water reactor) plants. The pebble-bed reactor also has a safety edge in that it is supposedly “meltdown proof;”  the reactor’s uranium “pebbles” (actually the size of billiard balls) are coated with high density carbon, preventing exposure in the event of a coolant leak. Thus, in theory at least, the disasters of Chernobyl and Three Mile Island could not happen with a PBMR. Furthermore, because the pebble-bed reactor design is modular, extra generating capacity can be added over time, allowing for further development as needed and less lump sum expense for initial construction.

China is in competition to develop the first commercially viable pebble-bed reactor with a consortium led by Eskom, South Africa’s state-run utility firm. Eskom claims to have a lead in technological development over China, but an environmental challenge in South African courts has created a legal hurdle Eskom must clear. (China, of course, does not have to trifle with annoying protesters who dare oppose national interest.) 

First-mover advantage is a potentially valuable prize, with the opportunity to license PBMR technology and construction to other countries hungry for an inexpensive and safe energy source. Eskom may still be in the running for a commercial product even if China gets there first; while China’s main focus will be developing a new energy source quickly and building rapidly, Eskom’s niche could be in developing more safeguards and design efficiencies--worth the price tag for more prosperous (and litigious) societies where any nuclear solution must meet stringent high standards.

On another experimental front, China is spending more than $3 billion on a coal liquefaction plant in Inner Mongolia. The Shenhua Group, China’s largest coal producer, has partnered with a US technology provider to convert coal into petroleum products. In a nutshell, the process involves breaking coal down into hydrogen enriched molecules, which are then converted to traditional oil products. According to Zhang Yuzhou, vice-president of Shenhua Group, “The project consists of two phases of construction, and after the second is complete, the plant aims to yield five million tons of oil products annually and greatly reduce China’s reliance on crude oil imports.” 

The economic viability of coal liquefaction hinges on the cost of crude. Oil must remain above a breakeven point of approximately $32 a barrel for the process to be profitable. If the price of oil falls below $30 for a sustained period of time, the liquefaction plant may prove to be a costly albatross. But this is a risk China is more than willing to take, especially given the boost in energy security that internal production provides. As China continues on a path of dramatic growth, reliance on oil imports is expected to grow steeply in percentage terms as well, so alternative energy investments would do well just to keep pace with this trend. If oil imports represent less than half of consumption in the year 2020, China will have won an important strategic victory.

The winners and losers in China’s quest for energy security revolve around transport, exploration, and technology. China’s demand for oil imports will rise inexorably over time, even as their internal energy sources come on line. This will create a rising demand for tankers, which in turn may benefit shipbuilders over the long cycle.

As oil economics turn in favor of further exploration, there will be more opportunity in development and wildcat style exploration projects, with big profits to the winners and heartbreak for those who come up dry. Look for the oil majors to participate indirectly in any exploration boom as well, spreading their risk through funding and backing of smaller players.

And of course, alternative energy technology is coming into its own. For the past few decades, alternative energy was simply not an economically viable option: energy was too cheap, and the initial development costs too high, to take alternatives seriously. But now the development seeds are being sown, with compelling economics on the horizon for fossil fuel substitutes. In this arena, the companies positioned to profit most are those with hands-on intellectual property… alternative technologies that can be sold, licensed or leased but not easily copied or stolen, due to implementation requirements and need for hands-on expertise.

Next, Part IV: Building Regional Ties.