The Fuse

What Does China’s Status as Largest Oil Importer Mean for U.S. Interests?

by Skylar Drennen | August 23, 2017

China is now the world’s number one crude oil importer, overtaking the United States during the first half of 2017. Since 2010, crude oil flows into China have increased by a massive 80 percent, growing to 8.6 million barrels per day (mbd) in 2016. The recent uptick in imports is not being fueled by a sudden increase in Chinese fuel consumption. Rather, steadily increasing strategic and commercial inventory volumes account for the bulk of new imports, which have risen by a substantial 510,000 barrels per day (b/d) year-on-year in 2017.

China’s growing dependence on imports highlights the serious national security dilemmas that could entangle the Chinese government in international conflicts for decades to come.

If the current crude import trend holds through the end of the year, this development will mark a historically significant milestone in Chinese history and the world economy. The country’s growing oil demand is not altogether surprising given its relatively weak domestic supply and impressive economic growth rate. It nevertheless highlights the serious national security dilemmas that could entangle the Chinese government in international conflicts for decades to come. China’s greater emergence on the world stage will extend the economic reach of the Chinese yuan, solidify an increasingly central geopolitical role for China, and grant China larger control over oil markets. But it will also expose Beijing to domestic and international unrest, conflict, and more. Given the United States’ own tumultuous history as the world’s top buyer of oil, the Chinese government should be wary of the unintended consequences that come from this new oil-hungry status.

The Upshot for China

If China were to solidify its spot as the top global oil importer, the country might make a more concerted effort to advance the international status of its currency, the yuan. The proliferation of the yuan has been a long-term political priority of the Chinese Communist Party (CCP), which aims to increase its international legitimacy and challenge the power of the U.S. dollar. The 2008 financial crisis solidified this desire as Chinese and other worldwide holders of American treasuries were forced to buy dollars to maintain the value of their own holdings. Becoming the world’s largest oil and energy importer may be a conduit for the CCP to challenge American economic hegemony, a long-term strategic goal of the Chinese government.

Oil and natural resource purchases have already helped increase the yuan’s international position. In 2011, Nigeria began holding yuan in reserves as it agreed to sell oil to China in exchange for yuan. Iran accepted its first yuan payments from China in 2012 in exchange for oil and gas shipments. By moving away from the dollar, Iran and China skirted dollar-delineated U.S. sanctions. Russia followed suit in 2015, taking yuan payments for oil in gas to contest the power of the dollar and to maneuver amid sanctions from the west. China successfully lobbied the International Monetary Fund (IMF) to make the yuan an official currency with IMF Special Drawing Rights (SDR) status. Making up more than 10 percent of the SDR basket, the yuan is now the third largest component. Winning a place in the SDR signified an ideological and geopolitical victory for the Chinese.

Advancing the power of its currency is one massive step toward attaining China’s geopolitical goal of subverting the unipolar power it perceives that the U.S. wields on the world stage.

Advancing the power of its currency is one massive step toward attaining China’s geopolitical goal of subverting the unipolar power it perceives that the U.S. wields on the world stage. By providing an alternative to the dollar, and to a lesser extend the euro and the yen, China is also providing an alternative to Western influence. This strategy is consistent with Chinese foreign policy dating back to when it embraced its position in the “third world” when global power politics divided the world in two during the Cold War. Increased yuan payments for oil—and greater bargaining power from becoming the world’s biggest importer of oil—could provide China a means to increase the international power of the yuan.

Still no crude benchmark in China

Crude exports to Asia are traditionally priced against dated Brent or Dubai benchmarks, reinforcing that China needs its own marker to boost its clout in the global oil market. China has been working to launch crude oil futures trading on the Shanghai International Energy Exchange. Various factors, including bureaucratic turf wars, uncertainty over eligible crudes for physical delivery, and volatility in stock markets have delayed the launch of the futures contract.

China has seen its influence over global oil prices grow considerably as its economy has expanded at a rapid clip and imports have risen inexorably. Now that it is the largest net importer of crude, expect its impact to increase even more.

Over the last decade and a half, China has seen its influence over global oil prices grow considerably as its economy has expanded at a rapid clip and imports have risen inexorably. Now that it is the largest net importer of crude, expect its impact to increase even more. China’s buying has the ability to distort global oil prices, particularly since Chinese traders having an outsized influence over the Dubai/Oman benchmark. Currently, assessments for Dubai and Oman crudes by price reporting agency Platts are the closest thing to an Asian benchmark, and Chinese oil companies’ active role in these markets reflect their market power and ability to push prices in the direction they want. Dubai/Oman is extremely sensitive to OPEC supply cuts, but also to China’s buying. In this specific benchmark, a slight dislocation of supply—by OPEC producers or anyone else selling to Asia—along with China’s buying can cause rapid changes in the spreads versus Brent or WTI, the Atlantic basin markers. In this case, China can exert its powerful influence not only on Dubai/Oman, but also on all global prices. Furthermore, China has been buying crude from U.S. sellers in an effort to diversify its supply base, an example of how the country’s thirst for more oil is unambiguously having a global impact on trade flows and pricing.

A Chinese futures benchmark may bring some benefits and transparency. A futures contract in China would allow for better resource allocation and hedging, and greater control of oil volatility through financial regulations that are similar to the regulations in place for currency and equities. But some market watchers believe it will simply operate similarly to Dubai/Oman, with few big Chinese players having outsized influence on the market, and by extension regional and global prices.

At the same time, increased domestic oil refining capacity also builds the country’s clout in the global market. Higher downstream capacity enables China to create jobs and maintain political stability. Just as critically, by importing more crude oil and fewer refined petroleum products, the Chinese stand to increase their market share along the petroleum value chain. In fact, the country has become a big exporter of refined products over the year, allowing it to further flex its muscles in the Asian market.

United States’ power challenged

Now, as oil-producing countries hold fewer U.S. treasuries, and as the dollar’s influence is chipped away, the U.S.’ longstanding monetary advantage could be at risk.

With the rise of one power, inevitably comes the relative weakening of another. Losing its position as the world’s undisputed long-time oil importer does have downsides. Principally, the factors shifting global power from a unipolar to a multi-polar model may threaten the U.S.’ sole-superpower position. The dollar has stood as the dominant global currency since the launch of the Bretton Woods system, and the transition from a gold-backed dollar to the petrodollar maintained American monetary dominance. Now, as oil-producing countries hold fewer U.S. treasuries, and as the dollar’s influence is chipped away, the U.S.’ longstanding monetary advantage could be at risk. Merely promoting the yuan through oil payments will not create the multi-polar power structure that China wants, but it is a strategically palatable move in a longer-term power-play.

There will be other implications of a stronger China that will receive mixed reactions in the U.S. The U.S. will lose some of its clout in major oil-producing regions, for better or for worse. China’s closer diplomatic relationships with countries that the U.S. has traditionally been the main powerful trading partner (most notably Saudi Arabia) will reduce Washington’s influence and grant Beijing a growing role in global issues. This is not fully a bad outcome for the world or for the U.S., given that it could dial back on military engagements overseas. But it does mark a major change for the U.S—which would have to adjust to no longer being the biggest name at the table in international diplomacy. In such a case, conflicts in oil-producing countries where the U.S. has interests will gain an additional dimension of complexity.

A Precarious Position

The most challenging aspect of increased reliance on imported oil is the political and investment risk that comes with closer ties with oil-producing countries. The Chinese strategy is complex and relies heavily on regional organizations to solve problems. However in the case of the Middle East, in the era of renewed Sunni and Shi’ite conflict, the regional powers often have diametrically opposed agendas. A growing footprint in conflict-prone places may only heighten the potential for instability, forcing China to act to protect its citizens and economic interests. In 2015, China deployed its first ever peacekeeping troops to South Sudan, and this year it opened a military base near the strategically important Bab al-Mandab Strait in Djibouti. Reports from multiple sources also suggest that Chinese patrols are operating in Afghanistan in an effort to maintain border stability in the event that the United States pulls out.

If China’s economy becomes more dependent on foreign oil, then the CCP’s legitimacy will, in many respects, be tied to the whims of the oil market.

If China’s economy becomes more dependent on foreign oil, then the CCP’s legitimacy will, in many respects, be tied to the whims of the oil market. As reported by Bloomberg this year, although China’s major oil investments have been constrained to mostly Iraq and Iran, Saudi Arabia is moving to win Chinese loyalty and investments. Saudi Aramco is currently in talks to buy a $2 billion and 30 percent stake in a refinery owned by China National Petroleum Corporation. This agreement comes with hopes that the Chinese will buy major stakes in Aramco when it commences an IPO. China’s oil acquisition strategy has thus far avoided areas where the U.S. has a strong presence. Nevertheless, as China grows more reliant on oil from Iran, Russia, Saudi Arabia, and Iraq, the task of managing a neutral position among trading partners will become increasingly more complex. Tighter relationships with these producers will bring about an increased probability of international interventions to protect China’s interests. To that end, China risks exposing itself to the same types of long-term risks that the U.S. has seen from dependence on imported oil.

One Belt One Road and China’s future

China must grapple with these issues as it takes the not-so coveted position as the world’s top oil importer. Although one of the main policy goals of the Chinese One Belt One Road (OBOR) policy is to increase energy security by diversifying supply and transport routes, buying more foreign oil means higher vulnerability to supply and price shocks. The OBOR policy is a massive investment undertaking of the Chinese government to create supply chains, build infrastructure, develop markets, and diversify energy sources across Asia and reaching into Africa and Europe. One such approach involves constructing a pipeline through Myanmar that bypasses the maritime chokepoint at the Straits of Malacca. The OBOR initiative has garnered significant attention for being—as one New York Times piece commented—a “more audacious Marshall plan,” aiming to build global commerce “on China’s terms.” The same article notes that this investment plan helps spur economic growth as a means of quelling the spread of radical Islam across China’s shared border with Pakistan. With estimates of its Muslim inhabitants ranging between 20 and 50 million, China has a larger Islamic population than Syria. For this reason, the Chinese government has become increasingly anxious about its Uighur population in the far west province of Xinjiang. It is possible that by increasing its presence in the Middle East to secure oil supply, China will find partners that are ideologically outraged by the way it treats its own Islamic citizens. There could be a time where China becomes both the lead purchaser of the oil and the main target of state sponsored extremism, a position not unfamiliar to the United States.

China’s quest for energy and economic stability will be an important factor in shaping the geopolitics of the 21st Century.

Becoming the world’s largest importer of oil does not mean that China will immediately take on all the potential advantages and shortcomings of such leverage. Nor does it mean that the U.S.’ lower ranking will strip the superpower of the consequences of its own massive oil consumption. It does, however, expose China to future opportunities and pitfalls that the emerging power will struggle with as its policy continues to support growing oil imports. Of course, at the same time, the Chinese government is pursing long-term strategies that are designed to reduce dependence on international energy supply. China’s electric vehicle quota and domestic shale exploration plans are two such policies that would mitigate risk. The problem for the Chinese, then, is one of scale, timing, and feasibility. Will medium-term energy dependence transform into long-term strategic partnerships and increased economic power? Or will the country find itself in a precarious position as real problems overshadow potential benefits? Regardless, China’s quest for energy and economic stability will be an important factor in shaping the geopolitics of the 21st Century.

 

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