Quest for Crude

By Matthew Forney

Yang Hua's passport is stamped with visas that would alarm immigration clerks around the world. He showed up in Indonesia two days after the Bali disco bombing in 2002. He has logged trips on a moment's notice to Iran, Yemen and Qatar as well as the U.S., Australia, Canada, England and Brazil. And Yang doesn't try to hide the substances contained in little glass vials that he brings home from his travels. In fact, they're lined up on the windowsill of his Beijing office, affixed with labels like SAUDI SWEET. Yang, it turns out, works for the China National Offshore Oil Corp. (CNOOC) and is responsible for the state-owned company's efforts to secure oil and gas supplies all over the globe. The samples of crude are souvenirs that testify to how far he must roam in his search. "I'd like it if there was oil under Paris," he says, "but I spend my time in less comfortable places."

Yang's globe trotting reflects just how powerful China's thirst for fossil fuels has become. A booming but energy-inefficient economy and an emerging middle class in love with cars and other modern conveniences have caused energy demand in China to soar. The nation's oil imports have doubled over the past three years and surged nearly 40% in the first half of 2004 alone, pushing the country past Japan to become the world's second largest oil consumer, behind the U.S.

Today numerous factors are driving up the price of crude, from chaos in Iraq to turmoil in Nigeria to hurricanes in the Gulf of Mexico. "It is neither fair nor accurate to blame China for most of the rise in oil prices," says Jeffrey Logan of the Paris-based International Energy Agency. But China's impact should not be ignored. Even if China's blazing GDP growth of 9.1% in the first three quarters of this year (compared with the same period the previous year) slows to 8% in 2005, as the Chinese Academy of Social Sciences predicts, the country has become a permanent player in the global competition for oil. "More than a billion Chinese are joining the oil market," says Bo Lin, an energy specialist at the Asian Development Bank. "How can prices go down?"

China has not always been so dependent on imported oil. The discovery in 1959 of the Daqing oil fields under the Manchurian grasslands meant that the once largely agrarian country was for decades able to produce more crude than it required, a circumstance that the government celebrated as a political victory. ("Study Daqing!" chanted legions of Red Guards during the 1966-76 Cultural Revolution.) Oil and gas discoveries in the South China Sea and the Bohai Gulf, where drilling began in 1979, made China seem all the more invulnerable to oil shocks, and the country remained an oil exporter until 1993. Today, however, output from China's top four oil fields is in decline. By some estimates, the country's current proven reserves will be depleted in as little as 14 years. Meanwhile, it is not economically feasible to drill largely untapped petroleum pools believed to lie beneath western China's desolate Tarim Basin, even with prices at $50 a barrel.

That doesn't mean China's robust economic engine will grind to a halt. The mainland meets more than two-thirds of its energy needs with coal and boasts the world's largest reserves. But to keep its economy racing ahead--and to ease some of the pollution that comes from burning coal--China's leaders have been forced to seek ever greater supplies of petroleum from overseas. More than half of China's oil imports currently come from the volatile Middle East, making oil security a growing concern in Beijing. China plans to build a strategic oil reserve, and the country has several pipelines planned that would theoretically provide supplies from fields in Russia, Central Asia and Burma. But China's state-controlled oil industry, consisting of three major companies (China National Petroleum Corp. [CNPC], CNOOC and Sinopec), and numerous overlapping bureaucracies have yet to develop a clear, comprehensive energy policy.

Leaders in Beijing want to avoid the fate of other oil-poor countries like South Korea, which buys all its crude on the open market and is therefore exposed to sharp price rises. The way to do that is to invest in exploration and development in countries that have oil fields but lack the capital or technology to exploit them. When Chinese companies have a stake in oil coming out of the ground, even if it originates abroad, they will have secured long-term supplies independent of the world's fickle prices. The process of overseas exploration began in 1997, when Premier Li Peng encouraged state-run oil concerns to look for investment opportunities outside China's borders, and in the past few years, the search has ranged all over the world.

CNOOC, for example, signed a deal two years ago to extract 1 million bbl. of oil a day in Indonesia, and a year ago, it signed a major contract to produce gas in Australia. In February, President Hu Jintao traveled to Gabon hoping to secure deals in Africa, and in June he led a delegation from China's natural-gas industry to Uzbekistan. Chinese oil executives have even begun courting Ecuador and Colombia. "Latin Americans feel frustrated that the U.S. has virtually ignored the region, so turning to China is prudent and will pay financial dividends down the line," says Cynthia Watson, a professor at the National War College in Washington.

China's stepped-up efforts have already created some friction. Earlier this year ONGC Videsh, the overseas-investment arm of India's largest oil and gas producer, was on the verge of completing a deal for an 11% stake in a proven oil field in Sudan when China's CNPC swooped in with an offer reportedly 17% higher--and snatched the deal away. "The Chinese are definitely very aggressive in the price they are willing to pay," says R.S. Butola, managing director of ONGC Videsh. Beijing has demonstrated that it is willing to face down international pressure to protect its energy interests. Last month the U.N. discussed imposing sanctions on Sudan as punishment for sponsoring genocide in Darfur. China--which has invested a reported $15 billion in Sudan oil projects and imports oil from there--threatened a veto. The Security Council passed a watered-down measure.

Despite that aggressiveness, China's overseas investments supply just 5% of imports--the rest is purchased on the open market. Mainland oil companies have twice been foiled in their efforts to buy stakes in fields in Kazakhstan, and they haven't secured any other significant drilling rights in Central Asia or the Middle East. The fields that Chinese companies have bought into are already mature, and many experts feel they have overpaid. "China has been singularly unsuccessful in its overseas ventures," says Jim Brock, a Beijing-based energy consultant. "They're trying to learn in a decade what it's taken big foreign companies a century to master."

The failure to secure a pipeline from Russia has especially frustrated China's leaders. Siberian oil is transported into China at great expense on trains and trucks. For years Beijing has lobbied its former communist brother for a pipeline to refineries in Daqing. During a visit to Moscow last month, Premier Wen Jiabao repeated China's entreaties but received no promises. Meanwhile, Japan has offered to pay for part of the multibillion-dollar pipeline--as long as it terminates in the Russian port of Nakhodka, near Japan. Moscow seems inclined to take Japan's offer. "China feels betrayed," says Bernard Cole, an expert on China's oil needs at the National War College.

Even at home, Beijing has faced setbacks. In August a consortium led by oil giant Shell pulled out of a just-finished gas pipeline--running 2,730 miles from the western deserts to Shanghai-- after the firms decided their returns would be too small. A planned oil pipeline covering the same distance has seen no takers. Then, last month, Shell and Unocal backed out of a multibillion-dollar project to tap gas fields under the East China Sea.

So China's import requirements will continue to rise--putting upward pressure on world crude prices. If China's oil demand keeps growing an average 7% a year, as it has since 1990, in less than 20 years the country will consume 21 million bbl. of oil a day, matching current U.S. consumption. "The world has the oil," says Chen Huai of China's Development Research Center, a think tank in Beijing run by China's Cabinet, "and China has the money." The question is, how much is China--and the world--willing to pay for it? --With reporting by Susan Jakes/Beijing

With reporting by Susan Jakes/Beijing