Shifting Sands: Saudi Arabia’s Oil Moves East to China

Published April 05, 2011 in Arabic Knowledge@Wharton

The pivotal year was 2009, according to the Paris-based International Energy Agency (IEA). It was then that China consumed more energy than any other country in the world, even the U.S., prompting an expert at the IEA expert to proclaim “the start of a new age in the history of energy.”

For Saudi Arabia, which has the world’s largest oil reserves and is the world’s largest oil exporter, that new age couldn’t begin fast enough. Over the past 10 years or so, the Kingdom had been forging closer trade ties with China, becoming its key source of oil. In 2009, Saudi oil exports to China reached one million barrels per day (bpd), or 20% of its total oil imports and nearly double the number of barrels it exported the previous year; in contrast, U.S. imports of Saudi oil fell to less than one million bpd in 2009 for the first time in over two decades.

According to Tim Niblock, professor of Arab Gulf studies at the University of Exeter in the U.K., the growing Sino-Saudi oil trade is a reflection of the two countries’ “mutually dependent relationship that has advanced fairly steadily since 2000.” The Chinese need Saudi Arabia as a stable, established oil producer — all the more so today as turmoil across the Middle East continues, pushing the price of Brent crude to as high as US$116 a barrel in early March, and the Kingdom calms markets with pledges to increase production to fill any shortfall in supply. The Saudis need China’s burgeoning demand for oil in light of flat, or even decreasing, demand among consumers in developed markets. Even with the Chinese government lowering the official target earlier this year for average GDP growth over the next five years to 7% from 7.5%, the country’s thirst for oil looks unlikely to abate.

But are those ties now being tested? As unrest sweeps across the Middle East and North Africa, the entire region is on the cusp of change in ways that will affect the geopolitics of oil. “The whole political situation is different than what it was a couple of months ago, and it will stay different for a long time,” says Niblock. “It is a major turning point. Inevitably, that will have foreign policy effects. But it is very difficult at this stage to know what the nature of those effects will be, because we’re really only at the beginning of a process.” Equally unclear, then, is where the Sino-Saudi oil relationship goes from here.

Growing Interest

Though diplomatic relations between the two countries were established in 1990, it wasn’t until 2006, when Saudi Arabia’s King Abdullah made China the first destination for his early state visits after succeeding his half-brother to the throne the previous year, that the bilateral relationship began to gel. As a result, “the Sino-Saudi relationship is expanding across all levels,” says Paul Gamble, head of research at Riyadh-based Jadwa Investments. He cites 2009 data showing that China was the source of 11.3% of the Kingdom’s imports, including textiles and heavy machinery, compared with 6.6% in 2004, while Saudi Arabia’s share of China’s imports rose to 11.2% from 4.8% over that time, thanks mostly to oil. In 2010, bilateral trade reached a record high of US$43 billion, a year-on-year increase of 33%, scooting the countries closer to their goal of having their trade reach $60 billion by 2015.

As for oil, Saudi Arabia shipped 36.7 million metric tons of oil to China in the first 10 months of 2010, about 19% of its foreign purchases, according to Chinese government data. Angola, the second-biggest source, sent 33.7 million tons and Iran 17.2 million tons.

It’s not just about trade, however. “One needs to take into account the significant contracts coming China’s way in Saudi Arabia,” says Niblock. Those contracts involve Chinese companies getting a slice of the US$385 billion that the Saudi government is investing in infrastructure, such as highways and railways, under its five-year development plan launched in 2009.

In reverse, Saudi companies are also investing in China. Saudi Aramco, the world’s largest oil company, has two refineries in China, one in Qingdao province that is fully owned and another in Fujian province run as a joint venture with Sinopec, a Chinese petroleum giant, and ExxonMobil of the U.S. Then there’s the US$32 billion oil-processing joint venture in Tianjin in northern China between two other Saudi-Sino giants — Sabic and Sinopec — which went into operation last year to produce 3.2 million tons a year of ethylene derivatives. More such partnerships could be on the way. During the Tianjin venture’s first quarter results announcement, Sabic’s chief executive, Mohammed al-Mady, cited lower labor and materials costs is a big reason why his company is open to making further investments in China.

An Insatiable Appetite

In other parts of the world besides Saudi Arabia, China has deployed a relatively straightforward strategy to secure access to natural resources — it simply opens its check book and uses a combination of inward investments and trade deals. In Brazil, for example, China lent US$10 billion to national oil company Petrobrás to secure future oil supplies. China’s oil giant Sinopec, meanwhile, bought a 40% stake in Brazil’s other major oil company RepsolBrazil for US$7.1 billion. By August last year, China was Brazil’s top foreign investor, with a finger in everything from iron ore and mineral processing to telecoms and electricity grids.

Though China is driven by an overwhelming need for secure oil supplies via the likes of Saudi Arabia, it’s not afraid of also tapping high-risk countries. Iraq is one example. Precarious political stability aside, Iraq has abundant oil reserves and underdeveloped oil fields. In 2009, China National Petroleum Corporation (CNPC) and BP entered into a 20-year service contract with Iraq’s State Oil Marketing Company to develop the war-ravaged country’s Rumaila oil field. Reports in China’s state press from earlier this year say that daily output from Rumaila, currently the world’s fourth-largest oilfield, is 1.03 million barrels and rising. “The scale and the dynamics of this contract have no precedent,” observes David Butter, head of Middle East research at the Economist Intelligence Unit (EIU) in London. “It provides an interesting paradigm in terms of the working relationship between an increasingly confident Chinese oil company and an old-school Western major.”

China is also banking on oil-rich Russia. “China’s oil production is pretty much maxed out and it needs Russian oil,” Laban Yu, an energy analyst at Macquarie Hong Kong, told Bloomberg in September. “In fact, it needs oil full stop and Russia is close and convenient. As part of agreements to supply oil, Russia wants to have stakes inside China in ventures,” including a venture being discussed between CNPC and Russia’s state-owned Rosneft to build a US$5 billion refinery in Tianjin. And to increase exports from Russia, the first oil pipeline between the two countries was opened earlier this year, financed by a US$25 billion loan from China to Russia.

And it’s not only China’s sizeable check book that has made it such an attractive business partner. Its policy of refusing to meddle in the politics of the countries in which it invests has also opened doors in parts of the world shunned by other governments. While such policy “agnosticism” might be a welcome counterweight in some oil-producing markets to what’s seen as meddling U.S. foreign policy, it has been drawing increasing criticism from other trading partners.Iran, which has the world’s second-largest oil and gas reserves, is a case in point. Despite several rounds of arms and financial sanctions by the United Nations Security Council, the U.S. and the European Union over Iran’s contentious nuclear program, China has continued to sign oil deals with it.

But even close partnerships that eschew politics cannot guarantee oil supplies, according to Ben Simpfendorfer, an economist and editor of China Insider web site. “The best security [for supply] Chinese companies can hope for is to buy oil at the highest possible price,” he noted in his 2009 book, The New Silk Road: How a Rising Arab World Is Turning Away from the West and Rediscovering China, citing examples of China’s state-owned oil companies with deep pockets paying above market rates for oil imports around the world.

Drilling Down

Meanwhile, in cash-rich Saudi Arabia, China has needed a different deal-making strategy. “With one of the world’s most developed energy sectors in terms of infrastructure and operating efficiency, Saudi Arabia is not desperate to attract foreign investment to help expand its capacity to produce and export oil,” a blog on the Saudi-U.S. Relations Service web site notes.  Instead, Saudi Arabia wants to find new sources of steady, long-term demand as Western countries decrease their oil consumption of oil.

“Chinese investment in the Saudi energy sector is relatively modest at present, owing to limited opportunities in the upstream segment and Saudi Arabia’s historical preference for tying up with Western firms offering advanced technology,” says David Butter, head of Middle East research at the Economist Intelligence Unit (EIU) in London. “What is interesting is the building of partnerships and joint ventures between Chinese and Saudi companies. That’s as close as the Chinese can get to owning any oil assets,” he adds.

Those partnerships and joint ventures mark an important recalibration of the Kingdom’s oil policy. “Saudi’s economic relationship is certainly shifting,” says Niblock. “Most Saudi oil is going eastward than westward. Its relationship with the East is becoming more important, and probably more so in the future. It’s not just China. Japan and South Korea are importing a lot of Saudi oil, too.” And as more Saudi oil goes eastward than westward, there’s a new layer of complexity in the geopolitics of oil, involving one of Saudi Arabia’s closest ally, the U.S.

In a bid to diversify its energy sources, the U.S. has been reducing its oil imports from Saudi Arabia, now its fourth-largest supplier of oil, behind Canada, Mexico and Venezuela. But Saudi Arabia and the U.S. are tethered together in ways that go beyond oil. That includes interlocking defence and security strategies in the region. The U.S. State Department also confirmed last autumn that it plans to sell as much as US$60 billion in advanced military aircraft, the largest-ever U.S. overseas arms deal. “Neither China nor Saudi Arabia want to politicize their relations because each of them have good reason not to,” says Niblock. “Saudi Arabia because it remains strategically dependent on the U.S. in weaponry and some other key ways; and in conversations I have had with Chinese officials, they say they are worried about the relationship with the U.S. — they realize the Gulf is very important to the United States, and they don’t want to undermine this.”

But other observers wonder whether tensions might be mounting. In a 2008 report titled, “The Vital Triangle: China, the United States and the Middle East,” Washington, D.C.-based Center for Strategic and International Studies (CSIS) noted that China military buildup around the “vital” sea lanes for shipping oil out of the Middle East, for which the U.S. has long provided security is causing unease. “Analysts wonder about the purpose of the Chinese-built deep-sea port in Gwadar, Pakistan, and its implications for a Chinese military presence far beyond the Pacific Ocean. Gwadar is only 45 miles from the Iranian border and 250 miles from the Strait of Hormuz, making it close to the region’s most vital waterways,” the report noted. Nonetheless, the report’s authors conceded that the China’s “capacity to regulate and dominate the 7,000 miles of ocean between Shanghai and the Strait of Hormuz lies, by generous estimate, half a century down the road. In addition, at present, the Chinese have expressed satisfaction with simply ‘free-riding’ off of U.S. control of the aforementioned supply lines.”

In a radio interview shortly before a China-Arab trade forum last September, Yang Guang, director of the Institute of West Asia and African Studies at the Chinese Academy of Social Sciences in Beijing, said he sees no real sign of a geopolitical rebalancing, even though China is increasingly important for Saudi Arabia and its Middle Eastern neighbors. “If you look at the proportion of trade and investment in the Arab world, China still accounts for a very, very limited proportion. The lion’s share of the business is done with U.S. and Europe,” said Yang.

( Original Aritcle )

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Posted on April 6, 2011, in China, GEOPOLITICS, Middle East, Natural Gas, Saudi Arabia, United States and tagged , , , , , , , , , , , , , , . Bookmark the permalink. Comments Off.

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