China Goes Long--On Oil

Economists like Angry Bear have a hard time understanding the fuss over the Unocal deal. In conventional terms, they are right. Oil is fungible, it doesn’t matter too much where it comes out of the earth, and, given China’s enormous energy needs, if the Chinese buy Unocal, they are likely to be doing everything they can through their Unocal investment to increase the world’s supply of petroleum.

Even if the Chinese wanted to suck every drop of Unocal’s oil into their economy, they wouldn’t be piping and shipping it from their far-flung Unocal outposts to the Chinese mainland. They’d sell the Unocal oil to the most suitable market, take the revenues, and buy oil from some closer producer at a better price.

Net effect on the international oil market—in conventional terms and under ordinary circumstances—zip.

The key factor, however, is that the Chinese perceive that the international free market in oil, and China’s ability to import oil on stable, economically rational terms, are at risk.

Even before the Bush administration, the U.S. has played the oil card in foreign affairs, especially in an effort to hem in Russia and keep it from leveraging its oil surplus into leadership of some Central Asian Opekhistan. Case in point: the recently opened Baku-Tbilisi-Ceyhan pipeline, which represents a decade-long U.S. investment in diplomacy, influence, and revolution in order to dick with Russia and Iran in their backyard.

We’ll probably never find out what was in Cheney’s energy task force papers, but there’s a good bet that there was a lot of thought given to the role of petroleum imports as a strategic factor in containing China.

Unfortunately I can’t come up with the citation now, but I was pretty amazed to read back in 2002 that the U.S. State Department had filed a brief supporting dismissal of a case against a multi-national oil company for human rights violations at its operations in Aceh, Indonesia because legal hassles for the oil company might create an opening for Chinese interests to come in, and that was bad for our national security.

With the Unocal bid, these issues come to the fore, and the New York Times responded with a good article from Joseph Kahn in the business section and, for once, a bad one from Paul Krugman.

Kahn’s China’s Costly Quest for Energy Control does an excellent job of describing China’s energy insecurity, which is to say China’s fear that the United States will use China’s dependence on oil imports as a weapon.

China would of course be vulnerable to sanctions if the United States were able to marshal international support for a legal cutoff of oil in the case of an open confrontation over Taiwan or some other hot button issue.

In that case, it probably wouldn’t matter if China owned Unocal, Chevron, and ExxonMobil put together—none of that oil would be coming in.

But China would also be vulnerable to a spike in oil prices if the United States decided to use its influence over oil producers, oil ocean transport, and the oil market to hammer the Chinese economy in case of undeclared hostilities…

…or simply to drain down China’s irritating forex reserves if we decided that we didn’t want them as a major player in the T-bill market anymore.

In this context, CNOOC’s bid for Unocal is actually a hopeful bet on a stable global economy buttressed by a genuine free market in petroleum.

If CNOOC controls the kind of oil Unocal produces—freely traded on world markets and not tied up in government-to-government agreements—then CNOOC—and China’s forex reserves—will benefit proportionally if the U.S. pulls some Enronesque stunt like jerking Iraq crude off the market because of “pipeline sabotage”.

And if China secures increased open-market reserves through Unocal and other deals, the effectiveness—and likelihood--of this kind of tactic becomes less likely. (However, if all this peak oil talk is true, then the entire international market—and the world economy—will become increasingly vulnerable to ever more minor interventions.)

In futures-market talk, China wants to “go long”—take title to petroleum in anticipation of a price rise in order to hedge its risks, and ensure that the world economy is not held hostage to OPEC-type monopoly plays by the United States that would suck disproportionate amounts of the world’s forex reserves into the pockets of a few companies.

As such it’s a bet on the viability of the global free market economy that should be encouraged.

Kahn states the issue well:

Now Washington has the chance to shape China's frenetic quest. The China National Offshore Oil Corporation, known as CNOOC, has offered $18.5 billion for the American oil company Unocal. If its bid is successful, Beijing will have a greater stake in the global oil markets, in the same way that Japanese and European oil companies work closely with major American companies around the world.

If the bid were rejected by the United States on national security grounds, as some members of Congress have publicly advocated, China could be motivated to build more ties to rogue states and step up its courtship of major oil producers in Africa and Latin America that in the past have looked mainly to the United States market.

In that context, it’s disappointing that Paul Krugman takes the exact opposite and, to me, incorrect view in his column The Chinese Challenge. He says he would would oppose the deal—because it would give China Unocal’s leverage in pursuing Great Game-style dastardly deals with dictators.

China does play the captive-oil pipeline-and-allocation game on the Eurasian continent—but government-to-government, as all the players do. The Unocal deal probably has very little to do with this.