CHINA FILES: ENERGY COMMODITIES VULNERABILITIES
In the past decade, there has been an increasing divergence in China’s energy security policy between avoiding supply-nation dependency for energy commodities and ensuring the open geographic movement of those critical resources. As a land power with expanding energy demand, China’s initiative since the turn of the century has been to substantially increase its supply of overland transported energy resources from its energy-rich neighbor states. This was in part done as primary sources of critical commodities were rapidly opening up vulnerabilities in its supply chain and becoming increasingly offshore dependencies. The political and structural infeasibility of overland supply superseding seaborne imports, however, has shifted Beijing’s focus to simultaneously ensuring protection of its vital sea-lane arterial network.
Energy Import Dependencies
In 2011, China’s five-year plan made clear efforts to enhance energy security, particularly through sustainable power generation sources. The plan outlined growth targets that would reach a cumulative 151 GW of new hydroelectric production, nuclear power, and additional wind generated power. In order to maintain economic growth above 8 percent, however, Chinese industry and consumers require a sustained increase in the country’s primary sources of energy: coal and crude, as well as enhancing natural gas power generation. Chinese demand makes up about 20.3% of total global primary energy consumption and the International Energy Agency (IEA) estimates that by 2035, Chinese consumption will rise further to consist of 30% of global consumption. For Beijing to reach a modicum of success in its energy security strategy it will need to address the continuing and growing vulnerabilities in its foreign energy commodities import supply chain.
China has been susceptible to energy commodities dependency with its key import sources: Australia, Saudi Arabia, Iran, and Angola. Australia and Saudi Arabia have presented particularly difficult barriers to a diversified energy portfolio that enhances Chinese energy security. Despite abundance of domestic coal reserves—only about 22% of reserves are of the functional coking variety—the trajectory of demand from China’s steelmaking industry portends an increasing vulnerability in its supply of coking coal used for metallurgical processes. Imports of coking coal saw an explosion of growth in 2008, with the most substantial bulk coming from Australia. Similarly, China’s imports of natural gas from Australia far exceed in volume other import sources peaking at 87% of imports in 2007. Its most significant dependency, however, is in crude imports which will make up a projected 55.2% of total consumption in 2011. Saudi crude has averaged 17% of total imports in the past decade and will see further growth as demand for petroleum refined projects surges due to growth in consumer demand for vehicles. Chinese refining systems have for decades oriented processing primarily and most significantly around medium sour crude, of which Saudi and Iranian exports generally consist.
Beijing’s energy security program faces challenges in diversification from Saudi crude and Australian natural gas, although significant moves have been made to ensure prevention of severe vulnerabilities due to overreliance on a single exporting source. Enhanced production capacity in Mongolia’s coking coal industry paved the way for a new import source to this crucial Chinese import. Imports from Australia dropped to about 26.8% of total import share in 2010 from 64% the previous year, losing substantial share to Mongolian imports. Already, through August of this year, Mongolia has become the leading supplier of coking coal to China, as costs of a ton of Mongolia’s coking coal have been as low as 33% of a ton of Australian coal. This land route through Sehee has proved critical to Chinese diversification strategies.
In a move to further diversify away from Australian dependency, China has enhanced natural gas pipeline capacity to harness relations with neighboring energy powers. While natural gas only makes up 4% of China’s total energy production mix, Beijing’s slated goal to shift away from dirty coal and the growing global economic viability of natural gas production will raise the profile share of gas substantially in the coming decade. Beijing’s appreciation of import vulnerabilities has led to a development of a vigorous and broad portfolio of suppliers. Agreements with Turkmenistan have already shown substantive changes in the supply dynamic, with a Turkmen piped gas imports taking a 22% share in 2010. An agreement was reached this year by which Turkmenistan would supply 65 billion cubic meters annually to China, about 50% of its current consumption levels. Simultaneously, the Myanmar-China gas pipeline is slated to come on stream by 2013, which will provide an additional 12 billion cubic meters to supply lines. The development of LNG receiving terminals also accrues natural gas import sources by providing alternatives to piped gas and incorporating growing producers like Qatar and Yemen.
Chinese crude imports from Angola, its second largest supplier, may surpass Saudi derived imports. Angolan crude made up almost the same share in value of Chinese imports from Saudi Arabia in 2006 and 2007 and Angolan imports continue to increase with a 22.41% y-o-y increase in 2010. Significantly, Beijing has also aimed to further diversify from Saudi or Angolan crude import dependency by increasing its supply sources from neighboring crude producers like Kazakhstan. Chinese national oil companies (NOCs) avidly look for new markets from which to procure crude, such as vigorous attempts at enter the Nigerian market and dramatic growth in activity and imports from Iraq since the immediate post-invasion era.
Supply Route Vulnerabilities
At the geopolitical level of energy security, Beijing has made discernible maneuvers to augment overland import capacity for critical energy commodities. China has been successful in increasing imports via land routes, particularly through pipeline production and better-integrated infrastructure networks. Beijing has found this particularly necessary as US power in East Asia and naval presence in and around the SLOCs through which much of its energy commodities travel create potentially severe vulnerabilities in supply networks. In Beijing’s 12th Five-Year Plan, gas and crude pipelines are slated to double in the amount of kilometers of to 90,000 km. This strategy, however, remains to provide a capable and sustainable supply channel for burgeoning energy commodity demand. The reality of China’s energy security challenges is that despite hopes to sustain land supply networks, a dependency on seaborne shipping imports will be prolonged and increased, due to constraints of pipeline capacity and regional political pitfalls.
China’s overland supply of natural gas from Turkmenistan via the Central Asia-China gas pipeline and imports of coking coal off take from Mongolia via its rail network have allowed for substantive diversification in supply sources. Internal Mongolian wariness of economic dependency with China, however, prohibited a direct rail line from its largest reserve at Tavan Tolgoi, which would have ensured supply to Chinese importers. Rather, Mongolia connected the new rail line from Tavan Tolgoi to its domestic network by which exports of coking coal could reach other Central Asian and East Asian sources in order to avoid sole Chinese demand dependency. The Gazprom competition with Turkmengaz may also shape Turkmenistan’s export market, as both producers attempt to access the European market, potentially redirecting substantial gas volumes away from China.
The Skovorodino-Daqing portion of the East Siberia Pacific Ocean pipeline (ESPO) came online in January 2011. While the Chinese branch of the ESPO pipeline will increase the efficiency of Russian crude imports, the Russians have made clear their intentions to not divert more crude to China than the agreed upon quantity. Moscow has preferred to leverage vigorous East Asian oil demand competition by telling the Chinese that any desired volumes in excess of those to which previously agreed, would need to be picked up from the Kozmino port, as would other Asian market bidders. Russian crude has been transited via the Harbin-Vladivostok rail line, which is double the cost of pipeline transport. This is due to longer distances, inefficiency, and the different rail line gauge between the countries. While a decrease in transport costs makes the ESPO branch off viable, pipeline capacity is only 15 million tons, a total that solely cannot provide sufficient supply to meet Chinese demand.
Similarly, the Atasu-Alashankou-Dushanzi crude oil pipeline that originates in Kazakhstan and terminates in Xinjiang holds a 10 million ton capacity. While PetroChina will enhance capacity to 20 million tons by 2013, political calculations may slow full operational capacity. Online in since 2006, the pipeline did not reach full capacity until 2010.
The Kyaukryu-Kunming pipeline, while also delivering Burmese crude, is meant primarily as an alternative route to the potentially disabling Strait of Malacca chokepoint passage and acts as a shortcut route for Chinese imports, though significantly is still dependent on seaborne imports. The crude pipeline will have 22 million ton capacity when it and the Shwe Gas Project, natural gas line of 12 billion cubic meters, become fully operational in 2013. As the US overtures that it is thawing ties with Myanmar, a possible opening of the country to a diversity of foreign energy interests threatens China’s share in Burmese natural gas rendering the natural gas pipeline a major liability.
The shortfalls of Chinese overland supply routes necessitate an increased dependency on seaborne shipping imports. With all of its imports of primary energy commodities, China will rely heavily on seaborne transport networks. China’s oil consumption is expected to reach around 485 million tons in 2011. Imports 55.2% share of consumption will mean that about 40% of total crude consumption will be from seaborne imports. Chinese imports of steam coal, primarily from Australia and Indonesia make up 5% of consumption, a total that will increase until domestic restructuring of the industry allows for efficient production levels. Seaborne imports will continue for thermal and coking coal, as Australia remains an important source. Despite Turkmenistan gas imports, the surge in LNG import terminals and larger share of LNG in all natural gas imports will ensure a necessity of seaborne imports. Thus, China’s access denial system is fundamental to ensuring energy supply and will continue efforts to enhance maritime power to protect increasingly critical sea line supply routes.
FULL REPORT
COAL
China’s clear dependence on thermal coal for power generation and coking coal for steelmaking is a primary concern for Beijing’s energy diversification strategy. China is the largest producer of coal—producing 3.24 billion tons in 2010—but also the largest consumer for both thermal and coking coal, making up 48.4% of total global consumption. Despite higher domestic production levels, surging demand made China a net importer of coal in 2009. Surging growth rates in imports of thermal and coking coal have caused vulnerabilities for the Chinese supply chain.
In order to develop internal efficiency and thus avoid full dependency on its major export partners, the NDRC implemented a consolidation program that would aim to restructure China’s domestic coal industry by entrusting production to a handful of SOEs. This would increase mine safety and improve coal output by closing inefficient coalmines, improving transportation networks, and tightening emission standards. Implementation of the consolidation program noticeably occurred in 2010, when capacity of 230.61 million tons per year was taken offline by mine closures. The subsequent decrease in domestic supply left distributors facing higher transportation costs, as supplier sources were limited to Northeast and Central regions where infrastructure is weak and transport routes are further from heavy consuming localities. The restructuring policy and governmental pricing controls pushed imports up to delineate China’s vulnerable supply fault lines as price arbitrage favored foreign imported coal to domestically produced.
Australian imports made up 64% of Chinese imports of coking coal when imports surged in 2009 but dropped to about 26.8% in 2010, losing share to a massive jump in Mongolian imports in that year. Insufficient coking coal supply will make China increasingly dependent on Mongolian imports as a shared land border and relatively good transport networks link the producing and consuming nations. While tightened access to credit and slumping real estate prices in China contribute to lagging demand for steel and fixed investment, producers continue production levels to prevent deeper losses.
As it continues its consolidation program and restructuring of the domestic coal industry, Chinese imports of both thermal and coking coal will intensify until 2014. By this time, China’s infrastructure upgrades are expected to have reached major coal production regions and linked them with major consumption areas. In addition to improved infrastructure networks, the government’s consolidation program will have produced large-scale vertically integrated producing firms with the capacity for efficient production. A decrease in transportation costs will relieve the stress points on domestic thermal coal consumption, though imports are expected to make up an important continued share of total consumption. The 5% price hike in thermal coal prices, however, will likely lead to further imports from major providers like Indonesia and Australia.
CRUDE OIL
China became a net oil importer in 1993 and imports have increased to become an expected 55.2% of its oil consumption in 2011. The dependence on crude oil imports has increased from 33% in 2009, to 55% in 2010 (250.4 million tons, or 4.9 million barrels per day). The jump in import dependency had taken shape as industrial use of crude declined, with coal becoming a cheaper and more abundant alternative. The rising significance of crude to the Chinese economy, however, is owed to the evolving refined petroleum product demand from the passenger transportation sector.
With increasing wealth and broadening income increases, Chinese citizens have quickly shifted from sole use of bicycles to newly purchased vehicles. China’s passenger car sales are expected to increase by 10% in 2012. Despite possible changes to the government set price controls, cheap diesel and gasoline prices will provide a basis for continuing increases in car purchases, particularly from new buyer demand. Consumer demand from periphery central and western provinces is increasing despite demand curbing policies like higher borrowing costs and ending tax break incentives. Low ownership levels and rising wages in inland areas will further help support demand for passenger cars. Beijing realizes the growing dependency on imported oil and has moved to adjust strategic policy accordingly, particularly with regards to its main crude source partners.
In the past decade, crude imports from Saudi Arabia have averaged 17% of total imports, with share of value of around 20% in 2008 and 2009. China’s dependency on Saudi oil is clear, though there are indications that Beijing intends to diversify away from its major crude supplier at a time when surges in domestic Saudi consumption of its oil also threaten to decrease export capacity. Chinese imports from Angola, its second largest supplier, may surpass Saudi derived imports. Angolan crude made up almost the same share in value of Chinese imports from Saudi Arabia in 2006 and 2007 and Angolan imports continue to increase with a 22.41% y-o-y increase in 2010.