Is OPEC China's Problem?

The decision by the United States to wind down waivers on U.S. sanctions against Iranian oil exports has laid bare some new realities about oil geopolitics that were previously not well understood. Oil supply shortages --regardless of whether they are orchestrated by the Organization of Petroleum Exporting Countries (OPEC) or come about from sabotage of oil facilities or escalating military conflicts in the Middle East-- are more China’s problem than the United States’ worry. President Trump muddied the waters of that perception by simultaneously bragging about U.S. freedom molecules (e.g. U.S. oil and gas exports), but then constantly jawboning OPEC to keep oil supplies high. No doubt Americans care about gasoline prices and don’t stomach petro-blackmail well, but everyone from Iran’s Supreme Leader Ayatollah Ali Khamenei to Wall Street hedge fund strategists are focused on how President Trump cannot afford let U.S. gasoline prices rise in an election year, and they are missing the forest for the trees.

It is the Chinese economy, not the U.S. economy, that stands to lose the most from oil supply cutoffs. China’s oil imports have been rising and hit over 10.6 million barrels a day in April as the country’s refiners built up stockpiles ahead of expected disruptions from Iran and Venezuela.

That begs the geopolitical question: Who does Beijing consider a reliable energy supplier and can they afford to skip U.S. oil and gas exports?

If you are President Trump, you are probably thinking the answer to the second part of that question is no, especially since you are cutting off supplies from Iran.

To address the reliability issue, let’s take a tour of Chinese suppliers.

Saudi Arabia has been quietly shifting oil from the United States, where imports from the desert kingdom are nearing low levels not seen since the mid-1980s, to China where it is now the largest supplier to the Asian giant. But China has to worry about Saudi production cuts as part of future OPEC agreements as well as attacks on Saudi oil infrastructure.  

Igor Sechin, head of Rosneft, told the St. Petersburg International Economic Forum this week that China and Russia should increase their oil trade. The statement coincided with bilateral meetings between Russian President Vladimir Putin and Chinese leader Xi Jiping in Moscow.  But Chinese investments in Russian oil firms have run afoul in recent years and the massive contamination of oil supplies shipped via the Druzhba pipeline to Europe is raising questions about Russia’s reliability as an energy supplier.

China’s $160 plus billion in investments in foreign oil fields to garner secure equity crude oil supply in rogue petro-states has not panned out well. Several oil states have defaulted on Chinese loans or failed to deliver the promised oil. Most recently, oil payments by Venezuela to cover its $60 billion in borrowing from Beijing has fallen by the wayside as the country’s oil production has collapsed. Prolonged civil wars in Sudan and South Sudan have severely restricted the amount of oil Chinese companies could extract. Now with U.S. sanctions, oil shipments from Iran are in question. Angola, another important Chinese supplier, could see its production plummet by a third in the next few years if it cannot shore up investment.

All this puts more importance on other Middle East supplies, which could face increased geopolitical risk if the escalating conflict between Iran and Saudi Arabia leads to additional sabotage against Persian Gulf shipping and production. Iraq, Kuwait and the United Arab Emirates are major suppliers to China.

When the trade war with the United States worsened last year, Chinese firms curtailed spot market purchases of U.S. crude oil. It remains to be seen what the long run ramifications of less transitory, more structural worsening of U.S.-China relations would mean for energy ties. Presumably, China would intuitively feel relying on U.S. oil supplies would be strategically risky. And then, there is just the worry that the Gulf of Mexico hurricane season or a rapid downward spiral in oil prices could mean U.S. oil exports levels suddenly sink.

All this leads back to the main point. China, which has no real experience in jawboning OPEC for more supply because it was energy self-sufficient in 1973, and even in 1990 when Iraq invaded Kuwait, has not grappled yet with this new reality. To date, China’s complaints have focused on complaining about U.S. policies towards Iran. That belies the fact that China is freeriding off the U.S. President making statements about the need for adequate supplies from OPEC to keep the global economy from slowing down. Moreover, the United States is accommodating China by making those statements, even as Washington cuts off access to Iranian oil. That raises an important question: when (and in the future, if) Saudi Arabia and Russia fail to respond to U.S. appeals to put more oil in the global market, are they secretly, or at least inadvertently, attacking China? It is a question that bears asking in Beijing. Even if Russia and Saudi Arabia have offered China extra oil in recent weeks, if that oil is just coming from elsewhere in the market (e.g. commodity shuffling) and doesn’t reflect added barrels, as is currently the case, the bill could someday be sent to Chinese consumers in the form of higher oil prices and a shrinking trade surplus.