China and African oil

President Hu Jintao’s recent tour of eight African nations, his third visit to this continent as President, and the gathering in Beijing in November 2006 of more than thirty eight African heads of state together mark a milestone in China’s policy to re-engage with this continent. The search for energy and natural resources has formed a key component of this re-engagement ever since CNPC signed its first deal in Sudan ten years ago. 

China’s national oil companies (NOCs) are not alone in their desire to gain rights to Africa’s oil and gas resources. Western oil companies have been there for a long time and continue to expand their activities across the continent, with a few exceptions such as in Sudan. Like the Chinese NOCs, the oil companies from other developing states such as India and Malaysia are also seeking opportunities. But the Chinese are distinct from the other NOCs, and even some of the international oil companies, in the speed with which they are acquiring assets in Africa, and the larger quantities of money they are prepared to pay. In 2006 Chinese NOCs paid almost US$4 billion for oil blocks in Angola and Nigeria.


It is not my aim to explore the various international political controversies relating to China’s involvement in Africa, for that is beyond the scope of this column. Rather I will raise a few question relating to the economic objectives of the Chinese government and their NOCs, to the risks they face, and to the possible economic impact on the host nations of the arrival of Chinese NOCs and related companies.


The initial reasons that the Chinese government actively promoted the overseas activities of China’s NOCs related primarily to security of oil supply. With limited domestic reserves of oil, the government wanted to have ‘Chinese reserves’ overseas which could, in principle, be shipped back to China. Engagement with major oil producers in Africa would allow China to reduce its dependence on imports from the Middle East. Indeed Angola is China’s largest supplier now. Further, these investments would allow the NOCs themselves to build an international business and to serve as a catalyst for other Chinese investments, for trade and for construction services employing large numbers of Chinese workers.


Whilst many African leaders have welcomed China’s involvement and its willingness to provide aid and political engagement as well as commercial activities, not all Africans are so positive and the Chinese government faces the risk of losing its reputation at two levels: amongst the African leaders of today and tomorrow, and amongst the people of Africa.  From the economic perspective this risk has three sources. The first may arise if the economy of the African nation becomes over-dependent on China’s trade and investment, to the exclusion of other countries. Resentment may build against China’s economic dominance. The second arises from the potential scale of the negative impact of Chinese imports on local manufacturers, constraining economic diversification. The low price for Chinese imports generally undercuts those of local manufacturers. Although this also occurs across the rest of the world, on other continents the range of alternative economic activities is generally greater than in Africa. Thus Chinese imports threaten African development at its source.  The third source of risk relates to the preference by Chinese NOCs and other Chinese companies for using Chinese labour and thus reducing the opportunities for employment among the indigenous people. Africa countries have very high levels of unemployment, and it must be galling to the local people to see thousands of Chinese labourers at work.


For the Chinese oil companies, overseas investment is a necessary part of their survival strategies. The opportunities for long-term expansion at home were limited. Future growth of reserves, production and profits would only come through overseas activities. The risks they face are the same as those facing other oil companies. They include geological risk, commercial risk, market risk, safety risk, environmental risk, legal risk and political risk. However all oil companies operating overseas have had to actively address their relationship with local communities; and this is an expensive and time-consuming exercise. A breakdown of relationships with a local community can result in kidnapping and death at one extreme, or a suspension of production and revenue at the other extreme.


On top of and embracing all of these risks is reputational risk. As BP and Shell have found in the last few years, it only needs one or two major incidents to severely diminish glowing reputations built up over decades.


A key question is whether the senior managers of China’s NOCs have sufficient appreciation of the wide range of risks they face, and whether they have the capacity to assess and manage these risks. If they do, then China’s NOCs may well be very successful in their overseas ventures. If they don’t, and if they don’t acquire this appreciation and capacity then they could become the pariah’s of the international oil world, penniless and wanted by nobody.


The risks facing the Chinese government and the Chinese NOCs are intertwined, particularly those which affect reputation. Thus the government is right to be very concerned to understand and monitor the oil companies’ activities in Africa. Because of the apparently close collaboration between government and oil company, any perceived deficiencies on the part of the Chinese NOC will reflect badly on China as a  country.


Yes, I have dwelt on the risks; but risk  identification and risk management is a key part of the job of both company managers and government officials. But one can equally take a more positive view, at least in the short term, and say that China’s extensive and expensive engagement in Africa’s oil and gas sector will indeed bring economic benefits to African nations and commercial benefits to China’s oil companies. It may also add to the world’s supplies of oil and gas, and slightly enhance China’s security of energy supply. However the long-term road of economic and energy interactions between the world’s poorest continent and the world’s fastest growing large economy is likely to be full of twists and turns, and unpleasant surprises for both sides.

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