To be cash-rich in a cash-poor, low-price world, is a huge advantage. China has realised this, and is taking advantage of its relative strength in the extractive industries. As discussed in last month’s column, its government has been making generous loans and its companies have been making aggressive bids for corporate assets around the world. Evidence has now emerged that the government has been taking advantage of the fall in oil prices since mid-2008 to fill its newly constructed strategic oil reserve tanks. Further, its refining industry is raising the quantity of oil product exported and plans for a massive expansion of refining capacity.
In the past, China’s major influence on world oil markets was limited to fluctuations in its import requirement for crude oil caused by changing domestic demand. From now on, its policies and actions relating to its strategic storage, and its growing ability to export oil product will further enhance the country’s role in international oil markets.
As a result of its ever rising level of oil imports, the government decided in 2003 to construct emergency oil storage facilities. This decision came a full ten years after the country first became a net importer, and just as international oil prices were rising. The first phase of storage capacity was to amount to about 100 million barrels and was due to be completed in 2008. This was to be equivalent to about 30 days of net imports. This capacity was to be raised to 60 days by 2010 and 90 days by 2015, though it was understood that the filling of the tanks would lag behind the construction if oil prices were high.
In December 2007 the National Oil Reserve Centre was established to manage this reserve. This Centre now lies within the Oil and Natural Gas Department of the National Energy Administration within the National Development and Reform Commission.
The high level of oil prices over the period to mid-2006 deterred the Chinese from filling the tanks already constructed. But after the price fell in July 2008, China raised its crude oil imports to fill the first stage of tanks to reach 100 million barrels, which is about two weeks of consumption or 30 days of imports. The next stage aims by 2011 to create a further 180 million barrels of storage for crude oil, bringing the total to 35 days consumption or 70 days of imports, at present rates. In addition the government plans to create storage for 80 million barrels of refined oilproducts.
At the same time, China is announcing ambitious plans to expand its refinery output and capacity. This year alone, Sinopec plans to increase its output by 10% or 300,000 barrels per day, allowing it to export increasing quantities of oil product into an already depressed international market. The decision not to constrain output at a time of economic recession has been driven by an increase of prices Sinopec receives on the domestic market and by the re-introduction of VAT rebates for exports. The government has also announced a plan to construct nine new refining bases over the next three years with a total capacity of about 4 million barrels per day. This is equivalent to the country’s current net oil import requirement or about 50% of annual oil demand. This rapid construction programme is seen as part of the economic stimulus package design to increase GDP and employment, as well as boosting the international market power of the nation’s major oil companies, Sinopec and PetroChina.
The implications of these developments for international oil markets are potentially of great importance, not least because of the lack of policy transparency within China’s government and the consequent unpredictability of actions by government and of responses by national oil companies.
The management of oil stocks has become highly politicised, wherever they are held in the world. The creation of the International Energy Agency (IEA) to address to oil crises of the 1970s led to the construction of substantial strategic oil reserves in those OECD countries which were members of the IEA. These stocks are governed by rules which provided for a coordinated release of these stocks in response to a reduction of supply of oil to international markets; or, in other words, in response to a physical disruption of supply. The rules do not provide for a release of stocks with the aim of constraining high oil prices.
Only three times has the IEA taken steps to prepare for stock release: at the time of the 1991 Gulf War, at the end of 1999 in advance of the beginning of the new millennium, and in advance of the 2002 invasion of Iraq. A stock release was only implemented in the first of these three cases. In contrast, the governments of the USA, Japan and South Korea have unilaterally released their own stocks of oil in order to constrain high oil prices. In the case of the USA, stock release and the sale of this crude oil has even been used to generate revenues for the government.
Though China has not published its official policy and rules for managing its strategic oil stocks, it has made clear that intends to use these stocks for price control as well as for reacting to physical disruptions. Though China has been involved in discussions with the IEA, with the US government and within the ASEAN-plus-Three framework on the subject of the management of strategic oil sticks, it is not evident that the Chinese government will wish to have a formal collaborative agreement covering stock release in the near future. It is more likely that they wish to learn from others but maintain their independence.
Though China’s planned oil stocks are modest in size compared to Japan’s 750 million barrels or the USA’s more than 1,500 million barrels, their existence, growth and use will almost certainly have impacts on international markets. For as long as oil prices remain near today’s levels, then China is likely to fill its newly constructed tanks as soon as they are completed. This will add upward pressure on international prices crude oil and oil product prices; for the new tanks will be for crude oil and oil product.
At times of high prices, there will be great uncertainty as to the government’s approach to releasing stocks. If they do release stocks, this will apply a downward pressure on international prices. Though this might be considered as a beneficial action, stabilising fluctuating prices, frequent and unpredictable releases of oil will just add to uncertainty in the market, and will distort long-term price signals to investors.
With respect to China’s oil refineries, with a capacity of about 8 million barrels per day, China accounts for nearly 9% of the world’s refining capacity and is the second largest refiner of oil in the world, after the USA. If the oil companies succeed in their plan to construct an additional 4 million barrels per day capacity in the next three years, this would add 50% to the country’s existing capacity and more than 4% to existing global capacity. Beyond the probability that this construction will result in over-capacity in the world refining industry in the short-term, it is likely that China’s refining industry will have a progressively larger influence over international markets in the future.
Given the unpredictable nature in China of oil demand and of corporate behaviour with respect to refinery throughput and to the export of products, this rapidly growing refining industry is likely to create significant fluctuations international markets for crude oil, depending on its import behaviour, and for oil products, depending on its export behaviour. As even China’s government can taken unawares by the actions of its own oil industry, predicting trading behaviour from outside China will become increasingly challenging.
Philip Andrews-Speed is Director of the Centre for Energy and Mineral Law and Policy at the University of Dundee, Scotland.