The Energy Future: China and the U.S. – What the United States ought to Do

We have heard today about the magnitude of China’s energy appetite, and about China’s plans and options for dealing with its mushrooming energy needs. I do not plan to elaborate on that discussion, which has covered the subject well. My background is in the policy formulation process of the U.S. Government. So I will instead talk about the challenges that China’s growing need for and consumption of energy poses for the United States, and different ways the U.S. might react.

The emergence of China as a factor in global energy and oil market potentially affects U.S. interests in the following six ways:

Price: in 2004, China was responsible for approximately 35% of the incremental increase in world oil consumption, greater than the U.S. share of 25% and almost equal to the increment of the rest of the non-China/non-U.S. part of the world. Incremental demand drives prices, and therefore the Chinese actual and anticipated demand is a noteworthy factor in rising prices, despite China’s correct insistence that it is responsible for about 8% of the world’s oil consumption.

Access: Currently the world’s third largest oil importer, China should surpass Japan to become the world’s second largest oil importer within the next decade. At the same time PFC Energy projects that after 2015-2020, world oil supply will flatten and then slowly decline. Of course, other factors, such as prices, alternative sources of energy, technologically induced efficiency, and alterations in growth patterns will affect the adequacy of the global petroleum pool. But if supplies and recoverable reserves cease to expand or in fact do dwindle, we should recognize that there will be zero-sum game elements among large consumers, including the U.S. and China. On the other hand, precisely this same factor – a finite supply of oil – creates a common interest between China and the U.S. to limit their respective drain on those supplies.

Bad actors: There are oil-producing countries that act contrary to international norms. Iran and Sudan come prominently to mind, and Venezuela, Burma, and some of the states of Central Asia flirt with entry into the group. In a few instances, notably in Iran, Sudan, and Burma, the U.S. is seeking to achieve behavior alteration through mobilizing international pressure. In others, it does not wish to see a producing country draw strength and support from other powers. China is developing significant state-to-state and energy ties with virtually all of these countries, and provides a potential hedge for them to resist American and western pressure to alter unacceptable conduct.

U.S. competitiveness: Several of the major international oil companies, as well as lesser actors in different phases of the upstream and downstream cycles, are U.S.-headquartered, U.S.-listed, employers of U.S. labor, and pay dividends to American shareholders. Like all businesses they welcome competition everywhere except in their own lines of business. But the Chinese national oil companies (NOC’s) offer a different and more worrying competition than that of other NOC’s. For a start, there is the extent of their presence, in 50 countries around the world, an unprecedented global reach for a NOC. Of greater concern is the willingness of the Chinese NOC’s to play by different rules than the international oil companies (IOC’s). Chinese NOC’s are not constrained by the Foreign Corrupt Practices Act, by OECD guidelines on export credit competition and tied loans, or by segregation from other businesses that can be added to a package to make it more attractive, such as non-energy construction and engineering projects.

Improving global governance: This willingness to play by different rules not only provides a competitive advantage to Chinese NOC’s, but it also can have a negative effect on U.S. and EU efforts to promote sound and transparent governance in countries where such practices are exceptional. In west Africa, where corruption is a significant factor in sustaining poverty and autocracy, the addition of the habits of Chinese NOC’s to the landscape can undercut efforts to establish a different environment.

Pollution: China will be the world’s largest producer of greenhouse gas emissions by 2025. It already is a major contributor to pollution in Hong Kong and Japan. As its economy grows, its energy choices will affect not only the health of its own citizens, but the environment of the planet.

How should the United States, and more precisely the U.S. Government, react to these challenges? Instead of simply listing my 10 point plan, let me fall back on a tried and true technique learned in my days in the Government—offer three options, which might be generically described as nuclear war, surrender, and the pragmatic middle. As veterans of the State Department know, the middle option is always the preferred one. In this instance, I’d like to lay out these options in a way that describes them realistically.

1) Confrontation: There is no plausible way short of military conflict to seriously deny China access to oil, and even in a wartime situation it would be a difficult proposition. Also, it makes little sense to pursue a policy aimed at depriving China of energy at the same time that the U.S. is not pursuing a policy of economic isolation of China, since energy is a fundamental component of economic growth. So under foreseeable circumstances one cannot envision a policy designed to deprive China of oil.

But it is possible to envision a US-China relationship that deteriorates, and in which we would seek to pressure China for broader policy objectives in which employing the energy weapon could be useful to U.S. policymakers. What possible steps could the U.S. take in such an eventuality? I’ll reserve judgment on the likelihood that each of these would be effective or wise until the end of this list.

• Prevent investment by Chinese NOC’s in the U.S., as Congress apparently sought in the case of the attempt by the China National Offshore Oil Corporation (CNOOC) to acquire Unocal. Congress could, for example, impose a prohibition against investment or contracting to Chinese NOC’s in the Arctic National Wildlife Reserve. We should understand that such actions would not deprive China of oil, since their effect would simply be to shift the geographic location of the portion of the global pool from which China draws.
• The U.S. could apply diplomatic pressure on major producers, particularly short-haul producers in Central Asia and the Persian Gulf, not to grant equity or other investments by Chinese NOC’s or to negotiate pipeline deals with China.
• The U.S. Government could discourage U.S.-based IOC’s, or ILSA-like, their foreign affiliates, from partnering with Chinese NOC’s in their “going out” investments.
• Eximbank and the Trade and Development Agency (TDA) could be prohibited from financing energy products involving Chinese NOC’s or for projects, such as pipelines aimed at providing oil or gas to China.
• The U.S. Government could pressure the Canadian Government not to permit Chinese investment in development of oil sands fields in Alberta.
• The U.S. Government could move from a position of neutrality to support for the Japanese position on rights to gas resources in the East China Sea, either by explicit recognition of the validity of Japanese claims or by deploying 7th Fleet assets in the region in a supportive way.

While there may be circumstances under which the U.S. might resort to some of these measures, we should be clear that most or all would be part and parcel of a broader policy of containment and hostility toward China, which is not the current Administration’s policy, has not been American policy under the last seven Presidents, and which in my view should not be a course that the U.S. should embark upon, but only undertake if China leaves us no choice. Collectively and individually, they would not prevent China from acquiring the energy resources it needs for its development, though they might have an incremental impact on the cost of its doing so. They certainly would heighten tensions between our two countries, lend strength to the view within China that the U.S. is unrelievedly hostile to China’s development, and encourage China to devote more resources to its military, in particular development of a blue water navy.

2) At the other pole, there are powerful incentives for development of a cooperative relationship between China and the U.S. on energy issues, since we have common interests as consuming/importing countries that need secure, continuous access to oil at reasonable prices. What kinds of activities might the U.S. and China take to build cooperation in the energy field?

• We could establish a U.S.-China energy partnership at the national level, with a number of subsidiary elements. Presidents Hu and Bush could announce establishment of such a relationship at their April summit. It is crucial how such a proposal is presented to the Chinese. If it comes across as a means of restricting Chinese energy use, and therefore growth, while imposing no constraints on our own energy habits, it will be still-born.
• President Bush could offer public assurances that the U.S. will not interfere with China’s access to overseas sources of energy, or use our dominant position in patrolling the International Sea Lines of Communication to restrict Chinese access to oil (in peacetime).
• The U.S. and China could seek to coordinate maintenance and operation of strategic petroleum reserves both through bilateral and multilateral consultation.
• In that connection, the U.S. could lobby for Chinese membership in the International Energy Agency (IEA), perhaps with a waiver of the requirement for OECD membership, or if that proves impossible for a privileged relationship between China and the IEA to allow coordination of stockpile management.
• The U.S. Government could make clear it does not object to Chinese NOC’s “going out.” One way to manifest that would be to encourage U.S. companies to co-invest with Chinese NOC’s. Chinese companies could, for example, provide commercial benefits to U.S. partners by providing opportunities in markets where Chinese companies have better political access, by bringing cash and risk mitigation to the deal, and by providing relationship-building that could provide greater access for the U.S. partner to China downstream markets.
• The U.S. Government could encourage China to join the U.S. in “jawboning” Saudi Arabia and OPEC to moderate prices.
• The Department of Energy and the National Development and Reform Commission (NDRC) could provide funding for joint research by American and Chinese institutions and scholars on alternative sources of fuel and fuel-saving technologies – the latter is of particular importance to China because of its energy inefficiency.
• Appropriate U.S. Government agencies could offer incentives to American companies to provide energy-saving technologies for temperature control office buildings.
• U.S. Government agencies, such as TDA, the Overseas Private Investment Corporation (if we were to lift the prohibition on OPIC’s activity in China), EximBank, and the Department of Energy could fund either commercial ventures or research projects designed to allow China to use its vast reserves of coal in “green” projects with limited environmental impact.
• The U.S. Bureau of Mines could work with China on a joint project designed to improve safety of coal mines (over 80% of the world’s coal mining deaths occur each year in China).
• The U.S. and China could explore creation of a “buyers’ cartel.” There was discussion of such a response by consuming countries to the first OPEC-created oil shock in the early 1970’s. It did not prove feasible then. The obstacles to creation of a “buyers’ cartel” are considerably more imposing than, for instance, creation of a “buyers’ cartel” would be on a more fungible and less essential product than oil. But perhaps there are more modest cooperative models that could provide leverage to downstream consuming companies that face a producers’ cartel.
• The U.S. Government could offer aggressive assistance to China’s program for peaceful use of nuclear energy through Exim loans and high-level assurances of future reliability of American service of Chinese nuclear plants.

3) Finally, there is the middle course that I indicated earlier is always the bureaucrat’s safe choice. Which doesn’t necessarily mean it’s the right choice for us, though frankly it appeals to me because it is both politically realistic and forward-leaning.

This would entail following the logic laid out in Deputy Secretary of State Robert Zoellick’s “responsible stakeholder” speech to the National Committee on US-China Relations on September 19, 2005, which now seems to be a kind of Administration road map for a strong and cooperative U.S.-China relationship. In his speech, Zoellick suggested ways in which China could demonstrate its willingness to enhance the international system, with an implicit quid pro quo of U.S. willingness to interact positively with China in response. Zoellick explicitly called for energy cooperation between our two countries in his speech. While he did not link energy cooperation with resolution of other elements of discord in the relationship, it would enhance the likelihood of an ambitious energy agenda with China being politically sustainable if it were put in place in the context of steps the Chinese might take. The ones that relate most directly to energy issues are:

• Cooperation with the U.S. and EU on resolution of the Iran nuclear issue.
• Support in non-military ways in stabilizing Iraq, thereby helping to facilitate resumption of Iraqi oil exports.
• Working with the U.S. to bring effective pressure on the Sudanese Government to end the genocide in Darfur.
• Entering a dialogue with the OECD to bring Chinese foreign investment behavior into line with the standards accepted by the U.S., Europe, Japan, and other major providers of foreign direct investment.

If China were to undertake these steps, it would solidify the political base in the U.S. for doing the kinds of things I have talked about under the rubric of cooperation.