Brad Setser

Follow the Money

Cross border flows, with a bit of macroeconomics

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Russia is to China as …

by Brad Setser
December 31, 2004

Canada is to the United States?

Large in area, scarcely populated, cold and a major supplier of natural resources to its large southern neighbor …

Well, not yet.

Russia, I think, generally exports its energy to Europe, not to China. The pipelines flow west, not south and east.

But that may be changing.

It seems like the Yukos stake formerly held by western investors is being offered to China. Before, Khodorkovsky controlled Yukos and foreign — mostly western — investors had a minority stake; now, the Russian state seems likely to gain majority control, with China getting a minority stake.

There is one clear difference between Russia and China and Canada and the US: the state plays a much bigger — and a much less transparent — role in both the Russian and Chinese economies …

China clearly does not just want to buy the world’s surplus (production in excess of national demand) oil. It wants to own a share of the companies that are producing the oil China expects to buy. Look at Iran, Sudan and now Russia. China’s state oil companies go where the oil is …

Make no mistake, if you forecast out China’s future demand for oil, China is gonna be a big buyer. China’s government has plenty of cash. The Wall Street Journal reports China’s reserves reached $542.7 billion at the end of October, up an amazing $28.2 billion in a single month. There is a pretty natural marriage between China’s surplus cash and the world’s surplus oil: oil companies supplying a growing Chinese market are likely to earn more than US Treasuries (or Agencies) …

Billmon, in one of his comments to an earlier post, asked whether China at the turn of this century is to the US as Germany was to Britain at the turn of the last century, or as the US was to Britain at the turn of the last century.

Few questions are more important. Consequently, the (hidden) battle between private US companies (and investors) and state owned Chinese companies for control over existing oil fields (or more precisely, for minority stakes in locally owned oil firms that have control over most countries domestic oil fields) is worth watching. The really high stake game, though, is for control over new oil fields which, with foregn investment, can be brought on line to meet the world’s growing demand for energy — not for control of the world’s existing oil fields.

US grand strategists presumably would rather China invest in say Exxon, and then rely on Exxon to supply oil to meet China’s growing need for energy. China seems to have other ideas.A (long) aside: the Economist compared Mexico to its platonic ideal of a market economy, and found it lacking. That more or less was the Economist’s explanation for Mexico’s comparatively low growth since its 94-95 peso crisis.

Of course, if you compared China to the Economist‘s platonic ideal of a market economy, it would be found even more lacking. Afterall, massive state-owned banks intermediate a very large fraction of China’s savings, the Chinese state controls bank lending rates (though perhaps not all that effectively) and offers administrative guidance indicating who should get access to credit, the state limits (though not always very effectively) labor mobility, Chinese peasants do not own their own land (and thus do not profit if their land is in the way of a growing city and thus prime property for luxury real estate development) … I could go on and on. I don’t think China’s domestic oil fields are any more open to foreign investment than Mexico’s, for example.

Compare slow growing Mexico to fast growing China and look for lessons, and you might well conclude the state plays too small a role in Mexico’s economy. I don’t believe that. Nor do I believe that the extensive role of China’s state in China’s economy has been a net plus for China. China’s state run banking system right now probably has as many problems as Mexico’s just privatized banking system had prior to its devaluation. The eventual revaluation of the undervalued renminbi will test China’s banks just as the devaluation of the overvalued (back in 94) Mexican peso tested Mexico’s banks, though in different ways.

But I do think that the Economist should have mentioned Mexico’s comparatively low savings rate, which, given Mexico’s prudent post-crisis macroeconomic management, generally translates into a low rate of investment. That alone probably explains a large share of the growth difference between Mexico and Asia. Putting all the emphasis on structural reform seems off when Asia’s structural problems — using the Economist’s implicit definition of structural problems — are at least as big as Mexico’s. If you can finance investment of well over 40% of GDP out of domestic savings, you are likely to grow fast, even if structural problems mean a large fraction of domestic savings is being invested inefficiently … that, it seems to me, is the real lesson as Asia’s post war miracle, and China’s current economic miracle.


  • Posted by Billmon

    “US grand strategists presumably would rather China invest in say Exxon, and then rely on Exxon to supply oil to meet China’s growing need for energy. China seems to have other ideas.”

    China’s long-term energy choices don’t look very enviable – depend on the United States (Exxon with a carrier fleet) to ensure the security of oil from the Persian Gulf and/or other seaborne sources, or depend on Russia for land access to Siberian and/or Caspian sources. One a potential global strategic rival; the other a historic enemy and immediate threat (I think Russia’s border with China is actually longer than Canada’s border with the USA).

    It makes sense for China to try to hedge its bets as much as possible – triangulating between Exxon and Putin, while nailing down independent access to as many other global oil sources as possible.

    To me the surprise is that Russia is inviting China into the Yukos deal, which at least implies a much more significant strategic choice. I was under the impression the Russians were absolutely paranoid about growing Chinese influence in, and designs on, Siberia. (Siberia really is to China what Canada is to the U.S., in that an overwhelming majority of its inhabitants live in a narrow strip relatively close to the Chinese border.)

    But the Yukos deal doesn’t sound like the act of a paranoid. Putin seems to understand the value of doing a little triangulating himself. Maybe his soul brother in the White House will ask him about it the next time they have a heart to heart.

    It would seem the neocons’ unipolar world is already sprouting a few extra poles.

  • Posted by Ravi

    China’s appetite for oil is why they are going to have to let the yuan appreciate eventually. Otherwise oil is going to cost too much (and that will have negative economic consequences for them). When do they reach the tipping point? Who knows? But I’d be very worried if oil prices spiked in the new year or if oil-producing countries starting diversifying away from the dollar in larger numbers. Though (as you previously reported, I think) Russia and some Middle Eastern countries are already bulking up their euro portfolios…

  • Posted by brad

    Ravi — with oil at 55 (briefly) in october, and around 50 in november, I think it is safe to assume that Russia and other oil producers were bulking up both their dollar and euro portfolios … the “diversifiction” comes from buying more euros than they did at the past on the margins.

    The stunning thing about China this year is that is export growth to the US (and I presume europe, but I don’t know the data as well) was so strong that it seems to have been able to pay lots more to import the oil it needs (and the soybeans and iron ore it neeeds) without cutting into its global trade surplus very much. Long-term, though, I suspect you are right. If oil says priced in dollars, China can cuts its oil bill in 1/2 (in real terms) by letting the renminbi rise from 8 to 4 … that will be an attractive option should US import growth cool, making it hard for growing exports to the us to pay for growing oil imports, and oil stay high.

  • Posted by brad

    In Braudel’s classic works on the mediterranean, he noted that Venice was — as the ship sales — almost as close to constaniople/ the levant as it was to genoa. Go down through the adriatic, around greece and you are in the “east”; getting to genoa mean going down the adriatic, aroung the boot and up — not a short journey. Venice was the western and northern terminus of the eastern Med —

    I have been reading Tom Barnett’s “The Pentagon’s New Map” (much more on that later), so have been looking at maps. The persian gulf is a lot closer to East Asia, as the super tanker floats, than to the US — and it would be a lot closer to East Asia than to Europe too, but for lots of European and American engineering — the suez canal and the transarabian pipeline that brings crude from the gulf to the red sea.

    Geo-oil says the US gets supplied from Vennie and West Africa (almost as close to the US as to Europe, as the supertanker floats), and the rest of the world drinks in the Gulf, with a bit of Russian crude thrown in. Geo-politics, though, has the US troops sitting on or next to the gulf oil fields, and the US navy defending the sea lanes that take gulf oil to Singapore to be refined, and then up the South China Sea to the world’s new industrial heartland.

    An interesting mix. China has to trust us to assure the steady supply of their oil, even in a global supply shortage, or try to hedge their bets. The irony is that right now they seem more inclined to hedge their bets on oil than to hedge their exposure to the dollar …

  • Posted by Billmon

    “The irony is that right now they seem more inclined to hedge their bets on oil than to hedge their exposure to the dollar …”

    The currency thing is short-term, oil is long-term. Exchange rates go up and down, reserve balance rise and fall. Oil fields don’t move.

  • Posted by Diane

    China is also very interested in the Canadian oil sands. See The New York Times had a similar story on Dec. 23, but you have to pay to get it at their website.

    China has an advantage over the U.S. because they can make a long-term national energy plan, and can build refineries which can process the heavy oil [i.e., high sulfur content] from the oil sands. The U.S. hasn’t built any new refineries for about 30 years.

    The New York Times also reported that the China has a new oil deal with Venezuela:

    I haven’t been able to read the PENTAGON’S NEW MAP yet, but I saw Barnett on CSPAN about a week ago. He expects China and other countries to have a military presence in the Middle East within 20 years, not because they’re hostile but just because they want secure oil supplies.

    I think it’s very smart for China to use their dollar reserves to buy oil.

  • Posted by Tom DC/VA

    Good thread. It should be noted that it is America’s overconsuption that is financing China’s acquisition of resources that we might like to own, or even need to own, if we don’t get a real energy policy anytime soon.

  • Posted by s

    I find it interesting that nobody has yet mentioned Iran in this thread.

    Here is some interesting analysis on the implications of China’s deal with Iran.

    China, Iran sign biggest oil & gas deal 2004-10-30 17:06:16

    BEIJING, Oct. 30 (Xinhuanet) — China’s oil giant Sinopec Group has signed a $70 billion oil and natural gas agreement with Iran, which is China’s biggest energy deal with the No. 2 OPEC producer.

    Under a memorandum of understanding signed Thursday, Sinopec Group will buy 250 million tons of liquefied natural gas over 30 years from Iran and develop the giant Yadavaran field.

    Iran is also committed to export 150,000 barrels per day of crude oil to China for 25 years at market prices after commissioning of the field.

    Iran’s oil Minister Bijan Zanganeh, who is on a two-day visit to Beijing pursuing closer ties, said Iran is China’s biggest oil supplier and wants to be its long-term business partner.

    Official figures show that China imported 226 million tons of oil in2003, about 13 percent of which coming from Iran.

    Beijing expects to secure foreign energy supplies by the deals for its economy, which has turned China into a major oil importer but suffers severe power shortages

  • Posted by anne

    China is also increasingly active in southern Africa; I wish we were far more involved in Africa from humane to economic interests.

  • Posted by praktike

    Billmon, are you gonna open the Whiskey Bar back up? You know you want to …

    As for China/Russia, this is what China’s fascinating National Defense Strategy says:
    “With the strengthening of the strategic and cooperative partnership between China and Russia, the two countries have established a senior-level meeting mechanism to exchange views on major issues. They have also held consultations on major strategic issues between relevant departments. In 2003, China and Russia conducted a number of vice-foreign-ministerial level consultations on the nuclear issue on the Korean Peninsula, the questions of Iraq and the Middle East, and other international, regional and bilateral issues of common concern. In 2004, the two countries held a counter-terrorism working group meeting and consultation on strategic stability at the vice-foreign-ministerial level. The two militaries established a consultation mechanism in 1997, and the General Staff headquarters of the two militaries held the seventh and eighth rounds of strategic consultations in 2003 and 2004 respectively.”

  • Posted by glory

    John Maynard Keynes Misses Out on China Rise
    By William Pesek Jr.

    Dec. 31 (Bloomberg) — If John Maynard Keynes is looking down from the heavens these days, he may be lamenting missing out on China’s ascension.

    The rise of Asia’s No. 2 economy isn’t just a business story, but history in the making. Never has such an underdeveloped economy with such a huge population stepped into the global community with such alacrity. If economists like Keynes thought the rise of the U.S. in last century was something, just wait for China’s in this one.

    And then there’s India, Asia’s other rising superpower. While China and India are often thought of as competitors, there’s also ample scope for both economies to work together.

  • Posted by glory

    […I]f we look at what happened to per capita oil consumption during phases of industrialization in the US between 1900 and 1970, we see that per capita consumption rose from one barrel per year to around 28 barrels. In the case of Japan’s industrialization between 1950 and 1970 and South-Korea’s between 1965 and 1990, per capita oil consumption rose from one barrel to 17 barrels.

    In the case of China, oil demand per capita is still only 1.7 barrels per year, and for India it has only reached 0.7 barrels. By comparison Mexico consumes annually about 7 barrels of oil per capita and the entire Latin American continent around 4.5 barrels.

    Therefore, starting from such a low base, oil consumption in Asia will, in my opinion, double in the next ten to 15 years from currently 20 million barrels per day to around 40 million barrels per day.

    Remember also, that if China’s per capita oil consumption went to the level of Mexico’s per capita consumption China would consume 24 million barrels of oil daily, which would be close to 30% of global production. And since it is most unlikely that current total global oil production of 80 million barrels per day can be increased much – in fact, it may begin to decline because no major oil field has been discovered since 1965 – I expect that prices will increase further in future – possibly far more than anyone is now expecting.


    And, in the case that oil prices were to rise in real terms to their 1980s highs – well over US$ 100 – then the foundation for World War Three would be laid and most certainly begin to weigh heavily on equity prices for which I cannot share the prevailing widespread optimism anyway…

  • Posted by DF

    Happy new year to all.

    I d like to post an ironic positive note :

    One can only die one time. Therefore :
    If a major depression-deflation by debt is about to hit, as indeed I believe :
    Then oil reserves won’t be so much of a problem for at least some years – a decade.
    A major world recession would lead to a fall in the demand.

    Since oil peak is about to be reached, the good news is that global warming will not be as dire as most models show. In fact there won’t be enough oil around to lead to the worst case scenario that are now envisionned.

    Hopefully the recession about to hit will give us time to find new energy sources (fusion, solar, wind) and develop technologies that spare energy.
    Hopefully also the failure of capitalism will pave the way to a new and more spiritual era.

    I wish you all a deeper connection to the cosmos.

    I envision a world where linux like projects flourish and while market and hierarchies lose power.

    All around me, people learn to meditate. I see it as a sign.

  • Posted by marku

    “Economist’s platonic ideal of a market economy”

    I love it!

    I had often cosidered radical marketism as a religion, but describing it as a romantic ideal is even better.

    Great thread and comments.

  • Posted by A Chinese visitor

    China wants to make its oil supplier more pluralistic,it is as rational as Russia wants more oil consumers.
    Besides that, energy cooperation can improve the two countries political relations and help on a more stable relationship between the two big countries.