Brad Setser

Follow the Money

Cross border flows, with a bit of macroeconomics

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Oil makes for strange bedfellows

by Brad Setser
October 29, 2006

I certainly didn't see this coming.   It makes a certain amount of sense. 

Iraq needs investors with a high willingness to take risk …

China doesn't exactly have a low risk portfolio of external assets right now.   It is very exposed to moves in the dollar/ RMB.    But it does have a generally low-yielding external portfolio.  If my estimates are right, it does have a concentrated ($700b) portfolio of dollar-denominated assets that pay around 5%, maybe a bit more.    Diversifying into even-lower-yielding euro assets doesn't offer much additional benefit — the RMB/ euro could move more than the RMB/ dollar. 

But diversifying into oil is another thing altogether.   China is rather clearly is willing to take on a more than a bit more risk to try to profit from the rise in oil demand associated with its development.  In Angola (now China's largest supplier of oil).   In Sudan.  In Nigeria.  In Iran (though more for gas than oil).  In Kazahkstan.

And now in Iraq.   Southern Iraq that is.

China's willingness to put its surplus savings to work by snatching up the world's oil field's is clearly bad news for the world's private oil companies.  It will be harder and harder to find oil fields to buy on the "cheap" — the price oil companies have to pay to develop a country's oil will go up.  But I am not sure it is bad news for the US.  If Iraq's oil flows to China, more oil will be available somewhere else to supply the rest of the world.

Still, I rather doubt those who led the charge to invade Iraq intended to open up Iraq's oil for Chinese investment.  Then again, they don't seem to have anticipated the majority of the consequences of the US invasion of Iraq ….


  • Posted by gillies

    “Still, I rather doubt those who led the charge to invade Iraq intended to open up Iraq’s oil for Chinese investment.”

    there was a considerable tension between factions among ‘those who led the charge’ if i remember. geopolitical/military aims clashed with commercial/multinational oil aims once iraq was invaded.
    it makes me wonder whether ‘the players’ for the high level stakes are actually ‘the U S’ and ‘china.’? or are the various interests at geopolitical level more complex than that?
    and is it true that who gets the oil is less important than where the oil producer spends / invests the proceeds ?

  • Posted by blaze

    Yeah, I always thought that was those were the two goals of the US: put the oil in democratic hands (ie, give it up to the market, rather than in the hands of a fascist monsters) and remove oil money from small, unstable enenmies of America.

    Laudable goals, I think, but they screwed it up so badly. They should have had more people going in and the de baathification was completely amateurish.

  • Posted by

    Also, we do have to appreciate that in many ways the Chinese are underwriting the war in Iraq, so it’s only fair that they get some of the spoils.

  • Posted by bsetser

    Blaze. Given that the only entity buying more Treasuries than the PBoC right now is the social security trust fund, you have a point.

  • Posted by Peter

    Brad, I think the economic side of the invasion had to do with oil money, not oil itself. There’s a global market in the gooey stuff, and folks who have it are going to sell it, so “access to oil” is not the issue, at least not now. But as your work has shown, there is a lot of green matter coursing through the global system due to oil rents, and it is very much in the national interest of the US to make sure that as much of it as possible gets recycled to ours truly. Saudi Arabia remains the big prize, but there are lots of other prizes in that region, and a client state in Iraq was supposed to anchor US influence.

    Thus far the deteriorating US position in Iraq hasn’t prevented the oil dollars from finding their way back here, and maybe for structural reasons there’s nowhere else for them to go at the moment anyway. (There is continuing speculation about oil states and others shifting reserves into euros, but it is strongly in the interest of Euroland to pass them along back to us.)

    As for why the Chinese are so aggressive about locking in supplies, well, I’d love to ask the folks in charge. My guess is that they don’t want to shell out for the portion of the rent that ends up in the middle of the supply chain, and they are also apprehensive about the future geo-military designs of the US. What say you?

  • Posted by bsetser

    re: China’s motivations

    1) It is late to the party. Offshore reserves account for a far smaller share of China’s oil cos reserves than of Exxon Mobil or Chevron or BP or any other western major.

    2) It believes in China, Inc. If you think demand will keep on rising and supply is gonna be constrained relative to demand, buy now … and I suspect Chinese oil cos have yet to be burned in a big way offshore, so they are not as conservative as the western majors. The Chinese seem to have been the first to raise their expected long-term price for oil .. and thus have been willing to bid a bit more.

    3) It is cash rich — China’s problem is finding enough places to invest its dollars, not the other way around (as was noticed). If you are gonna overpay for Treasuries, why not for oil fields?

    4) It wants the rent in the middle (as you noted)

    5) It doesn’t fully trust the western oilcos in the event of a supply disruption … if oil is really limited, China would prefer to have Chinese cos with the oil, not to rely on Exxon and BP to sell to the highest bidder (relates to 1)

    6) It wants oil that the US navy cannot interdict in a crisis (i.e. Kazahk oil + a pipeline, Siberian oil if available — but not gulf/ african oil)

    7) It thinks it can capitalize on the unpopularity of the United sTates’ efforts to spread freedom with its vision of respecting the sovereignity of all/ doing business of oil. China, Inc won’t lecture sheiks, mullahs or secular dictators on democracy …

    Re: Iraq, I don’t think the US has a conscious strategy of keeping the oil rents in dollars. The US position is more or less do what you want — we are confident we can always attract the financing we need. The US hasn’t pushed china to keep its peg (the real constraint on its offshore investment allocation) or pushed the Gulf states to hold dollars. Indeed, it has pushed China to change and the Patriot act has hardly encouraged “onshore” $ flows from the gulf.

    But i agree in general with your point about oil rents. I don’t think the US worries so much about trading oil rent for euros rather than dollars. But it doesn’t want folks in the gulf — whether Iran, Iraq or S. Arabia — trade oil rents for nukes. Alas, its strategy in Iraq provided helped supply Iran with the means (more oil profits) and the incentive (if you are part of the axs of evil, better to have a nuke than not) to accelerate its nuclear program … or so it seems.

    Incidentally, the Shadid account of Baghdad (one of the links) is devastating — it is amazing and sad that the US could preside over Baghdad’s descent into living hell, as the lawless capital of what sure looks like a failed state.

  • Posted by HK

    Brad–I think China’s intention is quite clear, as you explained us. What is not clear is whether they will succeed in securing supply of oil and gas though their companies. Germany had lots of money, and Japan had lots fo money, and yet they failed in securing oil and gas through their companies. I doubt China’s ability to sucure supply as well, because their partnership with such unreliable and dangerous countries as Nigeria (politically unstable), Sudan (failed state), Russia (geopolitical rival), Iraq (so difficult), etc. is likely to fail. I am sure that China will soon find that Western oil majors are far more reliable than those partners.

  • Posted by Guest

    “…The argument that China’s global quest for energy resources threatens to destabilize international and regional security, and may even lead to conflict, is widely shared among analysts outside of China and in the international press…”

  • Posted by gillies

    ” I think the economic side of the invasion had to do with oil money, not oil itself.”

    the invasion was a geopolitical move. geopolitics is nearly always about everything, not about one thing. (things that are about one thing are merely local and tactical.)

    if there is one thing that geopolitics is not about, it is the advertised reason. geopolitics are too important to be left to the people, thus you can be sure that the reasons given for the people to debate (weapons of mass destruction – conspiracy theories of saddam’s connections to 9/11 – democracy etc.) can be excluded by serious students.

    o yes and pearl harbour was about oil. a surprise attack by a geopolitical rival facing loss of access to its sources of oil. worth remembering that.

  • Posted by Emmanuel

    Dont forget Myanmar.

  • Posted by Barkley Rosser

    I do not see anything surprising about
    this development. Why should not the
    current Iraqi government honor contracts
    signed with major customers by the
    previous government? It might have
    been surprising if the US had turned
    over the Iraqi oil fields to US companies,
    as many thought would happen, but it did

    BTW, China was briefly an oil exporter.
    Most focus on the rising demand for oil
    in China, but the supply side has also
    contributed to their current interest
    in securing foreign sources. They have
    what has been one of the world’s top
    producing oil fields, Daqing. But it
    has peaked and is in decline. This is
    contributing to their needs to import,
    just as the peaking of oil production in
    the US has done so here as well.

    BTW, this does not mean that I think
    we have reached a global peak in oil
    production. Maybe maybe not. I think
    that will be determined by one field,
    the world’s largest, responsible for
    4-5% of world oil production, al Ghawar
    in Saudi Arabia.

  • Posted by Guest

    gillies :

    I myself ridiculed for months those believingthat oil was behind the Irak invasion…

    Until I came across some White house documents

    However crazy, contrary the US /world interests (our logic and the logic of decent people), oil was a major cause for the US invasion.

    You may want to start your painful discovery by readinng Paul ONeil’s book – he wasthe US Treasury Minister at the time, he’s GOP right wing, so he should know…