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China’s energy security needs have much in common with countries that spread rhetoric about its plans

China’s appetite for oil has been soaring over the past two decades, and its oil imports will continue to soar in the decades ahead. The country will thus become far more exposed to the risk of international supply disruptions than it is today. This has raised great concern about China’s energy security, because its rapidly increasing oil imports come mainly from politically unstable regions and are shipped through lengthy sea lanes over which China has little say.

Given the strategic importance of the Strait of Malacca and China’s limited influence on the waterway, China has made great efforts on both the demand and supply sides to cope with the perceived “Malacca dilemma” and to enhance its energy security. China's responses on the demand side are well formulated and justified, but the same cannot be said for the supply side. One widely debated option on the supply side is the reliance on the oil production of Chinese national oil companies and aggressive acquisitions of overseas oil fields.

In the early 2000s, the Chinese government adopted the “going-out” policy to help state-owned companies, including oil companies, to achieve their ambition to grow and build global businesses. Arguably, the government also sees supporting Chinese oil companies' efforts to make overseas oil and natural gas mergers and acquisitions as a way to diversify its foreign exchange reserves away from low-yielding financial instruments such as US treasury bonds. As a result of the "going-out" policy supported by Chinese banks, these oil companies now have equity stakes in production in 20 countries.

Western political rhetoric characterizes China's efforts to secure energy supplies overseas as a major threat. That rhetoric further intensifies China's mistrust of global oil markets, sparking fears that the energy establishment will seek to deny China's access to the oil it needs for development. This mistrust, combined with great concerns about its increasing dependence on imported oil and heavy reliance on the Strait of Malacca for oil shipping, has in turn built China's false perception that its investments in oil fields overseas are able to help strengthen its energy security.

With oil as an internationally traded commodity, China’s endeavors to expand its global search for and production of oil are constantly confronted with the issue of whether this strategy is superior to simply buying oil in open markets. This is due to concerns about Chinese oil companies' overbidding and making investment losses abroad.

These oil companies have a history of overpaying for equity. Because China has viewed paying a higher price than its competitors to secure energy resources to be more of a national security issue than a pure business decision, the resulting bidding wars have intensified the tendency for Chinese oil companies to pay far above what their competitors offer.

It is important to note, however, that the higher bid does not always win in a politically charged industry such as energy. In 2005, the China National Offshore Oil Corporation failed to acquire petroleum explorer and marketer Unocal for $18.5 billion (13.7 billion Euros), although it beat Chevron's bid of $16.4 billion. In the end, Chevron won the deal based on other factors. This overpaying might partly reflect a need to overcome the kinds of political difficulties that hampered Chinese state-owned companies' overseas takeover attempts in recent years.

Nevertheless, Chinese oil companies are now more reluctant to overpay for assets for at least two reasons. First, these companies have moved up the technology and project-management learning curves that international oil companies had previously dominated, and have become increasingly sophisticated and capable in the global market. Second, they have been tightening up their premiums by examining the financial returns of their bids. CNOOC has started using a financial metric system that allows it to price its bids more accurately.

A recent study by the International Energy Agency uncovered no evidence of systematic or intentional overpayment associated with recent acquisitions. However, this is still an issue open to debate, and there is still disagreement. Some US analysts believe that Chinese oil companies continue to pay significant premiums to acquire overseas assets. One analyst from the conservative Heritage Foundation was quoted as saying that Chinese companies usually pay 20 to 30 percent more than other companies to secure assets. The premiums were generally seen as necessary to keep shareholders happy and quell any political concerns given anti-China sentiment in certain circles.

Another issue is related to wide concerns about the huge losses incurred when investing abroad. A study by the China University of Petroleum suggests that China's “big three” oil corporations had invested in some 144 overseas projects totaling $70 billion by the end of 2010, but two-thirds of such overseas investments suffered losses. Given that these state-owned companies can cover overseas losses through their access to capital at home, this has created a perception of these state-owned companies as irresponsible users of state funds.

It can be argued that economic rationale can take a backseat if Chinese oil companies' overseas production activities can help improve the country's energy security. The question is then whether or not these companies' equity oil shares improves China’s energy security.

First of all, if their overseas oil production is to help to improve China's energy security, then any oil produced needs to be shipped back to China. But, if the threat of a blockade is the concern, then sending Chinese oil companies' equity oil shares home faces the same problem.

Second, China's oil imports rapidly outpace the equity oil production of Chinese oil companies and their ability to acquire oil assets and accumulate investments in equity production abroad, so the equity oil strategy is hopelessly inadequate as a critical energy security strategy.

Third, there is little evidence to suggest that Chinese oil companies necessarily send their equity oil production back to China. Instead, the companies apparently prefer to let market conditions decide whether it is shipped back to China or whether it is sold to regional or international markets at the best price, as other international oil companies do.

Fourth, the available evidence does not suggest that oil produced from the Chinese oil companies would be either cheaper or more available to Chinese consumers in a supply crisis. Indeed, these Chinese oil companies have shown little inclination to grant Chinese customers a discount when prices are high. In fact, the oil companies responded to rising crude oil prices prior to 2008 by reducing supplies of refined products to the Chinese market, resulting in widespread shortages at the pump, since the government's controls over the prices of oil products did not allow them to pass their rising crude costs on to customers.

In the meantime, Chinese investments in oil fields overseas do help to pump more oil out of the fields and enlarge the overall availability of oil on the world market. This is seen as beneficial not only for Chinese consumers but also for other global consumers. Taking these points together, Chinese oil companies’ efforts to secure overseas oil and gas supplies are not a threat to US or Western energy security. But they do not unambiguously improve China's energy security because the oil companies do not necessarily send their equity oil production back to China.

It thus follows that China's global quest for energy security needs to be de-politicized. Western politicians need to recognize that their rhetoric in relation to China's efforts to secure energy supplies overseas has done nothing but intensify fears that they might seek to deny China access to the oil it needs for development. Meanwhile, China needs to reconsider its stance of distrusting global oil markets and recognize that its reliance on aggressive acquisitions of overseas oil fields and equity oil production has been of little help in strengthening its energy security.

Just like other oil importers, China’s energy security depends increasingly and deeply on the stability of global oil markets and the reliability and growth of oil supplies in the market. Thus, China and other major oil-importing countries share profound common interests in maintaining and strengthening the stability of global oil markets and reducing the chance of potential disruptions and the resulting damaging oil-price shocks.

ZhongXiang Zhang is chairman and a professor of School of Economics, Fudan University, Shanghai. The views do not necessarily reflect those of China Daily.

(China Daily 02/01/2013 page 9)