China's Shrewd Long-Term Oil Plan: What America Can Learn

Iraq recently signed its first oil deal in 35 years with a foreign company.

And – quite surprisingly to many observers – the company wasn’t one of ours.

Not surprisingly, the U.S. news media barely acknowledged the deal – even though the agreement was major news throughout the rest of the world.

According to reports from Baghdad, the 22-year deal between the Iraqi government and the China National Petroleum Co. involves $55 billion, or 87% of Iraq’s current total revenue at a conservative long-term estimate of $100 a barrel.

The deal is actually a renegotiated version of a 1997 agreement between China and a Saddam Hussein-led Iraq. That original deal included production-sharing rights, but profits, The New York Times reported. The payments will be made in cash – and won’t be “in kind” payments of crude oil, the newspaper said.

While this deal, on its face, appears to be just another global oil-services contract, it’s actually a very significant development in the hunt for long-term energy supplies. In fact, it actually demonstrates that – when it comes to nailing down those long-term oil supplies – China is an expert, and is playing a very deep game. And the outcome of that game will certainly have substantial long-term implications for consumers and investors both here in the United States, and in markets abroad. Here’s why:

• With estimated reserves of 115 billion barrels, Iraq is tied with Iran for the world’s No. 2 position. It trails Saudi Arabia, which has estimated reserves of 264 billion barrels, according to estimates from the Energy Information Administration.
• In a country where electricity is in short supply, the oil produced from the Ahdab Oil Field will help fuel a planned power plant that would be one of the largest in Iraq. By helping Iraq with this key initiative, China can expect to gain a solid foothold in one of the most oil-rich nations in the world, analysts say.
• At the end of the day, the deal clearly highlights something that most U.S. investors haven’t focused on yet – namely that the eventual winners in this game may not be such well-known giants as Chevron Corp. (CVX), ExxonMobil Corp. (XOM), or other household names. Deals like this one and the host of others that are undoubtedly close behind suggest that tomorrow’s winners may have names most English-speaking investors can’t pronounce, since they’ll be distinctly Arabic or Chinese in nature. [Two recent installments of Money Morning’s popular new “Buy, Sell or Hold” feature have focused on Chevron. Take some time to peruse the original story, as well as the update.]

China’s Shrewd Long-Term Oil Plan

The important thing for investors to understand now is that oil ownership, as I have said for many years, is an illusion. It does not guarantee price, nor profit. What really matters in the end is having secure supply lines and sources from the Middle East (and other parts of the world).

Under this new contract, CNPC will provide technical advisors, oil workers and equipment to help develop the Ahdab oil field southeast of Baghdad, said Assim Jihad, a spokesman for Iraq’s Oil Ministry.

While China won’t participate in the profits from the oil it helps pump, it is shrewd enough to realize there will be long-term benefits. Analysts who see the bigger picture here agree with our view.

Ibrahim Bahr al-Ulum, a former Iraqi oil minister, told The Times:

There are some political profits for China. They need access to Iraq, and when they need oil, at least the Iraqi people will feel that China has done something for them.

And, that’s not all. Before 2003, Iraq had oil agreements with China, Russia, Indonesia, India and Vietnam – three of which included production-sharing agreements, The Times reported. But the big jump in oil prices, the new government and a myriad of other changes that have taken place since that time prompted Iraq to reconsider the terms of those deals, Iraqi officials said.

Iraq continues to negotiate other service contracts with ExxonMobil, Royal Dutch Shell PLC (RDS.A) (RDS.B), Total SA (TOT), BP PLC (BP), Chevron, and some smaller oil companies. The deals have been reduced in length from two years to one after Iraq took a lot of flak for not putting the contracts out for competitive bidding.

But China’s contract was the first major one to be completed – and for one simple reason, Jihad, the Iraqi Oil Ministry spokesman, said. CNPC had “wide experience in this field,” and because many foreign oil companies were not willing to come to Iraq.

China has apparently learned how to play the global oil game with a pro’s touch. Ironically, it was the United States that crystallized this vision.

By invading Iraq, the United States dealt China’s central planning commission an embarrassing wakeup call when the second Gulf War summarily wiped out China’s oil interests in Iraq.

When that happened, China’s central planners realized two things:

• The status quo in the global oil game had changed.
• And China’s double-digit economic miracle could not be sustained with only a few oil suppliers.

What China fears most is that there will not be enough oil to go around in the very near future and that a U.S.-dominated supply chain could effectively “strangle” China’s growth.

So, it has done what the United States and other great powers have done at other times in history and gone on a buying spree from Darfur to Peru that’s turned heads and ruffled feathers all across the world.

What’s been especially frustrating for hapless Western leaders who do not understand that their actions caused this in the first place, is that China’s not afraid to do business with rogue nations like Iran, Sudan and Burma. It has even gotten chummy with Venezuela and Russia – much to the consternation of our present administration.

It’s a virtual certainty that China will maintain this policy going forward. My contacts in China and Africa have told me point blank that China’s leaders “don’t care about human rights or nukes or hostile governments. What matters is anyone who provides oil to China no matter what the rest of the world thinks.”

So, in as much as the U.S. media has dismissed this deal as only one in a long string of recent Chinese oil purchases, it’s arguably the most important deal yet. The reason: It suggests that China will go to extraordinary lengths to obtain the oil it wants and needs.

To add to its stable of captive oil suppliers, China will pay far more money, endure limitless criticism for ignoring human-rights issues and endure harsher business conditions than our companies can or will undertake. While U.S. firms must worry about sanctions, bad publicity or simply security, China worries about one thing and one thing only – getting oil.

It’s a lesson initially learned from us. Then they refined it. Perhaps it’s time we re-learned this lesson from China.

 

Comments

[Chris B:]

Perhaps someone from the Chinese embassy should go to Arlington National Cemetary and leave flowers in gratitude.

This story sure puts those idiotic magnetic "made in china" patriotic car stickers into perspective.

2008 Oct 16 09:05 AM

[Abdullah al...:]

Well I hope all of the Americans screaming that we went to war in Iraq for their oil are happy now that Red China (the beacon of human rights) is going to get it all.

2008 Oct 16 09:08 AM

[DataMan:]

China has had a "shrewd long term oil plan" for quite some time but I don't know what America can learn from it. Your article mentions China's oil initiatives in other parts of the world. It is much more aggressive and intense than you suggested. They are major investors in the Canada oil sands, Cuba, Venezuela, and other areas of South America. Some of their biggest plays are in Africa. About a year ago, Nigeria offered the first new concessions in over 10 years. China bought all four, shutting out the western producers for the first time ever. They have written long term contracts with several other African nations guaranteeing them the majority of all future oil along with major infrastructure contracts to build the facilities, pipelines, roads, etc., to implement production.
As global peak oil is upon us, China is guaranteeing their supply of future oil while the west is facing shrinking capacity. Ten years and forward, China will be in a dominant position and there is not much we can do about it because we've been ignoring their tactics for the past few years.

2008 Oct 16 09:16 AM

[phdinsuntan...:]

well, they paid the war with USTB, so they deserve the rewards

2008 Oct 16 09:22 AM

[Chris B:]

Here's a "shrewd long term oil plan"...

GET OFF OF IT!

-Chigago or European style light rail in all cities and between all cities.
-Cut income taxes and raise fuel taxes.
-Invest in fixing crime and schools - then inner cities will rebuild on their own and average commutes will shorten!
-Assist railroads in adding freight shipping capacity.
-Assist utilities with building nat gas infrastructure for heating in the Northeast.
-Tax credits for geothermal home heating / cooling systems.
-Manhattan project sized research inititive for alt-fuel vehicles (and no, not ethanol).

If China doesn't do this, they will in a few years be in as bad a position as we are - having recessions scheduled by oil sheiks. Not so smart.

2008 Oct 16 10:51 AM

[Gandalf:]

We must get our economy off of imported energy before we go bankrupt and China and the OPEC states own us. They will be in a position to pick up the pieces of our failed (non-existent) energy policy at 1% on the dollar. We are heading toward 30% now.

What ever happened at those "secret" Cheney energy policy meetings?

Were they so mesmerized by the Bush/Cheney/Rummy/Wolf...
IRAQ BS that they failed to secure our real national interests???

2008 Oct 16 10:53 AM

[longoil:]

This is a very interesting article.

There is a recent book by James R. Norman called "The Oil Card" where he discusses the circumstances around two key oil price movements in the last 25 yrs.

1) His first theory states that the major price drop of oil in the mid-1980's was orchestrated by the USA et al. to collapse the USSR. When combined with an expensive USSR campaign in Afghanistan and trying to keep with up Ronald Reagan's SDI "Star Wars", oil prices did indeed collapse the USSR.

2) He also theorizes that high oil prices are orchestrated by the USA to prevent China from becoming the dominant world power.

It is an interesting read.

2008 Oct 16 12:15 PM

[Urbane Gori...:]

I remember reading that China had signed the first oil contract with Iraq. At the time, I noted that China had been very busy signing contracts in many parts of the world, tieing up commodities.

Am I the only person that wonders if the 'non-emergence' of China after the Olympics is a means of beating down prices on shipping and ore?

Bear in mind that they are playing hardball with Vale (RIO) right now, and steel prices have plummeted. Fortesque (FSMPF.PK) is busy as a beaver renegotiating their ore prices with 'hard hit' Chinese founderies and is passing on shipping savings in order to keep ore going out. Meanwhile, Iran has finally sold off it's stored crude at sale prices. Also, consider all the stockpiles of commodities that they had before the Olympics.

Lets see; Ore is down, oil is down, shipping is down, and the Chinese seem to be the only people running around contracting, negotiating and setting themselves up????

Either, they are taking advantage of a down market, or perhaps, it was engineered???

jegan ;-)

2008 Oct 16 12:44 PM

[byrnemm:]

"well, they paid the war with USTB, so they deserve the rewards "

There is an unfortunate amount of truth in that comment, phdinsuntanning.

Can we go ahead and start building our alternative energy infrastructure so when we start running low on oil we will not be involved and we can sit back while China and the Middle East blow each other to hell?

2008 Oct 16 03:08 PM

[Socialism c...:]

@Chris B: I agree we must end our dependence on *middle east* oil. But I take exception to a few of your points:

[quote]
-Chigago or European style light rail in all cities and between all cities.
[/quote]

*All* cities? That's a heckuva flippin' lot!! Keeping in mind that the U.S. is so much bigger geographically than Europe, this does not make sense. What *does* make sense is regional rail systems.

a) the cities are close enough to be connected cost-effectively, and there would likely be more traffic between regional destinations.

b) the duration of a train journey (yes, even "high-speed") between non-regional cities, say Portland to Houston, or Boston to Denver is just too long compared to flight. The high-speed trains in Europe go a couple hundred miles per hour, compared to 500-600 mph for long-distance flights. Why would I ever want to take a 12 to 16 hour train trip when I could fly there in 3 or 4 hours?

My example of a regional system that would be great would be in the midwest, with lines that connect Chicago, Milwaukee, Madison, Green Bay, and the Twin Cities. All are within several hours drive of each other, with frequent travel between them.

[quote]
-Cut income taxes and raise fuel taxes.
[/quote]

*Eliminate* income taxes. The only tax should be sales tax -- that is power back to the people. When we don't like how government is spending our money, we quit all discretionary spending and voila! -- instant tightening of the government purse strings! If we can't get there, the next best (least worse?) alternative is a flat tax. I do agree that current income taxes are far too onerous. Only a much simpler flat tax or sales tax will provide the transparency as to how much everyone is actually paying!

[quote]
-Invest in fixing crime and schools - then inner cities will rebuild on their own and average commutes will shorten!
[/quote]

We already pay the highest average per pupil in the world!! And yet we lag further behind the leading educational nations. It's not about funding. It's about family life and the values instilled (or not) in the kids. Address the character and moral issues, and the crime and school issues get largely fixed.

[quote]
-Assist railroads in adding freight shipping capacity.
[/quote]

In what way? Are you talking building more separate freight lines, vs. passenger lines? Transfer mode facilities? Or what?

[quote]
-Assist utilities with building nat gas infrastructure for heating in the Northeast.
[/quote]

We are capitalist (or were!)...let private companies build it. And let them profit from their investments.

[quote]
-Tax credits for geothermal home heating / cooling systems.
-Manhattan project sized research inititive for alt-fuel vehicles (and no, not ethanol).
[/quote]

Again, no. The tax system is too complex already. Enough with the credits and loopholes, exemptions, etc. Flat tax. Or sales tax.

[quote]
If China doesn't do this, they will in a few years be in as bad a position as we are - having recessions scheduled by oil sheiks. Not so smart.
[/quote]

Certainly oil prices played a part. But we are not in recession because of that. That's just one factor. And even so, it could be maintained that that factor was "scheduled" by environmental groups and Democrats who have long opposed domestic drilling and production.

2008 Oct 16 04:53 PM

[Diegojames:]

That was Speaker Nancy Pelosi and the democrats.
Diegoj

2008 Oct 16 05:33 PM

[Diegojames:]

Fax your comment to Speaker Nancy Pelosi and the democratic party.
Diego

2008 Oct 16 05:35 PM

[Diegojames:]

Why did Speaker Pelosi and Obam argue against the war if they new we were doing it for China to buy more US Treasury bonds?

Diego

2008 Oct 16 05:36 PM

[Diegojames:]

Chris -Great thinking; those trains need to be like the Franch TGV (hi speed) electric powered from nuclear power generators(buy MDR and Shaw); alt energy cars very necessary in California with special lanes so all the SUVs don't kill them.
Diego
Hey Chris what do you think of SOLAR ??? Lots of sun out here all day long

2008 Oct 16 05:42 PM

[Chris B:]

Socialism,

Regarding your points about the economics of rail vs. car or airplane:

a) About 70% of the US population is concentrated within 150 miles of the coasts. Of the remainder in the middle, the majority live in metropolitan areas like Chicago, Dallas, St. Louis, KC, OKC, Denver, etc. No, rail will probably not be economical between 1000 person towns in South Dakota or New Mexico within our lifetimes, but if we could provide coverage to 70-90% of the population in dense areas, we'd be petroleum independent.

b) You'll take the train trip when it is several hundred dollars less than the airplane ticket in a world of $500 / barrel. Trains can move a ton of freight (or people) several miles on a gallon of diesel. Besides, all the airlines are propped up by government subsidies anyway (airports, FAA air traffic control, security, etc.). They'd be out of business if not for your tax dollars.

-the govt could help rail growth by (a) not getting in the way, and (b) prioritizing emminent domain issues that help us acheive petroleum independence.

-Why not use tax credits and govt. spending to encourage desired actions and discourage undesired actions? Look at what higher cigarette taxes do to cigarette consumption (well documented). Our govt. currently spends billions of tax dollars defending the Persian Gulf so the oil companies can make money. I say shift that spending to getting off oil. Then we can abandon that awful region rather than sinking money into it every year.

-How do you propose the government can force people to have good values? Is that even a proper goal for government? I say build enough jails, hire enough police, and quit abandoning the inner cities - a "surge" if you will. 50 mile commutes will be too expensive for people to live in the exurbs soon. Regarding schools, you will never have safe streets or a vibrant economy with millions of illiterate unemployable poor. That's not going to happen with 30+ kid class sizes and teachers basically providing daycare for $25k a year.

-The political wishful thinking myth of infinite oil under Pensacola beach can be refuted by any reputable petroleum geologist. Sure there's oil out there... maybe even 6 month's worth at current usage levels - which would be sold on the world market anyway. I say we preserve this resource for when everyone else's oil is running out, then use it in a last ditch effort to build the infrastructure we will need for a post-petroleum economy. Imagine the consequences of failing to do so.

2008 Oct 16 05:47 PM

[Diegojames:]

When the political brains constructed fannie and freddie to receive the lobbyist money was that capitalism , socialism, communism , Ponzism, Nazism, human rights, saving a tree, lunch for schoolism?????

We have to return to the taxpaying voter, not some one from ACORN selling a mortgage and getting a voter card for someone in the democratic party, watching what the government is doing.

Write your Congress Person. Say all incumbents out for this mess.

Diego,

2008 Oct 16 05:53 PM

[HaavBline:]

Your imagination ran wild. The commodity crash follows the global credit bubble crash which followed the US subprime bubble crash. Clearly, China will benefit from lower commodity prices in the long run. But to think the whole G7 world can only watch helplessly while Chine 'engineer' a global recession so that they can re-nogotiate some iron ore contracts is very silly.

2008 Oct 17 12:01 AM

[Witzy:]

"China are major investors in the Canadian oil sands..."?

I'm here in Canada, and I just do not see it. One medium sized play they were making was rebuffed and they pulled WAY back. The top 5 syndicates/companies represent 80% of current or immanent production, and China is a secondary partner in just one of these. UTS owns huge reserves, like Fort Hills with Petro-Canada, yet their stock price today reflected their cash reserves ONLY. So, if China is trying to buy in, where are they?

2008 Oct 17 01:42 AM

[MFP:]

"The important thing for investors to understand now is that oil ownership, as I have said for many years, is an illusion. It does not guarantee price, nor profit. What really matters in the end is having secure supply lines and sources from the Middle East (and other parts of the world).

...

While China won’t participate in the profits from the oil it helps pump, it is shrewd enough to realize there will be long-term benefits. Analysts who see the bigger picture here agree with our view."

I've linked this article to my blog, because it discusses Chinese oil production.

I've never read anything by you before, but please, change your style.

Nobody cares who agrees with you especially when you backhandedly define who can agree with you (only those who see the big picture).

"As I've said for many years."

Please. Tell me what oil will cost tomorrow and what Saudi Arabia will be producing next year. Otherwise, don't waste everybody's time with your nonexistent record of correct forecasts.

2008 Oct 17 02:22 AM

[MFP:]

Earlier in the comments -

"longoil" recommended James Norman's "The Oil Card."

I echo this.

This book is the best book written about oil recently (only 1 or two good one's come out a year).

I disagree with a lot of Norman's points and his thesis, but since I'm not publishing my review here I'll leave it at that.

The book contains excellent information on oil production and the industry. It is really about China.

Great book for those interested in these subjects. Good call, longoil.

2008 Oct 17 02:35 AM

[PeteK:]

We have billions & billions of tons of oil under our own ground but not allowed to drill, rather, pay billions of dollars to tyrants and fanatics for their oil. Why ? Some foreigners call Americans greedy because Americans want to use up other's oil first, then use their own when nobody else has any left. Maybe true.

2008 Oct 17 03:17 AM

[Chris B:]

Peppio,
Get your information from petroleum geologists, not Rush Limbaugh. Thinking there is infinite oil under pensacola beach that will drive the price of gasoline back to $0.70 is wishful thinking at best. Protected areas in the gulf PLUS Alaska could produce maybe 1% of world oil supply for a few years, at enormous cost. Meanwhile oil demand will grow probably 1.5% next year. Experts say that. Science says that. Media blowhards and lying politicians say otherwise.

The endgame is clear, but we're in denial thanks to media personalities and politicians promoting unscientific ideas.

I would say just open the areas to drilling just so we can debunk these conspiracy theories and move on to developing an actual plan to get off oil before oil wrecks our economy. However, I'm sure the next conspiracy theory would come along: "Yellowstone national park is the next Saudi Arabia, but those dammed environmentalists...."

2008 Oct 17 09:32 AM

[john s. gordon:]

gandalf - the agenda of the cheney energy task force of 2001 was to maximize profits over 2001-08 to the houston oil millionaires, never mind implications to citizens of the u.s.a for the future.
> jack

2008 Oct 17 09:50 AM

[DataMan:]

Correction: investments, not major investments.
China's involvement in the Alberta oil sands has been relatively small and tentative partially due to the political relationship between Canada and China. China Petrochemical Corp. owns a 40% stake in Canada’s Northern Lights oil sands project with Synenco Energy Inc. China National Offshore Oil Corp (CNOOC), holds a 17% stake in Canada’s MEG Energy Corp. These two investments are worth about $300 million combined. China has been buying up bits of Canadian oil sand land as well as investing in a variety of start-up producers. China National Petroleum Corp. acquired a majority stake in an exploration project in 259 square kilometers of oil sands territory in northern Alberta. Calgary-based Husky Oil, is majority-owned by billionaire Li Ka-shing of Hong Kong, rumored to be forming some sort of relationship with, one of the China state oil companies.

2008 Oct 17 11:59 AM

[DownOnMyLuck:]

Chris B., I read a National Geographic article in the 70s were petroleum geoligists said that we would run out of oil in the 80s. They have been predicting the end of oil since the beginning of oil. Some day they will be right. Scientists are no more accurate predicting the future as anyone else. Remember the coming ice age? the population bomb? mass starvation? etc. As Yogi Berra said, "It's hard to make predictions, especially about the future." He was partially correct. It's east to make predictions, but nearly impossible to make accurate predictions. Here's one: Curlin to win the Breeder's Cup at Santa Anita on Oct. 25th.

2008 Oct 17 12:55 PM

[Ferdinand E...:]

An interesting and useful article that deserves wide circulation, and the same is true of some of the comments. The point is to help the movers and shakers understand what kind of pressures are going to exist on the demand side of the oil market in the not too distant future. What about the supply side? This you can forget, because the exporters of oil are through selling it at bargain basement prices. Wouldn't you feel the same way if you were in their place?

2008 Oct 17 02:17 PM

[Chris B:]

DownOnMyLuck,

A 30 year old magazine article is hardly a good reason to consider political commentators to be more trustworthy than scientists who have studied these issues their entire lives.

I'm sure there's lots of oil still out there, but the question is, is it economical to produce? If there is a pool of 10,000 gallons of oil 8,000 ft under my house, it will never be economical to produce. Even if there were millions of these uneconomical little pools across the country, if they cannot be economically extracted, it's logical to say that we've run out. If it costs $500 to extract the oil to fill your tank - forget about it.

$75-$100 oil has inspired the development of all sorts of previously uneconomical fields. The oil that could have been obtained for $10/barrel is mostly gone. At what price per barrel do we admit we've run out? $100? $200? $500? $1,000?

At the right price, the market will produce that marginal barrel of oil, even if they have to synthesize it in a lab! However if that price is so high that it crashes our economy, I say that it's safe to say we've run out.

We will get to that point eventually, but if politicians convince people that there's infinite oil under Daytona beach that is being blocked by the opposition party, we might never adapt to the new reality until it's too late.

2008 Oct 20 10:14 AM

[nmelendez:]

Everyone keeps forgetting about natural gas and coal. People, get a grip on reality!!!! Oil is not the only fuel source. Heck, there are over 8 trillion cubic meters of methane on the ocean bottom.
If i lived in the US i would buy a Honda civic or accord powered by natural gas. You can buy a home filling station and fuel you vehicle in your garage directly from your LNG city supply while watchin Green Bay bash the Redskins!!!! Sheeeeeeesh.

2008 Nov 05 09:51 AM

[Pax Americana:]

My mind keeps reverting back to this statment..........."Oil is set to
run out in 35 years, using the highest level calculations available"
............without taking into account, growth in DEMAND!
We desperately need a proactive National Energy Policy, with the express purpose of Weaning America away from its addictive
dependence on foreign oil imports.

Jun 22 08:01 AM