China’s future troubles

No political risk appears to be too high for China in its quest for energy and commodities. The Chinese seem to thrive on political instability, much to the chagrin of western governments and multinationals. But what might look appealing to Beijing in the short term, could become a big headache in the long run. Ultimately China depends just as much on political stability as everyone else.

Whether it’s Repsol’s assets in Latin America, taking on assets in Uganda or thinking about launching hostile bids for Potash, China continues to snap up resources across the world. You would think that a heightened level of political risk would be a problem for China, but at this stage it’s not. If anything, it’s actually an asset: political instability makes for relatively easy access for Chinese oil majors in markets that would otherwise be tougher nuts to crack. What better way to get your foot in producer doors than in the absence of Western counterparts? Chinese officials striking deals in Guinea merely a week after the West African dictatorship launched a forceful crackdown against opposition protestors could probably give you a ballpark answer. China needs hydrocarbons, fast – and they are not stopping at anything to get their hands at them.

Instability comes in many guises for oil majors to contend with of course: hostile insurgencies, civil wars, terrorism or targeted use of political violence and civil unrest sit on one side of the political risk ledger, while expropriation, contract renegotiation, international sanctions and resource nationalism sit on the other. China isn’t particularly fussy at this stage as to which is thrown at them. They seem to be solely interested in what geological surveys sitting beneath a turbulent topsoil of heavily fertilized political risk can deliver. The ‘riskier the better’ might be an overstatement, but China is more than happy blazing a trail for concessions in Uganda, Chad, Somalia, Sudan, Nigeria, Burma, Venezuela, Russia, Iran and Iraq amongst many others – all of which display an impressive level of political risk for oil companies to navigate. North Korea has even been added to China’s list of potential destinations for natural resource extraction.

Money certainly isn’t a problem. China spent $25bn on such investments in 2007, $52.2bn in 2008 and far higher numbers into 2009/10, turning its $2.4 trillion in foreign reserves into a commodities hedge. But here’s the catch – instability is only ‘good’ for business for so long. Winning concessions, cementing political and commercial positions are all critically important to China in the short to medium

Here’s the catch – instability is only ‘good’ for business for so long
term to help shift the energy balance ‘East’, but in the long run, this must still translate into consistent, stable supplies heading for Chinese ports. And meeting domestic demand at an acceptable price really does matter for a political regime still staking its future on delivering economic growth rather than democratic legitimacy. It goes to the heart of the regime’s quest to create a ‘moderately well-off’ and ‘harmonious’ society by 2030. What might play well in the short to medium term could cost China dear down the line: in effect, China has a political instability paradox when it comes to producer states.

Magic button

China is of course not deliberately exporting instability for its own commodity ends at this stage. But it is only choosing to look at one side of the energy current account balance without considering what political debt it might be storing up on its credit card. Iran and Sudan provide the most telling examples of where China’s energy interests and stewardship of international order point towards a default on Beijing’s political credibility. Central, Eastern and Western Africa will likely provide other examples once the governance wheels fully fall off.

Why should China really care? It’s not as if the West has an ‘ethically pure’ balance sheet in this regard, and in many respects Beijing doesn’t really have any option but to play its game at a time when a global race for oil and other resources is on. If nothing else, a strategic presence across multiple producer states provides China with some useful bargaining chips down the line should it need to cash some assets in order to retain others.

China’s core concern is that some of its spread bets on natural resources actually convert into winning tickets in time to meet domestic demand. The Chinese focus is very much on striking more and more supply side contracts with politically shaky regimes (albeit with nuanced approaches as to what will work where and when) as a supposed route to plentiful supplies, rather than stabilizing producer states already on Beijing’s books. Stability is still only seen as a long term play for China once concessions are signed and a position of market dominance is secured.

But such a strategy could prove to be ultimately flawed, not least because the supply clock is politically ticking down for the CCP. Reserves simply have to become production for the Chinese, but as any political risk analyst will tell you, political instability does not play well for long-term, stable supplies.

If China assumes it will be able to find a ‘magic button’ capable of turning bastions of instability to oceans of calm just at the critical point when it needs the oil to flow thick and fast, it is likely to be disappointed. This is precisely when serious questions will be asked as to whether China has put the energy cart in front of the stability horse to secure long term reliable supplies. And if anything, China’s presence could enhance the bargaining power of producer states to play loose and fast with contractual terms. The juxtaposition of Central Asian and Russian supplies to the Chinese mainland is a good case in point. Is Russia supposed to be playing Central Asia, or Central Asia playing Russia? Or is China now playing both? Worse still, production could be clipped in previously stable regions should Beijing’s presence inadvertently reignite latent regional or geopolitical tensions. If this is the case, then we can expect the Chinese ‘non-intervention’ norm to die an early death – from a diplomatic perspective at the very least.

A credible Plan B?

China does of course have something of a plan B. It has been building stronger relations with energy bulwarks, most notably Saudi Arabia, Kuwait and the United Arab Emirates which have a secular history of delivering the goods to help reduce their dependence on more marginal players. But even here, it remains uncertain that such supplies will stay online if China continues to help nudge Iran towards the nuclear brink. Arab states still put politics ahead of oil when push comes to shove. This is a factor that Beijing will critically have to consider given the bulk of global reserves still residing in the Gulf.

Clever use of joint ventures by putting local energy players on the political frontline in Africa also appears a canny option to hedge political and reputational risks, but it assumes that the likes of Sonangol in Guinea will be more adept at steering places like Conakry towards a path of greater

The point here is not to bash the Chinese, but to emphasize that as its global energy footprint grows, Beijing can no longer afford the luxury of remaining politically aloof
stability and long term production than Beijing would be. ‘Pushing proxies’ in this way could actually complicate regional politics even further by placing Angolan-Chinese relations on a pedestal. Making Luanda the dominant energy player in the region has already ruffled feathers in neighbouring Nigeria; Lagos is now working hard to make up lost time on Chinese investment. Although China spread its bets more evenly in Latin America by virtue of investing in Venezuela, Brazil and Argentina in the hydrocarbons sector, how such investments will affect the political balance in the region remains to be seen. The point here is not to bash the Chinese, but to emphasize that as its global energy footprint grows, Beijing can no longer afford the luxury of remaining politically aloof. It is critical that Chinese strategists understand the local and regional contexts within which their energy companies are operating and the broader strategic implications this could hold given that they are now an integral part of the picture. This shouldn’t be sold to China on some spurious grounds of supporting international order - that would be massively hypocritical of the West to suggest - but purely in terms of the CCP’s own survival. While it might look politically appealing in the short term to sign new energy deals and plant flags in resource-rich states could prove disastrous for Beijing if such actions sustain, or indeed sharpen instability. Resources remaining buried in the ground due to ‘above ground’ risks, hardly does the trick.

Ultimately China’s race between time (brining reserves online) and space (increasing its global footprint in politically broken states) is one that it will lose unless the instability paradox is resolved. Until that day, energy (in)security will only increasingly rise up the agenda for the CCP as the messy political realities of energy geopolitics play out. Treading a little more carefully now could pay significant dividends for China in future. Not least because China will probably want to acquire the biggest prizes of all in the form of Western oil majors one day; when they do, they will need all the friends they can get.