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The Irony of China’s Search for Energy

by | published March 21st, 2012

Kent is in Huntington Beach, Calif., to present the keynote address on “The Future of U.S. Energy Policy” at the CoBank Annual Meetings.

I hope he didn’t have to rent a car. If so, he’s going to have sticker shock when returning to the airport.

The average price of regular gasoline in the Golden State is around $4.32 – a record high for this time of year.

He might be better off cruising down to Mexico to refill his tank instead.

Thanks to government regulations to artificially suppress the price, American drivers can find gasoline in Mexico for up to $1.50 a gallon cheaper than stations here. But drivers also have to ignore U.S. State Department travel warnings. A willingness to cross the border anyway shows just how important inexpensive fuel is to drivers living on a budget.

It all comes back to the subject that Kent and I have written on with a lot of passion in the last few months.

The U.S. has lacked a cohesive energy policy for the last four decades, with every President since Nixon ignoring his own calls for energy independence and an effective strategy moving forward.

And as the global economy becomes more competitive, access to less expensive sources of oil wanes, and political tensions drive greater uncertainty, there’s new irony to our lack of a real energy policy.

And it’s leading to new competition for fuels in our own back yard.

Are Foreign Policy and Energy Policy the Same?

Since California-Arabian Standard Oil Company first received oil concessions in 1933 from the Saudi Arabia government, United States foreign policy has maintained a steady mission of protecting energy interests abroad.

Eight decades later, he U.S. continues to have a strong interest in Middle Eastern affairs.

While I was a graduate student at Johns Hopkins, several of my energy policy professors argued that U.S. foreign policy centered entirely on the production and protection of American oil interests.

Not the spread of democracy.

Not the challenge of developing new trading partners.

Not fighting a competing ideology.

To these professors, one word has ruled all for eight decades: oil.

But this strikes me as a flawed argument, given that United States tax policy does not favor American companies producing oil in foreign lands.

Here’s why.

The United States is the only nation that double-taxes the profits of its energy companies abroad.

Foreign U.S. companies lease the lands from the host nations and pay royalties on all produced oil in those countries or offshore lands. They then pay a percentage of their foreign profits to the United States government.

This puts these American companies at an economic disadvantage when bidding on new leases on reservoirs of fuels from reserve nations (the countries that physically possess the oil). When American companies seek to develop newly discovered oil fields, they compete with state-owned or foreign private energy firms that don’t carry the same tax burden in their home countries.

A further disconnect between foreign policy and tax policy exists just within corporate tax rates. In 2010, the effective income tax rate for oil and natural gas companies averaged 41.1%, compared to 26.5% for other S&P Industrials.

If foreign policy centered on the increased development of energy production, we’d see even greater levels of tax breaks and encouragement from the Federal government.

So isn’t it ironic that China – a centrally planned economy that is growing at 9% a year and needs all the oil it can get in order to maintain its robust growth – is taking a page out of this academic playbook to procure massive new sources of energy abroad?

The Chinese Conundrum

Over the past decade, China has expanded its international presence in the procurement of all forms of energy. The country has used its economic influence and has sought to utilize incentives to nations resistant to foreign development (such as shared infrastructure projects) in order to ensure the development of oil and gas.

But as China rises to the international stage, its bureaucrats are learning the hard way that all host nations of oil are not the same, and political vulnerabilities and economic conditions are making it more and more difficult to procure oil over the long-term.

China is currently the second-largest importer of oil in the world after the United States, and poised to overtake the U.S. in the next two decades.

But where it’s sourcing its oil is increasingly more complex.

China’s three largest sources of oil are:

  • Saudi Arabia, a long-time ally of the United States and nation susceptible to political instability over the long-term;
  • Iran, which is currently threatening the global markets with supply disruptions over its nuclear program; and
  • Angola, another major U.S supplier with rising economic and social problems, and resistance to foreign development.

China has placed an increased emphasis on securing resources from African nations. In 2010, it became the continent’s largest trading partner. And as policy observers like Howard French at Columbia University have stated, China’s has done very little in the way of telling African leaders how to run their countries.

For now, at least.

As China continues its commitment to develop commodities across the world, criticism on its lack of focus on human rights and economic development for its host nations will dog the country. Should one of the nations that provide a significant amount of resources find itself in upheaval in the near future, China will be forced to make a decision on how to handle its long-term investment.

And over time, China will be learning the hard way how foreign policy and economic and energy development go hand in hand.

Which Brings Us to Canada

China’s Sinopec made headlines in October when it agreed to buy Canadian oil and gas company Daylight Energy for a little more than $2 billion. It was the latest in a string of energy deals that allowed China into the backyard of the United States’ biggest and most reliable foreign source of oil.

China recognizes that Canada offers economic stability and predictability from its Western supplies, which are the second-largest proven oil reserves in the world. Canada’s favorable economic climate, its nonresistance to foreign companies, and its willingness to collaborate and develop its own resources offer any customer the reliability it needs over the long-term, unlike the traditionally unstable resource nations in the Middle East or Africa.

But the U.S.’ most stable source of oil is the Canadian tar sands. And this is placing the States in an awkward situation. China’s foreign policy has incorporated the very American search and development of foreign oil.

And now we are susceptible to losing supplies we counted on.

Though the United States will continue to drill and seek to convert parts of its economy to using natural gas as a primary source of energy, the country will continue to compete with other emerging economies for reliable sources of crude.
And over time, China and the United States will have to continue to develop energy projects in nations all over the world – some more politically and economically unstable than others.

What we are seeing in Iran is just the beginning of a transition in how oil is priced on the international markets, as a greater focus on political uncertainty is factored into the price.

And it’s the political premium on oil (the costs the markets price into a barrel based on uncertainty) that will become an increasingly more important pricing component moving forward.

And that uncertainty will lead to one certainty: higher oil prices.

Sincerely,

James

[Editor's Note: Politicians, newspapers, and TV networks are getting it wrong when it comes to a very important question: What underlying factors are affecting oil prices?

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  1. March 21st, 2012 at 14:41 | #1

    I did not understand your recommendation to sell 50% of our holding in Golar LNG because of the “short” attack by Pandora’s Box. The stock had already dropped over 20% at the time of your recommendation. The analysis by Pandora’s Box was so flawed and, obviously, intended to support their short position that I would have expected you to recommend ADDING to the holding in GLNG to squeeze Pandora’s Box.

  2. jimbo
    March 21st, 2012 at 21:31 | #2

    not to mention how bad pandoras box stinks…………im down about $8236.47 and thats doin everything by myself……….are ya gettin it? golar……. like the rest of the NAT GAS WORLD……ARE WAITING ON THE MONEY WHORE…POWER CONSUMED…….RED TAPE…LAZY ASS……….ROTTON POLITITIONS TO KICK START AND QUIT PLAYING GAMES. ILL TELL…AMERICA IS SICK AND TIRED OF YOUR HEARTLESS.MINDLESS…BULLSHIT!

  3. eric taylor
    March 21st, 2012 at 22:30 | #3

    Natural Gas is going to take so-o long, you might as well reinvest
    the best cash flow dividend players available for the next 10 years.
    Warren Buffet says it’s good for prices to stay down for capital
    efficient companies, so you can reinvest like a bat out of hell!
    Companies are cutting back production because of the high glut and
    low price, and there is no quick and dirty political solution
    for saving your assets. At least Conoco, British Petro,and Exxon Mobile are set to sell LNG to China from Alaska. As for car gas, going to Mexico doesn’t sound so far fetched; Everyone wants to let Canada sell their pipeline overseas, but that won’t lower U.S. gas
    prices. We need more refineries for the U.S. market, and throw out
    the corn alcohol gas mixtures that cost more than they help!!!
    The government might try to keep some of the Canadian petroleum here
    in the U.S. to lower gasoline costs for consumers.

  4. Patrick
    March 22nd, 2012 at 00:36 | #4

    Its a dam shame our current political leadership (lack of leadership) has failed to create a comprehensive energy policy. As much as we bash China for various reasons, at least they have an energy policy and are going after it. There are so many new jobs, additional tax revenues, improved national security and improved balance of payments that could be achieved in a short, medium and long range time frames it is mind blowing.

    One problem with going to Mexico for cheaper gas, its a high security risk (getting shot at, robbed, kidnapped or ??) and I understand the heavy/long traffic lines both going and returning greatly reduces and cost savings if not breaks even.

    Regarding COP, BP, XOM considering a $40b pipeline to export LNG to China story…. here is the last sentence of the story, “The companies have warned that they need to assess the commercial case for the project, which would cost an estimated $40 billion-$50 billion and take at least 10 years to develop.” 10 years is too long to wait. They need to fast track it. http://www.cnbc.com/id/46813514/Alaska_Champions_40_Billion_Pipeline_Plan

    James do you or Kent have any comments about the Alaska pipeline story?

  5. David Rodriguez
    March 22nd, 2012 at 04:01 | #5

    I agree with Eric is there any more refineries on the way? And get rid of the corn gas it is making small lawnmowers very expensive. If you didn’t notice your lawnmower running badly because of the corn (alcohol) that is added. Come on USA wise up getting the economy going is a top priority and energy is the way to do it. Open up the reserves and build some refineries.

  6. enthusceptic
    March 22nd, 2012 at 17:15 | #6

    Sorry folks, my broken record is still turning: Even at 5 USD/gallon, gasoline is extremely cheap in the USA compared to many other countries. You North Americans can power your light vehicles with NG, like millions of people all over the world.
    I have seen no evidence that NG will power trucks, trains or ships.

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