China’s Relations With OPEC: Challenges for U.S.–Sino Relations

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Throughout the last two decades, China has championed an international energy strategy that until recently has enabled its rapid economic rise. This “going abroad” strategy, coupled with a staunch policy of non-interference, has led China to acquire a vast array of foreign oil holdings with little apparent concern for geopolitical risk. In the 1990s, China’s risk appetite stemmed from simple economics. Unable to compete with established Western oil firms, the newly formed “going abroad” strategy focused on international markets Chinese firms could most easily penetrate—particularly those facing US economic sanctions. Countries such as Iran, Iraq, Venezuela, Sudan, and Myanmar became ideal targets for China’s foreign acquisition campaign, and Chinese trade with Africa increased more than 350 percent over the course of a decade.

While the pragmatism of China’s dual-pronged approach—pursuing a “going abroad” strategy while adhering to a non-interference policy—was initially met with praise, the sustainability of this approach has come into question in Beijing policy circles in recent years. As domestic conflicts in Sudan and Libya and burgeoning political tensions in Iran and Venezuela force China to reevaluate the security of valuable energy assets and Chinese expatriates, China’s noninterference approach faces a test of durability. Rising geopolitical risk among its Organization of the Petroleum Exporting Countries (OPEC) suppliers has embroiled China in diplomatic scuffles and opened up the possibility of contract renegotiation and expropriation. Though still void of the ideological constraints indicative of a US alliance, the newfound risks facing Chinese investments, companies, and workers abroad will by virtue of a changing geopolitical scene force a significant reevaluation of China’s “going abroad” policy. China’s response to new oil strategic challenges is also influenced heavily by its own negative perceptions about US hegemony in the Middle East and China’s increasingly visible concerns about a US policy that “favors democratization” over Middle East “peace and stability.”

China’s emerging policies toward the Arab Spring and brewing Middle East conflicts are an emerging source of tension in US-Sino relations. Over the past year, the United States and Europe have intensified efforts to contain Iran’s nuclear program, putting the West increasingly at odds with China, which has to date declined to abandon its support for Tehran. In July 2012, the United States led a new initiative to strengthen economic sanctions against Tehran.

In January 2012, the European Union (EU) froze the assets of the Iranian Central Bank and imposed a ban on the sale of all Iranian crude, petroleum products, and ship insurance. The ban on crude products came into effect on July 1, 2012. The EU embargo followed US President Barack Obama’s decision in December 2011 to enact stringent sanctions on countries buying large volumes of crude oil products through the Iranian Central Bank. Under the new US sanctions law, foreign banks handling Iranian oil transactions would be cut off from the US financial system.

Cracking down further, in August 2012, the US government passed additional sanctions targeting companies involved in Iran’s oil and gas sectors, financial sector, insurance, infrastructure, services, consulting activities, and doing business with National Iranian Tanker Company (NITC) and National Iranian Oil Company (NIOC). The new bill, signed into law on August 10, includes a human rights aspect that targets the Islamic Revolutionary Guard Corps.

Twenty countries have qualified for exemptions from the US law. Initially, China was not among them, announcing its refusal to comply with the US restrictions on Iranian oil import volumes. Reports had surfaced in early 2012 that Iran had agreed to accept Chinese payments in gold, allowing China to bypass US sanctions. However, Beijing’s position seemed to change by June, when officials allegedly pledged to cut oil imports by around 18 percent in an effort to win a sanctions waiver from the US government. In March 2011, comments by State Department Special Adviser for Non-Proliferation and Arms Control Robert Einhorn indicated that Chinese firms were likely sharing sensitive technology that aided nuclear arms development.

In September 2012, the US State Department announced that the Obama administration had renewed waivers on Iran sanctions for Japan and 10 European countries because they had demonstrated that they had cut their crude imports from Iran. What this means is that banks in the 11 countries were granted a second 180-day reprieve from the threat of being cut off from the US financial system under the American sanctions targeting Iran’s nuclear program. The United States, which granted waivers to South Korea and India in June 2011, is expected to renew those two waivers in December 2012. As for China, which also received a waiver from Washington in June 2011 and therefore has an extension review set for December 2012, it will depend on how much Beijing continues to import from Iran in the remaining months of 2012 and whether the Obama administration feels it must send a stronger political and economic message to China and Iran.

The EU sanctions against Tehran effectively blocked European insurers (who are the dominant players in the marine insurance sector) from offering coverage on Iranian crude. The lack of shipping insurance coverage quickly disrupted flows of Iranian barrels to Tehran’s major Asian customers at the same time that EU nations stopped buying its oil altogether. Japan initially curtailed Iranian oil imports in July because of the lack of shipping insurance, and Beijing reportedly asked Iran to deliver oil with NIOC’s own tankers while pressing Iran hard on freight pricing. Since then, Asian buyers have been exploring other options to deal with the shipping insurance ban, with Japanese insurers increasing their maritime coverage to allow more domestic tankers to transport Iranian crude. India has been forced to depend on Iranian tankers to deliver crude, while South Korea initially stopped importing from Tehran altogether, but subsequently resumed with reduced volumes.

China has publicly reiterated its opposition to military intervention in the Syrian civil war, particularly from the West. But in contrast with its position of neutrality in regard to the passage of the UNSC resolution in March 2011 that established a no-fly zone over Libya, Beijing has repeatedly vetoed UNSC resolutions targeting the regime of President Bashar Assad throughout 2012. The fact that the Libyan no-fly resolution had been requested by the Arab League may have helped sway Beijing to adopt a more neutral stance. Reports in the Arab media surface in July 2012 that three Chinese ships loaded with weapons had recently passed through the Suez Canal en route to Syria. Egyptian officials denied the reports, claiming that the ships were carrying food and materials to the Ukraine.

China’s response to the US-led initiative on Iran highlights Beijing’s highly ambiguous goals in the Persian Gulf. Denying it has a commodity-driven policy, China has tried to straddle the fence in its Iran policy. It has offered its cooperation to US requests and Gulf Cooperation Council (GCC) diplomatic carrots by downgrading its investment activity in Iran and somewhat reducing its purchases of Iranian oil. But it continues to shield Iran diplomatically and has firmly backed Tehran’s geopolitical interests in Syria.

China continues to stand by Iran, even as international sanctions targeting the OPEC producer have proved hard for both Beijing and Tehran to elude. In a very public show of support, Beijing invited Iranian President Mahmoud Ahmadinejad to attend a June 2012 summit in Beijing of the Shanghai Cooperation Organization (SCO), in which the 11-member organization issued a statement warning against United States or other military force against Iran regarding the nuclear program dispute. The statement, in part, stated that any effort to settle the Iranian nuclear issue by external force was “unacceptable” to the SCO and would “lead to unpredictably serious consequences, which would threaten stability and security in the region and the entire world.”

During the Iranian leader’s visit to Beijing, Chinese Premier Wen Jiabao told Ahmadinejad that “Iran is a traditional friend of China and expansion of relations with Teheran is important for Beijing.” In addition, Iran’s Fars News Agency reported that the Chinese premier recommended that Beijing and Tehran further work with Iran on energy, infrastructure, and trade issues. Beijing’s motivations in the Middle East appear to be complex and multifaceted. Access to oil cannot be ruled out as a feature of Chinese involvement in the region. China says its long-term dependence on foreign oil imports means it cannot afford to relinquish bilateral energy relations with any major Middle East energy producer, including Iran. But China has paid a geopolitical price for betting incorrectly in and around the Middle East, and its support for Iran and Syria’s Assad regime currently puts its improving relations with Saudi Arabia and Kuwait in some jeopardy. Saudi Arabia and Qatar have taken active steps to support the overthrow of Syria’s Assad regime and to contain Iran’s regional influence. Riyadh and Doha have been supplying arms to the rebel Free Syria Army (FSA)11, and since April, the two Gulf nations have begun paying the salaries of the FSA with logistical support from Turkey. In February, the GCC announced that its member states were recalling their ambassadors from Damascus in light of the worsening crisis and demanded that Syrian diplomats leave the GCC nations. Saudi King Abdullah was one of the first Arab leaders to protest the Assad government’s brutal crackdown on its population, stating on August 7, 2011, that the Syrian leadership must “stop the killing machine and bloodshed … before it is too late.” The Saudi monarch’s statement at the time was widely interpreted as a warning to Iran, Syria’s strongest regional ally. Riyadh in the early months of 2011 accused Iran of supporting Shi’ite dissent in Bahrain, and both Saudi Arabia and Iran are competing for influence inside neighboring Iraq via proxies.

China now runs the risk that it will damage its own important oil and natural gas relationship with Saudi Arabia and Qatar by backing the wrong side in the brewing regional battle for supremacy between these important Sunni Arab states of the Gulf region and Shi’ite Iran and its satellite regional proxies. China’s increasingly strained relations with the new government in Libya is a cautionary tale about the vagaries of backing the wrong side in today’s rapidly shifting sands of Middle East politics, post-Tunisia. As the conflict between Saudi Arabia and Iran intensifies, China’s support for Iran will put it squarely in the crosshairs of the Saudi leadership, which views the suppression of Iran’s nuclear and regional military aspirations as existential to the Saudi regime’s survival.

In the 1990s, the Chinese oil industry’s campaign to attain oil and gas assets abroad seemed increasingly focused on countries with emerging geopolitical risks or human rights problems, such as Iran, Iraq, Libya, Sudan, Burma, and Venezuela. The strategy was not ideological per se but reflected initial difficulty in competing with Western firms in prolific oil areas where American and European firms were already well established. The solution, Chinese strategists felt, was to focus China’s international exploration drive on countries where Western, predominantly US firms, could not easily get in the way of Chinese deal-making. That meant in the mid- to late-1990s, many countries under US sanctions became ideally placed to target Chinese investment by state run firms that had little international experience at the time. Chinese policy analyst Yishan Xia describes the Chinese energy policy conundrum in the 1990s in terms of simple market penetration:

Western monopoly capital, with the support and assistance of their governments, has scrambled and seized the main oil and gas resource markets in all parts of the world. Almost all good resources markets in the world have been occupied and possessed by them. There is intense competition among different groups of Western monopoly capital. All of them will certainly try even harder to impede Chinese companies from obtaining these oil resources.

The solution, Chinese strategists felt, was to focus China’s international exploration drive on countries where Western, predominantly US, firms could not so easily get in the way. That meant in the mid- to late-1990s, many countries under US sanctions became ideally placed to target Chinese investment.

This policy, which was initially greeted in Chinese leadership circles as pragmatic and profitable, is now increasingly presenting problems. Since the early 2000s, China’s “going abroad” strategy has come to include hefty loan packages, with Beijing lending more than $32 billion to Caracas, $15 billion to Luanda, and approximately $15 billion to Khartoum prior to Sudan’s split. The combination of its oil investments and loan packages has rendered China an international stakeholder vulnerable to geopolitical complications, international pressure, and political backlash. Amidst structural upheaval in Sudan and Libya and the ongoing political uncertainties in Iran and Venezuela illustrate, China is learning that equity oil ownership in regions with high levels of political and contractual risk may not be as clear a conduit to energy security as it had previously imagined.

China’s relations with the new Libyan government remain strained, and Bejing is now enmeshed in domestic conflicts within the newly divided Sudan. For all its philosophical declarations of steering clear of interfering with another country’s internal affairs, Beijing—having for all intents and purposes supported the regime of Moammar Gadhafi until virtually the last possible moment—had fallen afoul of Libya’s interim National Transitional Council (NTC)—which was dissolved in August 2012 after handing over power to a newly-elected national assembly—and may lose out on business opportunities in the new Libya. That possible debacle follows the unfamiliar twin challenges of having the Libyan facilities of Chinese state oil firm China National Petroleum Corp (CNPC) come under attack and having hostilities escalate to the point where Beijing was forced to arrange for the evacuation of thousands of Chinese citizens working in the North African nation. China, it turns out, was also on the wrong side of conflict between North and South Sudan. The South eventually seceded based on a referendum supported by the international community, leaving China, whose oil properties are located mainly in the South and were attained in the 1990s, to scramble diplomatically to save its deals from the “reevaluation” announced by Juba for oil deals signed before the Sudan Comprehensive Peace Agreement went into effect in 2005. In late October 2011, China announced that it was granting South Sudan $31.5 million for improvements in education, agriculture, health, and water supplies. China also faces great uncertainties in Venezuela, where the serious illness of President Hugo Chavez is casting great uncertainties about the country’s future politics and the fate of China’s massive multibillion-dollar loans-for-oil arrangements.

Moreover, increasingly, China is worrying about the entanglements that the growing number of Chinese businessmen and workers in the Middle East region could entail. Will instability in the Middle East mean that China will have to provide protection and evacuation services for its citizens, as became necessary in Libya during the civil war there? At present, China is not equipped to meet this new potential challenge.

Realizing that its prior risky oil deals are less than ideal, China has been trying to diversify its holdings by shifting investments to the Americas and Australia. The shift to the Americas, however, has not been without its own risks. Increasingly, China has found that investments in Africa and Latin America can become problematic due to political and social instability, sensitive issues related to human rights, problems arising from resource nationalism, and the difficulty of managing local community relations and local environmental problems. More recently, China has faced greater political difficulties and local government opposition to its bids for new Africa acreage, being turned away by Angola and Nigeria on recent efforts, foreshadowing possible new challenges in Africa in the coming years.

Finally, China faces rising risks to its investments in Iran and elsewhere from its overarching interests to maintain healthy and durable economic ties with the United States. US Middle East policy is now perhaps the single biggest inhibitor to China’s successful implementation of its “going abroad” strategy. Most recently, US-led sanctions policy against Iran has forced Beijing to pull back on its commitments in the Iranian oil and gas industry. Instability in Iran that thwarts it from being a reliable oil and gas supplier, combined with the disincentives to confront head-on US efforts to sanction Iran for its nuclear aspirations, have prompted China to pressure its firms to slow activities in Iran to minimal tasks such as appraisal studies instead of active drilling and construction related to existing deals. In moves designed to be face-saving, China has cited lack of access to equipment from third-party countries as the reason its lack of progress at the North Azadegan field where CNPC was supposed to invest $2 billion to raise production to 75,000 barrels per day (b/d) in the coming four years. In the midst of the delays in the summer of 2011, Tehran threatened to rescind China’s deals. At the time, Iran did not appear to accept CNPC’s claim that lack of financial resources had delayed Phase 11 development. National Iranian Oil Company (NIOC) in October 2011 suspended CNPC’s North Pars deal as a means to put pressure on the Chinese firm to move forward on South Pars Phase 11. While CNPC finished FEED work on Phase 11 of the South Pars field development in early 2012, continued delays on this phase appear certain. CNPC may now be questioning whether Chinese gas demand will be sufficient enough to justify its commitment to the project. From the Iranian perspective, NIOC is reportedly uncomfortable with CNPC’s lack of LNG expertise, which was a similar concern in the North Pars project. There are reports that NIOC would prefer freezing the Phase 11 work and there has been speculation that NIOC may have suspended its contract with CNPC over the Chinese state firm’s feet-dragging. Iranian officials this month accused CNPC of stalling on South Pars because the Chinese firm is demanding a higher price for the natural gas it will help produce from the field. To date, China seems content to avoid the risk of additional investments, giving the United States some leverage with all concerned. However, China continues to buy Iranian crude oil despite the tightening of economic sanctions against Tehran.

As sanctions choke off Iran’s ability to ensure tanker shipping for its oil, Tehran has tried to relieve the pressure on its limited state-owned tanker fleet by filling Malaysian-flagged floating storage units (FSU) so it can better supply its key Asian customers. In September 2012, one tanker owned by the National Iranian Tanker Co. (NITC) reportedly discharged crude into an FSU near Labuan Island off East Malaysia while another NITC vessel unloaded 270,000 tons of fuel oil into an FSU at the Malaysian port of Tanjung Pelepas. In the second instance, which occurred on September 18, the Pioneer—a NITC-owned VLCC previously called Hadi—transferred the fuel oil into the Hercules, a VLCC that had been converted into a floating storage unit. The Pioneer was reported to have then returned to Iran.

Given tightening Western sanctions, Iran’s Asian customers have had difficulty finding ship owners willing to send their tankers to load crude and product from Iranian ports. The sanctions have put NITC under increasing pressure because the state tanker firm does not control sufficient tankage to both transport its exports to Asian customers China, India, and South Korea and simultaneously store the close to 1 million b/d of remaining production that cannot be sold.

NITC’s fleet includes 25 VLCCs, each with a 2 million barrel capacity, as well as nine Suezmax, five Aframax, and various other vessels. It would take at least 16 VLCCs for NIOC to supply Chinese and Indian export commitments. Shipments to South Korea, if alternative shipping is not available, require another four VLCCs from NITC, leaving the Iranian company strapped to meet the needs of other customers.

This paper will discuss the recent challenges of China’s “going abroad” policy of oil investments and trade and its important geopolitical implications for Beijing’s relationship with OPEC countries and for Sino-US relations. Through the prism of China’s oil endeavors, we hope to reveal new insights into China’s foreign policy, its shifting geopolitical role and its competitive relationship with the United States. In particular, we find that China’s policies toward the Middle East are multifaceted and only partially commodity driven. As a result, even though China and the United States have a common strategic interest in maintaining the free flow of oil internationally and, in particular, from the Persian Gulf, China perceives that its overall strategic interests in the Middle East diverge widely from those of the United States. China is pursuing goals in the region that are in direct conflict with the US interests and therefore these differences need to be managed diplomatically and strategically.

As will be discussed in this paper, we recommend that the United States needs to elevate communications between the United States and Chinese military. The nature of conflicts in the Middle East and Asia calls for a more proactive, high-level strategic dialogue between the US and Chinese militaries. At present, this dialogue is more tactical in nature. Even at the height of the Cold War, such consultative lines of communication between top US and Russian military brass were critical to avoiding escalation of conflicts in the Middle East to avoid dire global consequences. The same utility would be beneficial in the Sino-US relationship.

The United States also needs to rethink its cooperation with China on energy technology issues. Specifically, the United States might want to reconsider whether sharing advanced shale exploration and development technology—an initiative currently on the books as program of the US Department of State-—is in the long-term US interest. The United States gains substantial strategic advantages to reducing its own vulnerability to geopolitical events in the Middle East while at the same time leaving the Chinese economy more exposed than the US to instability in global oil and gas markets, until which time China shows a more significant commitment to partnering with the United States on Middle East conflict resolution. The Obama administration was effective last year when it linked Chinese commercial intentions to invest in US domestic shale natural gas plays with Beijing’s greater cooperation in abiding by US sanctions policy on Iranian investment and trade.

Finally, we find that given common interests in moderating volatility in the oil market, the US should still try to fashion a joint China-US diplomatic strategy toward the Organization of the Petroleum Exporting Countries (OPEC). For example, a joint communiqué from the United States and China citing a joint commitment to lower oil use through bilateral or global agreements on corporate average efficiency standards for automobiles or other coordinated conservation methods, or to coordinate on a release of strategic emergency stocks during a time of supply disruption, would certainly counterweigh OPEC’s ability to act in concert to lift oil prices.

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