The consensus of opinion is that China’s commitment to buy an additional US$52.4 billion in U.S. energy products in 2020/21 as part of the Phase 1 trade deal between the two countries is impossible to achieve. The consensus is wrong, as a paradigmatic shift currently taking place in the core power structure of China means that the new energy products import targets are eminently achievable. Whether China wants to achieve them, though, is another issue entirely.

Specifically, China has agreed to buy an extra US$18.5 billion of energy products in 2020 over and above the US$9.1 billion baseline of U.S. imports in 2017, and an extra US$33.9 billion in 2021. These quotas represent a doubling this year of China’s previous record monthly imports from the U.S. of crude oil, liquefied natural gas (LNG), and coal, and a tripling of it next year.

The crude oil element of the Phase 1 deal is regarded as the most difficult of the three new energy products quotas to fulfil for two key reasons. The first is that to reach the volumes of crude oil required in Phase 1 very large crude carriers (VLCCs) would have to be utilised almost daily, which would dramatically increase the freight cost element of the final delivered crude oil price for the Chinese buyers.

This final per barrel price of the delivered crude oil would be increased further because the size of VLCCs required would be too large to use the usual route via the Panama Canal for such deliveries from the U.S. Gulf Coast to Asia and would have to travel via the Horn of Africa instead.

Replacing the extra 15 to 20 VLCCs needed per month needed to meet the new crude oil quotas for this year and next with a greater number of smaller vessels that could travel through the Panama Canal would not meaningfully reduce the freight cost element, as each of the smaller vessels would have to pay the extremely expensive transit fee to use the Canal. Related: 5 Reasons Why Big Oil Is Here To Stay

The second key reason why the new crude oil quotas are regarded as the most difficult to fulfil is that logistical upheaval (and further associated cost) would result from the reconfiguration required in a sizable proportion of the refineries across China that are geared towards processing the heavier, sourer crudes of the Middle East rather than the lighter, sweeter U.S. WTI blend.

None of these considerations, however, are sufficient to pose a significant problem to the new Chinese power structure that began to emerge when Xi Jinping took over as General Secretary of the Communist Party in China in November 2012, and later as President of the People’s Republic of China in March 2013.

“Since then, the leadership of China has stressed the virtues of ‘self-reliance’ and has sought to develop relationships with global partners to make up for the ending of the ‘constructive engagement’ with the U.S. and its allies of the past four decades,” Jonathan Fenby, chairman of the China research team at TS Lombard, in London, exclusively told OilPrice.com last week.

In immediate practical terms, this shift in consciousness has been manifested in a broadening and deepening of the Communist Party’s role across all key areas of economic management in the country, most recently with a directive designed to enhance the political supervision of China’s state-owned enterprises (SOEs).

Already accounting for 26 per cent of China’s total imports, the SOE’s are likely to see their role increased in line with the ‘centralisation’ ethos of the Chinese Communist Party, as encapsulated in Xi Jinping’s recent statement that: “Government, military, civilian, and academic, east, west, south, north, and centre, the [Communist] Party leads everything.”

“Xi’s aim is to end the quasi-autonomy of the biggest SOEs under the weak leadership of his predecessor, Hu Jintao, when they deployed the vice-ministerial status enjoyed by their bosses and the political support they received from provincial authorities in return for guaranteeing economic activity and jobs, which often led to overcapacity and high leverage,” said Fenby.

“Xi has reversed the delegation of economic management to the [Chinese] government that was advocated by Deng Xiaoping, creating [Communist] Party Leading Groups to set policy and using Party Plenums to lay out policy goals while employing the anti-corruption drive to impose discipline,” he added.

With Xi’s drive to replace the authority of the government with the authority of the Communist Party as paramount, the Central Committee of the China Communist Party has just issued a set of regulations specifically designed to institutionalise political control on its own initiative, rather than going through the relevant government body.

“For the 97 national-level state firms, the Committee’s instruction lays down a requirement that all major business and management decisions must be discussed by the Communist Party cell in a company before being presented to the company’s board of directors or management,” underlined Fenby. “These cells, which are present in an estimated 90 per cent of SOEs, are generally immune from oversight by the courts or regulators and are answerable only to internal [Communist] Party organs,” he added.

More specifically, board directors and company executives now have the standing instruction to ‘execute the will of the Party’ and this applies equally to the SOEs, which – in addition to accounting for 26 per cent of China’s total imports - also account for 25 per cent of industrial output and hold monopolies or oligopolies in transport, the grid, and other core enterprises, including those relating to the energy sector. Related: The Fight For Venezuela’s Oil Is Heating Up

In broad terms, China’s approach to securing energy flows is twofold: firstly through cultivating multi-layered relationships with countries that hold massive quantities of relatively cheap but high quality oil and gas reserves that can absolutely be relied upon for decades to provide China with such energy flows, and secondly by developing China’s own oil and gas field reservoirs.

The former is almost exactly the same relationship template as the U.S. used in the understanding struck in 1945 between the then-U.S. President Franklin D. Roosevelt and the Saudi King at the time, Abdulaziz, on board the U.S. Navy cruiser Quincy in the Great Bitter Lake segment of the Suez Canal - analysed in depth in my new book on the global oil market. Specifically, the U.S. would receive all of the oil supplies it needed for as long as Saudi had oil in place, in return for which the U.S. would guarantee the security both of the country and of the ruling House of Saud.

In China’s case, and perfectly aligning with its general geopolitical plan to extend its influence from Asia-Pacific through Eurasia and the Middle East and into Europe, it is Iran and Iraq that have been the recent focus of cultivating such a relationship. Both have enormous oil and gas reserves, both have no interest in allying themselves to China’s natural global rival the U.S., and both need a lot of financing, technology, and expertise, not to mention recourse to China’s Permanent Member vote on the United Nations Security Council.

The onus of China’s efforts continues to fall on this method to secure its energy supplies as, although work is being done on developing its own oil and gas resources and finds are being made, they are as yet in nowhere near the quantities required for daily use in China (around 10 million barrels per day just of oil).

Right now for China, then, securing its energy needs in a reliable manner – the prime consideration over and above cost – broadly requires doing just enough to placate the U.S. on the issue of Phase 1 energy imports. This includes either removing the current 5 per cent import tax on U.S. crude, 25 per cent on LNG, and 25 per cent on coal, or just ensuring that the relevant Chinese just absorb them.

At the same time, this apparent acquiescence with the U.S. on the issue of energy imports allows China to do what it is actually happy to do, which is to go along with the agricultural elements of the Phase 1 deal, and what it wants to do, which is to avoid a showdown with the U.S. on technology, initially focused on Huawei, before it is ready to do so.

All the while, Fenby concluded: “This political-economic nexus is set to bring growing divergence from the U.S. as part of the wider agenda of the ‘national strengthening’ being pursued by Xi Jinping, and Beijing is shifting from being an economic adversary to the U.S. to a geopolitical alternative and this could result in a step change in the nature of the confrontation between the two countries.”

By Simon Watkins for Oilprice.com

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