Where Are Oil Prices Going in 2011?

Where have they been?


What the “pros” say:
“Projected WTI prices average … $86 per barrel in 2011.” USEIA’s Dec. 7 Short-Term Energy Outlook. NB: May be increased in Jan. 11 STEO due to higher actual Dec. prices.
“…this market is going as high as $120 to $130 by July… . It’s Inevitable.” Mark Waggoner, president of Excel Futures, quoted in Dec. 31 WSJ.
“Goldman Sachs, J.P. Morgan Chase and several other banks expect futures to reach triple-digits in 2011 as the global economy recovers.” WSJ
Upside Factors
Economic growth, which increases demand. (But higher prices will depress demand and economic growth.) Big countries to watch:
• US. Largest consumer of oil. Watch real (vs. Wall Street) economic growth (FedEx deliveries good proxy).
• China. By far largest source of incremental oil demand. May resume filling of its strategic oil reserves in 2011.
• India. Economic growth could top China in 2011, but weak infrastructure (roads, rail, airports, harbors) could damp oil demand increases. Higher global oil prices will further stress Indian budget through fuel subsidies.
Financial market pressures. Falling dollar, inflationary pressure, slowing rise in equities markets valuation, all make dollar-denominated, internationally traded physical commodities more attractive to investors.
• “Next year, some of the froth will come out of the other markets, such as metals, and head into food and energy.” Rich Ilczyszyn, Lind-Waldock broker in WSJ.
Downside Factors
China. Watch: anti-inflationary measures’ impact on China’s economic growth and efforts to address environmental problems by restricting automobile new registrations, driving.
Oil stocks. Major industrial country (OECD) oil stocks remain well above the five-year average. Despite drawdowns this winter because of cold weather and yearend 2010 inventory taxes, stocks are likely to remain high entering the 2011 driving season.
Oil output:
• Saudis most sensitive to impact of oil prices on industrialized countries’, especially American, economic growth. Will move to increase OPEC output as oil prices approach $100/bbl. (The International Energy Agency, Paris, expects OPEC spare capacity to drop from 6.14 million barrel per day in 2010 to 5.70 mmb/d in 2011, still a comfortable cushion.)
• Non-OPEC supply. The IEA projects an increase in non-OPEC supply of 0.62 mmb/d in 2011 (over 2010), meeting about half of IEA’s projected increase of global oil demand from 87.45 mmb/d in 2010 to 88.77 mmb/d in 2011.
BLACK SWAN ALERT !
If rising tensions in the Middle East lead to either an Israeli attack on Iran’s nuclear facilities or another war between Israel and Hezbollah, the sky’s the limit.
Or, another major oil spill, or a Saudi succession struggle, or …
My Call
Continued volatility with prices swinging between $80 and $110 per barrel. Prices likely to move toward or above $100 by the summer driving season, then level out.

Sanctions and Iran's LNG Export Plans

For a decade, in the face of increasing international sanctions to force Iran to halt nuclear developments than could be used for military purposes and to stop its support of international terrorism, Iranian government and company officials defiantly have announced nearly a dozen gas exports projects. These included both pipeline projects and liquefied natural gas (LNG) plants.
Following the June 9, 2010, imposition by the United Nations Security Council of its fourth round of sanctions against Iran’s nuclear program, both the United States and the European Union adopted sanctions that, in part, specifically target Iran’s oil and gas industry, including LNG technology.
Suddenly this month, Iran announced the suspension of development of several LNG plants. On August 7, National Iranian Oil Company Managing Director Ahmed Ghalebani announced that Iran was suspending some LNG projects, including Persian LNG. Three days later, Deputy Oil Minister Mohsen Khojastemehr stated that Iran would ice the Pars LNG project and “inject the gas from South Pars blocks 11, 13 and 14 into oil fields and in the national gas network. Khojastemehr said that “some countries had used a policy of lengthy negotiations and wasting time to impede the production of the South Pars projects.”
This blog will examine the potential effect of sanctions on Iran’s plans to export LNG; a subsequent blog will deal with Iran’s plans to expand its exports of natural gas via pipelines.
Iran’s Natural Gas Exports
Iran holds nearly 30 trillion cubic metres (1046 trillion cubic feet) or nearly 16 percent of global proved natural gas reserves, second only to Russia’s 44.4 tcm (1567 tcf). But failure to fully develop this resource left Iran with only 4.4 percent of 2009 natural gas production (131 bcm, compared with America’s 593, Russia’s 528 or Canada’s 161). Despite its huge proved reserves, Iran’s role in the international trade of gas is miniscule: it exports small amounts to Turkey and Armenia and imports gas from Turkmenistan, all via relatively small cross-border pipelines.
This failure to develop its extensive gas reserves particularly galls Iran because its huge South Pars gas field is the extension of Qatar’s undersea North Dome Field. The combined South Pars/North Dome gas condensate field is the world’s largest gas field, with an estimated 50 tcm of natural gas and some 50 billion barrels of condensates. North Dome Field was discovered in 1971 and Qatar began production in 1991. The field has fueled Qatar’s petrochemical and LNG plants at Ras Laffan and propelled Qatar to the position of the world’s largest LNG exports, ahead of Indonesia, in 2006. Last year Qatar exported nearly 50 bcm of LNG (and more than 17 bcm of pipeline gas). In 2011, when new trains at both RasGas and Qatargas come online, Qatar’s LNG export capacity will reach 77 million metric tones (about 104 bcm) annually. Further frustration for Iran comes from having missed a golden opportunity after Qatar in 2005 declared a moratorium on further North Dome Field development pending a full re-assessment of resources and potential markets; the moratorium is expected to end in three to four years.
This article will focus on Iran’s attempts to develop its natural gas resources for export as liquefied natural gas (LNG). A subsequent article will examine Iran’s plans for exports of natural gas via pipelines.

Foreign Assistance for LNG

The LNG business has been dominated by the major international oil companies because of their technical, and project management expertise, global marketing outreach, and not least, their ability to finance hugely capital intensive, expensive LNG projects, which included not only gas exploration, development, production, gathering and treatment, but also liquefaction, transport via specialized ships, and regasification facilities at the import end. A key part of the value chain is the process of liquefying natural gas at a temperature of about minus 260 degrees Fahrenheit (-162° Celsius). Four firms provide the technology used in most gas liquefaction plants worldwide: America’s Air Products and Conoco (the Phillips Cascade Technology acquired in the Conoco-Phillips merger), Anglo-Dutch Shell, and France’s Air Liquide.
Iran began bringing in foreign companies to help shape its LNG strategy a decade ago, with a tender for assistance on developing Iran LNG, the first Iranian LNG project. Also in 2001 Iran’s then Petroleum Minister Bijan Zanganeh created the National Iranian Gas Export Co. (NIGEC), with a focus on developing the countries LNG projects. At the time, it was believed that the domestically focused National Iranian Gas Co (NIGC) was too bureaucratic and ineffectual to lead the ambitious gas export portfolio. In this decade, officials from Iran’s government and various oil and gas entities have announced a deluge of deals for upstream gas development, LNG facility design and construction, and LNG exports.
Iran LNG. Based on gas from South Pars field, phase 12, Iran LNG was the first project developed. The National Iranian Oil Co. (NIOC) took 49% of the roughly US$ 4.5 billion project, with two Iranian oil industry pension funds taking 51%. The liquefaction and loading facilities are located at Tombak, on Iran’s west coast. With the three major purveyors of liquefaction technology in the U.S. and France blocked by sanctions, Iran reportedly turned to Statoil-Linde (Norway-Germany) to supply the liquefaction technology for the 10.8 million metric tons (MMT) annual capacity Iran LNG project. Linde supplied this technology for Statoil’s Snovit LNG plant in Norway and which experienced several years of startup problems. Other foreign companies involved in Iran LNG design and construction reportedly were South Korea’s Hyundai and Daelim, Italy’s Snamprogetti and APS Engineering, Germany’s Steiner-Prematechnik-Gastec, and China’s HuaFu Engineering Co. Iranian companies were involved in design and construction of both the plant and the jetty, offsite and utility plants. At least some of the foreign partners signed contracts with Iran’s Khatam-ol-Anbia Construction Headquarters, an engineering arm of Iran’s Islamic Republic Guards Corps. In April 2007, NIGEC signed an agreement with Austria’s OMV to ship 2.2 million metric tons (MMT) of LNG annually (term unknown) from Iran LNG to a terminal under construction in Croatia.
In August 2009, with insufficient internal funds for the $4.25 billion liquefaction facility, Iran planned to open 80% of the project to foreign investors to raise the $4 billion needed. When foreign offers were not forthcoming, in November 2009, Iran LNG tried to pressure two Indian firms to pay an advance of at least one billion U.S. dollars against the future supply of LNG to India. Talks between Iran and India on LNG supplies already had collapsed when Iran in July 2007 insisted that the contracted price of $3.215 be raised to $4.78. Earlier this year, the Mehr News Agency quoted Iran LNG Co. Managing Director Ali Kheyrandish as saying that costs for the project had risen to $5.5 billion, but that the project was 30% complete. First shipments from Iran LNG now are expected in the first quarter of 2012.
Pars LNG. In February 2004, NIOC engaged France’s Total and Malaysia’s Petronas to develop South Pars Field, phase 11, for the Pars LNG project. NIOC would hold 50%, Total 40% and Petronas 10%. Two years later, Pars LNG Co. entered into a preliminary agreement to export 3 MMT of LNG annually from Pars LNG to Thailand’s PTT Exploration & Production Co. starting in 2011. In January, 2008, the Fars News Agency reported that NIGEC Director of Investments and Participation Mohammad Javad Ahmadi Abhari suggested that half of Total’s shares be given to potential LNG buyers and gave Total until June to finalize the Pars LNG deal. Total appeared to drop plans in July 2008, a day after state media reported that the Iranian Revolutionary Guards had test-fired an updated version of the Shahab-3 missile, with a range of 2000 kilometres (1200 miles). Still, the project limped along until Iran, impatient with Total for not committing to development, handed Total’s share over to state-owned China National Petroleum Corp. earlier this year. Iran’s Deputy Oil Minister announced on August 10 that Iran would suspend the project and use the gas resources domestically.
Persian LNG. At about the same time it launched Pars LNG, NIOC brought in Shell and Spain’s Repsol for development of South Pars Field phases 13 and 14, to fuel Persian LNG. The $13 billion project would start with one 8.1 MMT train and add one more train in a second phase for a total export capacity of some 16.2 MMT annually. Earlier this year, Shell and Repsol dropped out of the project ahead of the June U.N. Security Council Sanctions. On August 7, NIOC Managing Director Ahmed Ghalebani announced that Iran was suspending Persian LNG.
North Pars LNG. In 2006, China National Offshore Oil Corp. (CNOOC) was proffered a role in the development of the North Pars field for an LNG project of some 20 MMT annual capacity. For its efforts, CNOOC also secures 25 years of LNG supply.
Golshan LNG. In December 2007, NICO offered Malaysia’s SKS Group half interest with NIOC in the $16 billion development of the Golshan and Ferdows fields in Bushehr Province for a 10 MMT LNG export project. ($5-6 billion for upstream development and $10-11 billion for the LNG plant and jetties.)
Others. There were two other LNG projects discussed. In August 2007, NIOC and the South Pars Oil & Gas Co. discussed development of South Pars Field, phases 19, 20 and 21 with Italy’s state oil and gas company Eni. Earlier that year, Germany’s gas giant Eon reported that it was in talks with Iran to buy LNG and one of Eon senior executives stated that Iranian LNG was necessary for European gas supply security. Finally, in February 2008, Poland’s PGNiG signed a letter of intent in Tehran with the Iranian Offshore Oil Co. to develop Iran’s Lavan gas field, with the possibility of LNG supplies.

Factors Impeding Iran’s LNG Development
As recently as December 2007, Iran LNG Company Managing Director Ali Kheir-Andish was quoted in the Tehran Times as telling a Tehran International Oil and Gas Conference that Iran would produce 22 MMT of LNG in 2015, 44 MMT in 2018 and about 88 MMT in 2022, with first deliveries in 2010. Now it appears Iran will find it a challenge to hit 11 MMT of LNG exports by 2015 and beyond that is pure speculation.
Clearly sanctions imposed by the United Nations’ Security Council, but more importantly, additional U.S. and European Union sanctions targeting Iran’s oil and gas industries, have impeded Iran’s LNG development. As stated above, LNG projects require a level of technology; project management financing; and upstream, shipping and marketing integration that have won major roles for the international oil companies in the global LNG business. But sanctions alone cannot account for the decade-long disaster of Iranian LNG development. Other factors hampering Iran’s plans to export LNG, beyond sanctions, include:
• Iran’s terms for foreign partners. Due to its constitution, Iran offers only buy-back contracts for oil and gas exploration and development, while international oil companies prefer production-sharing agreements. Buy-backs do not allow IOCs to book reserves discovered; Iran’s in particular have had short time frames, as little as four years, to recover costs; and Iran’s buy-backs have offered rates of return less than some international investors sought.
• use of gas to cover domestic demand. Demand for domestic natural gas—as for oil products—is artificially increased by massive subsidies. The internal Iranian price for natural gas is less than 40 cents per million British thermal units, compared with current spot LNG prices of some $12/MMBtu in Asia and $8/MMBut in Europe.
• internal opposition by some elements to gas exports. The internal conflicts about foreign access to Iranian oil and gas resources can lead to protracted and difficult negotiations with potential foreign partners.
• growing amounts of gas used to boost Iranian oil production. According to an October 2009 report by the Financial Times, to maintain pressure in its oil fields, Iran reinjects as much gas as Qatar exports.
• planning and construction on LNG export projects worldwide slowed in 2006-7 due to rapidly rising costs associated with supply constraints on materials, equipment, and design, engineering and construction crews.
• The 2008-9 global financial crisis and following recession dropped gas imports in major LNG importers—Asia, Europe and the U.S. In addition, the huge and rapid jump in shale gas production in the U.S. during 2008-2010 stifled LNG import demand in the U.S. to the extent that several U.S. terminals sought permission to re-export LNG. This glut further softened prices.

Iran’s LNG Future

Clearly international sanctions stymied Iran’s LNG program. In announcing the suspension of Pars LNG, Deputy Oil Minister Khohastemehr noted that pipeline “gas exports are cheaper and can be done faster, while exports of LNG not only require huge investments and complicated technology but are also time consuming.” Without the sanctions, Iran’s LNG projects would not have been as time consuming and foreign partners such as Total, Shell, Petronas and others with LNG experience could have supplied the investments and technology. Absent the sanctions, it is very possible that by now Iran LNG would be up and running and that Persian LNG or Pars LNG or possibly both would be moving toward completion.
Germany, France, Spain, Italy and other European countries would have liked to access Iranian LNG to reduce their overdependence on gas from Russia. China, India and other Asian countries see Iranian LNG as a way to reduce their dependence on imported oil and/or lower the rate of growth of coal combustion and its attendant local, national and global pollution problems.
Some countries support Iran’s efforts despite the sanctions. In May 2010, Iranian state tanker company executive director Mohammad Suri announced that Iran had placed an order with China for Iran’s first LNG tanker. Suri estimated that Iran would have to spend some $1.2 billion for the five ships needed for Iran LNG. Delivery of the first ship from China is expected in four years. Suri noted that China would pay 90% of the financing for construction of the tanker and that Chinese companies charge 10% less than South Korean companies. Although France and Norway have considerable experience building LNG tankers, South Korean and Japanese firms dominate the LNG tanker market. South Korean and Japanese companies have, respectively, some three and four decades experience. Hudong Zhonghua Shipyard built China’s first LNG tanker five years ago. An LNG ship building contract with Iran would have boosted China’s global role, but NIOC has since failed to approve the preliminary agreement with China for an LNG carrier and the deal is cancelled. As mentioned above, China Offshore Oil and Gas Co. and China National Petroleum Corp. remain active in Iranian oil and gas development.
It may be fortunate to have the gas originally planned for Persian LNG and Pars LNG available for oil field reinjection. Over the past four years, oil and gas prices have diverged considerably. Current LNG prices are less than $5/MMBtu in the U.S., about $8/MMBtu in Europe and some $12/MMBtu in Asia. And note that these are landed prices, i.e. liquefaction and shipping costs are included. Compare this with the roughly $80 per barrel or $13/MMBtu prices that oil commands and evidently Iran gains by reinjecting its gas—which it can produce later—to sell higher priced crude. This may be something of a false dichotomy, however, considering that with the huge size of Iran’s proven gas reserves, it could both reinject gas for enhanced oil production, export LNG and export gas via pipelines.
All this means that Iran LNG should be able to find long-term markets—probably in Asia—for its 11 MMT output by the time it comes onstream in 2012 or possibly later. But Iran is unlikely in this decade to reach the ranks of major LNG exporters.
The next blog will look at Iran’s planned natural gas pipeline export programs.

New Website for Asia Experts

Expertise in the field of contemporary Asian affairs is just one click away with the new online resource AccessAsia (Beta), a free specialized search engine that includes thousands of links to websites of Asian affairs experts. Whether you are seeking expert perspectives on nuclear proliferation in North Korea, scholars on maritime policy in the Malacca Strait, or further insight on Japan's upcoming upper house election, AccessAsia is your #1 source for expertise. The National Bureau of Asian Research in Seattle created this site and, I am pleased to announce, has selected me as one of its experts. To find Asia experts or nominate someone as an Asian expert for the site, click here.

Iranian Sanctions

Today, Monday, June 21, 2010, Senate Banking Committee Chairman Chris Dodd (D-CT) and House Foreign Affairs Committee Chairman Howard Berman (D-CA), conference chairs for the bill to strengthen Iran sanctions, announced that they had agreed on a draft joint text to reconcile the House and Senate bills imposing additional sanctions on Iran for its illicit nuclear program and support of terrorism. A press release from the House Committee stated that H.R. 2194, the Comprehensive Iran Sanctions, Accountability, and Divestment Act of 2010 would impose an array of tough new economic penalties aimed at persuading Iran to change its conduct, including targeting business entities involved in petroleum product sales to Iran.

The United Nations Security Council imposed its fourth round of sanctions against Iran’s nuclear program on June 9. While U.S. President Obama praised the UN resolution as “the toughest sanctions ever faced by the Iranian government,” the U.S. and its allies had taken months to negotiate sanctions that many felt were watered down to avoid vetoes by Russia or China, permanent members of the Security Council. China insisted that economic targets such as banks and energy companies not be singled out, but the U.S. succeeded in obtaining oblique language in the sanctions’ preamble noting “potential connection between Iran’s revenues derived from its energy sector” and possible financing for its nuclear program.

As other nations have increased sanctions on Iran, China and its companies have moved in to fill the void. According to a Financial Times analysis, China has overtaken the European Union to become Iran’s largest trading partner. Iran imports consumer goods and machinery from China, while China imports oil and petrochemicals and plans to import liquefied natural gas. A senior Iranian official reported has complained publicly about the quality of Chinese-made equipment.

The U.S. and Europe conceded that the sanctions fell far short of what they would have wanted by immediately announcing that they would enact more stringent sanctions on their own, once the resolution passed, giving them the UN imprimatur for harsher measures. The sanctions are intended to insure that Iran’s nuclear program is used only for domestic energy and not to fuel a nuclear weapons program. Iran claims that it needs nuclear power for domestic energy. Ironically, it is the international sanctions caused by Iran’s intransigence regarding inspection of its nuclear program that are crippling development of the country’s conventional oil and gas sources.

Iran’s Gasoline Imports

Iran’s proved oil reserves of 137.6 billion barrels (BP Statistical Review of World Energy 2010) accounted for more than 10 percent of the world total, ranking it number three behind Saudi Arabia and Venezuela. But its 2009 oil production of 4.3 million barrels per day represented only 5.3 percent of global output. Sanctions, among other factors, have prevented Iran from expanding its refining capacity, with the result that Iran still has to import more than a third of its gasoline requirements. This makes Iran’s gasoline imports a tempting target. As far back as June 2008, then British Prime Minister Gordon Brown called for oil and gas sanctions on Iran during a visit by then U.S. President Bush. In the meantime, both the U.S. House of Representatives and Senate have passed bills aimed at Iran’s gasoline imports and the text announced today by Sen. Dodd and Rep. Berman will form the basis for discussion by the Conference Committee. A reconciled bill could be passed by both chambers this summer, but whether President Obama would sign the bill into law may hinge on the Congress giving the President more leeway to relax the sanctions on countries or firms that are providing other support to constrain Iran’s nuclear program.

All of the U.S. and European rhetoric has had an effect. Companies who sold gasoline to Iran as recently as last year, but now have halted sales, reportedly include BP, Royal Dutch Shell, India’s Reliance Industries, Swiss firms Vitol and Glencore, Russia’s Lukoil and the Dutch company Trafigura. France’s Total and Malaysia’s Petronas remain Iran’s principal gasoline suppliers.

Several Chinese firms are believed to supply Iran, but this is difficult to trace as shipments often are reportedly routed via Singapore or other third parties or consist of spot purchases routed to Iran. JP Morgan commodities head Lawrence Eagles estimated that last autumn 30,000-40,000 barrels per day (b/d) of Chinese gasoline were moving from the Asian spot market to Iran via third parties. This suggests that even if Europe and the US impose sanctions on selling gasoline to Iran, various “black market” routes will continue to channel supplies, especially if the sanctions succeed in raising the gasoline price in Iran significantly higher than global trading prices.

According to Iran-China Chamber of deputy head Majid-Rez Hariri, China—the world’s second largest consumer and importer of oil after the U.S.—relies on Iran for 11 percent of its energy needs. Iran is China’s third-largest oil supplier, supplying some 460,000 b/d in 2009. China’s Zhuhai Zhenrong Corp., the largest single lifter of Iranian crude, extended its 240,000 b/d contract this year. China cut back purchases of Iranian petroleum products in 2009 due to uncompetitive pricing by Tehran. China National Petroleum Corp., the state-owned onshore giant, signed a $2 billion, 12-year MOU in July 2009 to develop Iran’s North Azadegan oilfied following withdrawl by a Japanese firm. China’s Sinopec, previously the state-owned refiner and marketer, but now a fully integrated state oil company, finalized a $2 billion deal in 2007 to develop Iran’s huge Yadavaran field.

With the U.S. and Europe increasing the pressure on Iran’s gasoline imports, supplies are likely to be constrained and price pressures greater. This might actually help the Iranian government to finally increase gasoline prices and reduce the huge impact of gasoline subsidies on the government budget. The higher gasoline prices also are likely to fuel a much larger black market. Whether these sanctions bring Iran to the bargaining table over its nuclear program remains to be seen.

China's NDPC Reorganizes Energy

China’s National People’s Congress convened last month for its annual session and made two organizational changes in the sectors of energy and the environment. As expected, China’s State Environmental Protection Agency was upgraded to ministerial status. Also, as expected, the Congress failed to create an energy ministry. This article looks at the impact of these decisions on China’s goals of reducing the economic and environmental impact of its rapidly rising energy demand . During the current Five Year Plan (2006-2010), China has committed to reduce energy consumption per unit of GDP by 20 percent and drop with discharges of key pollutants 10 percent.
The elevation of China’s State Environmental Protection Agency (SEPA) will put it in a stronger position when arguing its objectives against those of major economic ministries. This reflects the increasing importance China places on addressing the environmental impact of energy production and use, as well as pollution from other industrial process that has degraded China’s air, land and water. Addressing pollution is particularly acute for China, which continues to rely on coal to fuel some two-thirds of its energy demand and nearly three-quarters of its electricity generation. China is the world’s largest producer and consumer of coal and, despite efforts to increase nuclear and renewable energy, China’s use of coal is forecast to double by 2020. Last year The World Bank reported that “China is home to 20 of the world’s 30 most polluted cities due largely to high use of coal for energy. Serious soil erosion, acid rain and polluted waterways also affect the lives of millions. The national economy is dominated by manufacturing rather than services, which adds to environmental pressure.”
Speaking at a meeting of China’s State Council or cabinet last October, Premier Wen Jiabao called for a brake on investment in energy-intensive industries that create additional environmental burdens. "Currently, new projects are expanding too quickly. We must strictly control them, especially energy-intensive, highly polluting projects as well as those in sectors where there is over-capacity," Wen said. In addition to emissions of sulfur dioxides, nitrous oxides and particulate matter, it is widely believed that China surpassed the United States in 2007 in the emission of greenhouse gases. The premier was more categorical in March 2007, calling China’s economy "unstable, unbalanced, uncoordinated, and unsustainable."
While ministerial status will help in the bureaucratic infighting, more vital is the question of resources. SEPA’s staffing is variously reported as 300-450 in Beijing. By way of comparison, the State Environmental Protection Agency of California has an annual budget of $1.7 billion, which supports 4,781 personnel positions, while the U.S. federal EPA employs some 17,500 and spends about $7.5 billion annually. SEPA reportedly can call on some 60,000 local officials, but whether they further or frustrate environmental enforcement is a question.
This leads to the second problem not resolved by SEPA’s ministerial status: the lack of enforcement of environmental regulations at the provincial and township and village levels. With townships and villages frequently dependent on a few or even a single industry, local officials are loathe to levy fines for non-compliance. As Prof. Kenneth Lieberthal of the University of Michigan—and former Asia Director at the National Security Council—has reported, even when fines are assessed, local authorities sometimes reduce taxes or other fees on non-compliant companies to offset the fines. Finally, fines rarely reach, let alone exceed, the cost of compliance, so the financial incentive is to pay the fines, rather than make the changes needed to comply with environmental directives.
The failure to set fines sufficiently high to encourages compliance demonstrates the final failure, i.e. China’s continuing aversion to letting markets resolve environmental and energy issues. Not only is there not a market incentive to comply with environmental regulations, but continuing subsidies for many fuels stokes artificially high demand for energy, with resulting greater negative environmental impacts.
The National People’s Congress was even more timid in “restructuring” the energy portfolio. The failure to create an energy ministry came as no surprise. The Chinese state press organs for the last several months have been printing commentaries suggesting that bureaucratic infighting among the agencies that would be absorbed into an energy ministry made it unlikely that the 2008 Congress would approve such a reorganization. Western press commentaries carried contradictory reports on the views of major Chinese energy companies regarding an energy “mega-ministry.” Some reports said the companies would welcome a central agency to avoid the welter of mandates and regulations coming from disparate agencies, just as U.S. companies generally prefer national regulations rather than various state regulations. Other reports suggested that the companies opposed the consolidation of power into a single ministry. In any event, one needs to understand that Chinese companies cannot escape close supervision by the government, whatever its bureaucratic guise. Unlike international oil companies, Chinese companies are owned by the Government of China. Even a giant like PetroChina, which made headlines last November when its market capitalization reached over US$1 trillion-- more than double that of ExxonMobil, floats less than 30 percent of its shares. The rest of its shares are owned by its wholly government-owned parent China National Petroleum Corp. Also, the majority shareholder, i.e. the Communist Party of China, picks the heads of these companies. Although PetroChina Chairman and President Jiang Jiemin has 30 years experience in the oil and gas business, before he was named PetroChina vice chairman in May 2004, he served four years as deputy governor of Qinghai Province.
China last had an energy ministry from 1988 to 1993, when it was dissolved and devolved into separate ministries for petroleum, coal and electric power. Since 1993 China has lacked a central energy policy-making body, although the State Planning Commission (later the State Development Planning Commission and now the National Development and Reform Commission--NDRC) exerted de facto control of the energy sector because it had to authorize all major capital spending projects. The Ministries of Coal and Power remained until 1998, when further restructuring diffused policy-making by disbanding these ministries and delegating their power among several agencies, including the NDRC, and by default to state energy corporations. Recognizing the lack of a central energy policy body, in 2005, China created a National Energy Leading Group (NELG) to study major policy issues concerning China’s national energy development strategy, energy development, conservation, energy security, and emergency responses as well as international energy cooperation. It was responsible for providing advice and policy recommendations to the State Council. At the same time, it established a National Energy Office within the NDRC, led by NDRC Chairman Ma Kai, and reporting to the NELG, to implement policy and monitor progress on energy security issues.
The energy ministry most recently proposed presumably would have brought together the authorities of the NDRC as well as all or parts of the Ministry of Land and Resources; the Ministry of Water Resources; the Ministry of Commerce; the Ministry of Science and Technology (MOST); the State Commission of Science, Technology and Industry for National Defense (COSTIND); the Chinese Academy of Engineering; the State Electricity Regulatory Commission (SERC); and the State Assets Management Commission.
The decision of the 11th National People’s Congress created a high-level national energy commission, with a national bureau of energy set up as the commission’s working office under the NDRC. The new bureau is intended to integrate the NDRC’s present functions on energy management, the functions of the National Energy Leading Group (which is to be disbanded) and the nuclear power management of the Commission of Science, Technology and Industry for National Defense. Other than giving the NDRC authority over nuclear power management, it is not immediately evident how this set up differs from the one it replaces. And like the case of SEPA, moving the boxes about does not address central issues that stymie a unified and effective energy security policy.
As with the case of SEPA, funding and staffing are key constraints. NDRC vice chairman for energy Zhang Guobao never tired of asking American Secretaries of Energy how many people staffed the U.S. Department of Energy. When told that the USDOE had some 18,000 staff—about 4,000 directly engaged in energy, Zhang would note that the NDRC’s energy bureau consisted of some 60 staffers.
Like the SEPA, the NDRC also has officials in provincial and municipal Development and Reform Commissions to carry out national mandates, but as in the environmental sphere, in the energy field national mandates for greater energy efficiency and less intensive industrial development often fall on deaf ears at local levels due to the desire to keep plants running and fueling local economic growth. For example, the central government has had a policy for several years of shutting down small coal mines, not only because they pollute much more than larger, newer mines, but also because these small local operations account for a disproportionately large number of mining accidents and fatalities. But no sooner are they shut down, than they spring back into operation. More recently, the central government has increased pressure on local and provincial officials by evaluating them on their contributions to increasing energy efficiency and reducing pollution, not merely on increasing economic growth.
Finally, as in the environmental arena, energy efficiency efforts are thwarted by the lack of a market that communicates the full value of energy resources and the associated environmental costs of their use. With nation-wide inflation in China having reached 7.1 percent in January and 8.7 percent in February, well above the government’s 4.8 percent target , efforts to contain inflation trump long-term goals of moving energy prices to market levels. Putting price (and export) controls on energy is one method that may effectively restrain price pressures in the short term. Chinese authorities have raised refined oil prices eight times since 2005, most recently with 10 percent increases last year in both May and November. But the growing gap between world oil prices and Chinese petroleum prices is dramatically reflected in the whopping 12.3 billion yuan (US$ 1.7 billion) subsidy that state oil company Sinopec received for its 2007 losses in the refinery business from buying crude at world prices and selling into the Chinese market at controlled prices. These subsidized oil product prices also help explain why China only managed to reduce its energy/GDP ratio by 1.23 percent in 2006 and 3.27 percent in 2007, compared to its goal over the 2006-2010 period of 4 percent every year. These lower fuel prices, as has long been the case in the U.S., encourage purchases of inefficient vehicles that stay in the fleet for years. In 2007, car sales in China rose 22 percent over 2006, but sales of small cars declined 30 percent while SUV sales jumped by 58 percent.
The organizational changes made by the 11th National People’s Congress will give the State Environmental Protection Agency additional heft in interagency debates; it is less clear that the restructuring of the energy sector will make any difference. To achieve its ambitious environmental and energy security goals, China must
• increase staffing and funding for these agencies,
• create greater accountability for provincial and local government and industry officials in cutting the growth of energy use and emissions, and
• move more rapidly to market pricing.
What is needed is not organizational change, but organic change. Until this happens, China remains unlikely to meet its ambitious targets to reduce energy intensity and environmental damage.

China's Strategic Oil Reserves

David Winning wrote in the Dec. 19 edition of the Wall Street Journal about China’s announcement to establish a center to manage its strategic petroleum reserves (SPR). It noted that during the U.S.-China Strategic Economic Dialogue in China the previous week, both sides agreed to cooperate more closely on construction and management of SPRs. Winning further noted that as China is not a member of the International Energy Agency of the Organization for Economic Cooperation and Development, it is not bound by IEA guidelines that limit SPR use to times of supply disruption vs. using the Chinese SPR as a buffer stock to influence domestic prices.

While China appeared initially to view their reserves as a buffer stock, both US and IEA officials have had extensive discussions with Chinese officials, particularly at the National Development and Reform Commission (the successor to the State Planning Commission) about SPR policy. In particular, they have emphasized that China’s reserves--currently less than 20 million barrels or coverage for about 5 days of oil imports--would have little impact on world oil prices used on their own. Thus, it is to China’s advantage to leverage any withdrawal from its SPR with the IEA, whose members at end 2006 held some 4,100 million barrels or coverage for 122 days of their oil imports.

To aid China in its considerations of oil stock policies, the United States hosted a delegation from China in June 2001 for discussions of strategic petroleum storage policy at Department of Energy headquarters in Washington, followed by a tour of the U.S. Strategic Petroleum Reserve at Bayou Choctaw, Louisiana. The U.S., Japan and other member countries of the IEA encouraged the Agency to conduct a “Seminar on Oil Stocks and Emergency Response” in Beijing in December 2002. Further, senior Chinese officials have participated as observers and commentators at the last four biennial IEA Ministerial meetings.

In July 2005, the Energy Working Group of the Asia-Pacific Economic Cooperation forum, of which China is a member economy, held an Oil Stocks Workshop in Honolulu. The U.S., Japan, Korea and others gave presentations on both policy and practicalities of constructing, financing and using strategic oil stocks, based on their past experiences, while China and India gave presentations on their plans to build, manage and finance strategic oil stocks. The latest development in China is a new draft energy law that also would require Chinese oil companies to maintain strategic oil stocks. If held as oil products, rather than crude oil, this could increase Chinese oil supply security. The U.S. discovered, during the 2005 devastation caused by Hurricanes Katrina and Rita, that having only crude oil reserves created a problem when a significant portion of the country’s refining capacity was down.

Thus, while it certainly is true that China is not bound by IEA decisions--not being a member country--it understands that it can significantly magnify the impact of its actions by coordination with the IEA and has continued to consult with both the IEA and its member countries as China develops its strategic petroleum reserve capability.

Chinese Leadership Changes

While attending the 8th US-China Oil & Gas Industry Forum in San Francisco this week, heard a lot of buzz about possible Chinese leadership changes. These changes won't occur at during the Chinese Communist Party Congress, which begins October 15, but more probably will be announced during the National People's Congress meeting in March 2008. The first changes concern the National Development and Reform Commission (NDRC), the successor to the old State Planning Commission. Rumor is that former SPC Chairman and current vice premier ZENG Peiyan will retire and be replaced as vice premier by current NDRC Chairman MA Kai; in turn, MA will be replaced as NDRC Chairman by current vice chairman CHEN Deming, who overseas energy matters at NDRC, in conjunction with vice chairman ZHANG Guobao, who is expected to retire. Also, there was talk that FU Chenyu, currently president of the China National Offshore Oil Corp. (CNOOC) will be named as minister of commerce or as governor of one of China's provinces.