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CHINA’S RISE
It was one of those sharp, cold nights in Beijing when the smell of burning, crisp and a little sweet, wafted through the dark. This was the very end of the 1990s when the swelling hordes of cars were beginning to fill the new eight-lane highways and push the bicycles to the side. The burning still mainly came not from the cars but rather from the many hundreds of thousands of oldfashioned coal ovens throughout the city that people were still using to cook and heat their homes.
The dinner had gone on for a long time in the China Club, once the home of a merchant, and then a favorite restaurant of Deng Xiaoping, who had launched China’s great reforms at the end of the 1970s. Coal may have been in the air that night, but oil was on the agenda. With the dinner over, the CEO of one of China’s state-owned oil companies had stepped out into the enclosed courtyard with the other guests. Everybody’s overcoats were buttoned to the top against the cold. He and his management team were facing something he would never have anticipated when he started as a geologist in western China, more than three decades ago. For now they were charged with taking a significant part of China’s oil and gas industry—built to serve the command-and-control centrally planned economy of Mao Tse-tung—and turning it into a competitive company that would meet the listing requirements for an IPO on the New York Stock Exchange.
The reasons for this sharp break with the past were clear—the specter of China’s future oil requirement and the challenge of how to meet it—although that evening they could not visualize how rapidly consumption would grow. As the group paused in the courtyard outside the restaurant, the CEO was asked a pertinent question: Why go to all the trouble of becoming a public company? For then the management would be responsible not only to the senior authorities in Beijing but also to young analysts and money managers in New York City and London, and in Singapore and Hong Kong , all of whom would scrutinize and pass judgment on strategies, expenses, and profitability—and on the job they all were doing.
It wasn’t at all obvious that the CEO relished such an “opportunity.” But he replied, “We have no choice. If we are going to reform, we have to benchmark ourselves against the world economy.”
That was still the time when China was moving from being a minor player in the world oil market to something more, although how much more was not at all clear. What was clear, however, was that China was fast integrating with the world economy and beginning to transition to a new and far larger role in it.
Over the years that followed, these changes would transform calculations about the world economy and the global balance of power. Would all of this mean a more interdependent world? Or, people would ask in the years to come, would it lead to intensified commercial competition, petro-rivalry, and a growing risk of a clash of nations over access to resources and over the sea-lanes through which those resources are borne?
“CHINA RISK”
None of these questions were much in the air that night, on the very eve of the new century, at least in terms of energy. Indeed, at that moment, the prospects for the IPOs of the three state-owned companies looked, at best, quite problematic, and even somewhat dubious.
The IPO for PetroChina, the new subsidiary of China National Petroleum Corporation (CNPC), the largest of the companies, would be the first one successfully out of the gate. But getting ready for the IPO was proving harder than might have been imagined. Financial accounts that could satisfy the requirements of the U.S. Securities and Exchange Commission had to be carved out and formulated from the undigested, confusing, and poorly organized data of a vast Chinese state organization that had never had to pay attention to any such metrics—and certainly never had any reason to heed to the U.S. agency that regulated the New York Stock Exchange. Management knew that a whole new set of values and norms had to be inculcated into the organization. Add to this the fact that some of the company’s overseas investments were generating protests, and the picture became exceedingly unclear. It took a long prospectus—384 pages—to spell out all the risks.1
For their part, the international investors in the United States and Britain, and even those closer to China, in Singapore and Hong Kong, were skeptical. They worried about the China risk—uncertainty about the political stability and economic growth of the country. Also, this was an oil company at a time when the new economy—the Internet and Internet stocks—was booming. By contrast, the oil business was seen as quintessential old economy—stagnant, uninteresting, and stuck in what was thought to be the doldrums of permanent overcapacity and low prices.
As 2000 began, the appetite of global investors appeared tepid. The IPO was scaled back, substantially. But, finally, in April 2000 it went forward, though just barely, and PetroChina was launched as a public entity, partly owned by international investors but still majority owned by CNPC.
Over the next year, it was followed by the IPOs of the other two companies also cut from the once-monolithic ministries—Sinopec (the China Petroleum and Chemical Company) and CNOOC (China National Offshore Oil Corporation). They received the same tepid welcome. But as the years went on, the skepticism among investors disappeared, and with good reason. A decade after its IPO, PetroChina’s market capitalization had increased almost seventy times over. Its market value by that point was greater than that of Royal Dutch Shell, which is a century older, greater than Walmart’s, and was second only to ExxonMobil.
That increase in value calibrates the growing importance of the People’s Republic of China (PRC) in the balances of world energy and the rise of China itself. Since reforms began in 1979, more than 600 million Chinese people have been lifted out of gripping poverty, with as many as 300 million people in the middle-income level. Over that same time, China’s economy has grown more than fifteenfold. By 2010 it had overtaken Japan’s to become the second-largest economy in the world.2
“THE BUILD-OUT OF CHINA”
This great economic expansion has changed China’s oil position. Two decades ago China was not only self-sufficient in oil but an actual exporter of petroleum. Today it imports about half of its oil, and that share will go up as demand increases. The People’s Republic of China is now the second-largest oil consumer in the world, behind only the United States. Between 2000 and 2010, its petroleum consumption more than doubled. All this reflects what happens when the economy of a nation of 1.3 billion expands at 9 or 10 or 11 percent a year—year after year after year.
As China continues to grow, so will its oil demand. Sometime around 2020 it could pull ahead of the United States as the world’s largest oil consumer. It is an almost inevitable result of what can be described as the “great build-out of China”—urbanization at a speed and scale the world has never seen, massive investment in new infrastructure, and mass construction of buildings, power plants, roads, and high-speed rail lines—all of it reshaping China’s economy and society.
This build-out of China over the next two or three decades will be one of the defining forces not just for China but for the world economy. It is certainly one of the main explanations for a long-lasting boom in commodities. China’s urban population is growing very fast. In 1978 the country was only 18 percent urbanized. Today it is almost 50 percent urbanized, with more than 170 cities over a million people, and a number of megacities with populations exceeding 10 million. Every year another 20 million or so Chinese move from the countryside looking for work and housing and a higher standard of living. Asked by George W. Bush what worry kept him up at night, President Hu Jintao said that his biggest concern was “creating 25 million new jobs a year.” That was the basic requirement for both development and social stability.3
As a result of this build-out, the country has become a vast construction site for homes and factories and offices and public services, requiring not only more energy but also more commodities of all kinds—a seemingly endless demand for concrete, steel, and copper wiring. An expansion on this scale will likely mean real estate booms and bubbles and busts. It is only when it is largely finished and China, mainly urbanized, sometime in the 2030s and 2040s, that the tempo of demand will slow.
All this growth, all this new construction, all these new factories, all these new apartments and their new appliances, and all the transportation that comes with this—all of it depends upon energy. This is on top of the huge energy requirements of all the factories that make China the world’s leading manufacturing country and supplier of goods to the global economy. It all adds up—more coal, more oil, more natural gas, more nuclear power, more renewables. Today coal remains the backbone of China’s energy. But in terms of the relationship with international markets and the world economy, the dominating factor is oil.
GROWTH AND ANXIETY
China’s rapid growth in oil demand generates great anxiety, both for China and for the rest of the world. For Chinese oil companies, and the government, assuring sufficient oil supplies is a national imperative. It is crucial to Beijing’s vision of energy security—guaranteeing that shortages of energy do not constrain the economic growth that is required to reduce poverty and tamp down the social and political turbulence that could otherwise ensue in such a fast-changing society. At the same time, a sharp awareness has developed that rising energy demand must be balanced with greater environmental protections.
In other countries, some fear that the Chinese companies, in their quest for oil, could preempt future supplies around the world—and deny access to other countries. Some also worry that the inevitable growth in Chinese demand, along with that of other fast-growing emerging markets, will put unbearable and unsustainable pressure on world oil supplies—leading to global shortage.
These anxieties suddenly burst into view in 2004—the year of the global demand shock, when world oil consumption grew in a single year by what normally would have been the growth over two and a half years. The surge in Chinese consumption was one of the central elements in the jump in demand.
The demand shock forced perceptions to catch up with a fundamental reality. Until then, many had seen China mainly as a low-cost competitor, a manufacturer of cheap goods, a challenge to wages in industrial countries, and the supplier for the shelves in Walmart and Target and other discount stores around the world. China, with its low costs, had become the Great Inflation Lid, giving central bankers the comfort to allow faster economic growth than they otherwise would feel safe doing.
But now one also had to look at China as a market of decisive importance, with the heft to significantly affect the supply and demand—and, therefore, the price—of oil, along with other commodities and all sorts of other goods. Until 2004 it would never have occurred to motorists in the United States or Europe that the prices they paid at the pump could be so strongly influenced by bottlenecks in coal supplies and shortages of electricity in China that would force a sudden switch to oil. And it certainly would never have occurred to the management of General Motors, the prototypical American car company, that within just a few years it would be selling more new cars in China than the United States. But such is the new reality of today’s global economy. This is also true for trade in general. China is the biggest export market for countries like Brazil and Chile—not necessarily surprising for countries that export commodities. For countries like Germany, China is now also a key export market.
For the oil market, there is only one meaningful analogy for China’s rapidly growing importance. It was the massive growth in petroleum demand—and imports—in Europe and Japan in the 1950s and 1960s that resulted from the rapid economic growth during the years of their economic miracles. That growth in demand certainly had a transformative impact on the world energy scene and on global politics.
But there is a risk around this change in the balance in the world oil market: that commercial competition could turn into a national rivalry that gets cast in terms of “threats” and “security,” disrupting the working relationships that the world economy requires. As always in international relations, the danger is that miscalculation and miscommunication can in turn escalate security “risks” into something more serious—confrontation and conflict.
This emphasizes the importance of not recasting commercial competition into petro-rivalry and a contest of nation-states. After all, change is inevitable as a result of China’s rapidly growing economy and from the new balance that will inevitably result. Moreover, the global oil and gas markets do not exist in a vacuum. They are part of a much larger and ever more dense network of economic linkages and connections, including huge trade and financial and investment flows—and, indeed, flows of people. These connections, of course, generate their own tensions, particularly around trade and currencies. Yet overall, the mutual benefits and common interests much outweigh the points of conflict.
Whatever the tensions today, this degree of integration and collaboration would have been inconceivable in the earlier era of confrontation, when Mao proclaimed that “the east is red” and the Bamboo Curtain closed off China from the rest of the world.
“POOR IN OIL”
On a Sunday night, from the top floor of the China World Hotel, one looks down at an endless stream of headlights, gliding in multiple streams, from the four lanes in each direction of Chang’an Avenue, Beijing’s most important road, onto the elevated Third Ring Road expressway, which is constantly at capacity. This is the new China. Satisfying these streams of demand is part of China’s preoccupation when it comes to oil.
There was no way that Zhou Qingzu, the venerable chief economist of China National Petroleum Company, could have imagined the panorama he was watching, twenty floors down, when he joined the oil industry as a geologist in 1952. At that time, China’s entire production was less than 3,500 barrels a day. As his first assignment, he was sent to China’s far west to join an early exploration effort. He was one of just a small handful of geologists going into an industry whose prospects were hardly promising. Decades earlier, after World War I, a Stanford University professor had delivered what had been taken as the definitive verdict: “China will never produce large quantities of oil.” The meager experience of the succeeding decades seemed to bear out that conclusion.
Yet after the Second World War, no one could doubt that oil was essential for a modern economy—and for military might and political power. But China had virtually no oil of its own and had to depend on imports to meet its needs. Following the victory of Mao Tse-tung’s communist revolution in 1949, the United States sought to limit Western oil exports to China and then, after the outbreak of the Korean War, to cut them off altogether, which constrained Chinese military operations during the war. “Self-reliance” became an urgent imperative, and Mao’s five-year plans made the development of the oil industry a very high priority. Despite disappointing results from exploration, the Chinese leadership simply refused to accept that China was “poor in oil.”
The Chinese Revolution did have one asset on which to draw in the search for oil—its fraternal relations with its communist brethren, the Soviet Union, which was a large oil producer. “We were just getting started,” recalled Zhou. “Our major teachers were the Russians. We called the Russians ‘our big brothers.’ ” The Soviets sent experts, equipment, technology, and financial aid to China, and a whole generation of young Chinese went off in the other direction, to Moscow, to be trained in petroleum.4
Some new fields were developed in the remote west, with Soviet help, but the overall results, as Zhou found from personal experience, were almost negligible. Pessimism was so rife that some Chinese experts thought the country should turn to synthetic oil, making petroleum from its abundant coal resources, as the Germans had done during the Second World War.
DAQING : THE “GREAT CELEBRATION”
But then, unexpectedly, in the grasslands of the northeast, in Manchuria, a vast new oil field was found. It was called Daqing—which means “Great Celebration.”
The development of the field, arduous as it was, became even more difficult when the “brotherhood” with the Soviet Union splintered and the two countries became bitter rivals for leadership of the communist world. Moscow abruptly pulled out its people and equipment, and demanded repayment of debts. Mao repaid the Soviets in vituperation, denouncing them as “renegades and scabs . . . slaves and accomplices of imperialism, false friends and double-dealers.”
The Chinese were now on their own for Daqing. No modern technology. No nearby urban areas. No housing. Thousands and thousands of oil field workers were hastily dispatched like troops in a military campaign. Despite the harsh cold, they slept in tents or huts or holes in the ground or just out in the open; they used candles and bonfires for light and heat; they scrounged the countryside for wild vegetables. Operations were headquartered in cattle sheds. And they worked terribly hard. To make matters worse, the Soviets reduced their oil exports to China. “Once imports are cut off, airplanes could be forced to stop flying,” warned one senior official, “certain combat vehicles could be forced to stop operating.” He added, “We should not rely on imports again.” From then on, self-sufficiency and the determination represented by the “Spirit of Daqing” became the guiding principles of China’s oil development.5
“IRON MAN” WANG
The embodiment of the Spirit of Daqing became a driller named Wang Jinxi. He achieved fame across China as the “Iron Man of Daqing oilfield” and was celebrated as the “national model worker.” According to legend, when Wang had once visited Beijing , he had seen buses with large units on top that burned coal to make gas to power the vehicles. To Wang , this clear evidence of China’s shortage of oil was an outrage. “I simply want to now open the earth with my fist,” he declared, “to let the black oil gush out and dump our backwardness in petroleum into the Pacific.”
Wang’s team drilled at a furious rate. Wang himself would not be stayed. After one injury, it is said, he crept out of the hospital and went back to the drilling site, where he directed operations from his crutches. In his most famous exploit, in order to prevent a blowout that would have destroyed the drilling rig , he ordered bags of cement to be poured into a pit. Since there was no mixer, Wang jumped in and mixed the cement with his legs, forestalling the blowout and further injuring himself. Following the success of Daqing, Premier Zhou En Lai welcomed Iron Man Wang and his fellow Daqing workers to Beijing as national heroes. Mao himself declared that Chinese industry should “learn from the Daqing oil field.”
Many other fields followed, the pace pushed by a famous oil minister and later vice premier, Kang Shien. China succeeded in becoming self-sufficient in petroleum, which, the People’s Daily announced, had “blown the theory of oil scarcity in China sky high.” Another publication declared that, “The so-called theory that China is poor in oil only serves the U.S. imperialist policy of aggression and plunder.” The United States was not the only antagonist. The victory in the oil campaign was also hailed as a fusillade against “the Soviet revisionist renegade clique.”6
RED GUARDS
In the mid-1960s, Mao recognized that he was being pushed aside because of the dismal failure of his disastrous economic policy, the Great Leap Forward, which had caused an estimated 30 million people to die from starvation. In 1966 he counterattacked and declared war on the Communist Party itself, charging that it had been captured by renegades with “bourgeois mentality.” To carry out his “Cultural Revolution,” Mao mobilized youthful zealots, the Red Guards, who waged a vicious battle against all the institutions of society, whether enterprises, government bureaus, universities, or the party itself. Prominent figures were humiliated, paraded around with donkey heads, beaten up, sent to do manual labor, or killed. Universities closed, and young people were dispatched to factories or the countryside to toil with the masses. The nation was in turmoil.7
But because of the oil industry’s importance to national security, Premier Zhou En Lai took it under his personal protection, using the army to insulate the industry and ensure that it kept working. This led to notable incongruities. “During the day, I organized production as usual,” recalled Zhou Qingzu, the chief economist at CNPC. “At night, I would sit in front of the students and workers and say I was wrong and apologize and write out my errors and apologies. I would listen very attentively to their criticism and write notes. During the day, I was a boss. At night, I was a nobody.”8
Eventually the Cultural Revolution went too far even for Mao, in terms of the chaos it had created, and he used the army to throttle back the Red Guards.
“EXPORT AS MUCH OIL AS WE CAN”
Henry Kissinger, President Nixon’s special assistant for national security, fell ill during a dinner in his honor in Pakistan in July 1971. Pakistan’s president, the dinner’s host, strenuously suggested that Kissinger, in order to escape the heat and thus speed his recovery, should recuperate in an estate up in the much cooler hills. This was very definitely a diplomatic illness. The supposed trip to the hills was a ruse, to provide cover for Kissinger’s real purpose. Meanwhile, Kissinger himself—now code-named “Principal Traveller”—was given a hat and sunglasses to disguise himself at the airport prior to taking off for his actual destination, although the disguise might have seemed a little excessive since it was 4 a.m. in the morning.9
Only a week later did the sensational news break. From Pakistan, Kissinger had flown secretly over the Himalayas to Beijing, creating an opening in the Bamboo Curtain that had surrounded China since the communist victory in 1949. Half a year later, President Richard Nixon went through that opening. In the course of his historic visit to Beijing , Nixon supped with Mao, clinked glasses with Zhou En Lai, and dramatically reset the table of international relations.
For both sides it was a matter of realpolitik. The United States, looking for a way out of the stalemated Vietnam War, wanted to create a balance against the Soviet Union. For China, this was a means to strengthen its strategic position against the Soviet Union and reduce the risk of a “two-front war” with the Soviet Union and the United States. This was no mere theoretical matter, for Russian and Chinese military forces had already clashed on the border along the Amur and Ussuri rivers.
The Chinese had a second set of reasons as well. The most virulent phase of the Cultural Revolution was over. Vice Premier Deng Xiaoping and others were trying to get the country working again. They knew that self-reliance could not work. China needed access to international technology and equipment to modernize the economy and restore economic growth. But a very big obstacle stood in the way: How to pay for such imports?
“Petroleum export–led growth”—that was Deng’s answer. “To import, we must export,” he said in 1975. “The first to my mind is oil.” The country must “export as much oil as we can. We may obtain in return many good things.”
By this time, Deng was already becoming the manager-in-chief of the new strategy of opening toward the world. A stalwart communist since his student and worker days in France after World War I, he had emerged as one of the top leaders after the communists came to power. He then became one of the foremost targets of the Cultural Revolution and of his leftist rivals. His family had suffered much; his son had been pushed out of an upper-floor window and left paralyzed. Deng himself had spent those years variously working in a tractor repair shop and by himself, in solitary confinement. He had spent many hours pacing his courtyard, asking himself what had gone so wrong under Mao and how China’s economy could be restored. In some ways, he had always been a pragmatist. (Even while organizing underground communist activities in France after World War I, he had also started and run a successful Chinese restaurant.) The traumas of the Cultural Revolution—national and personal—only reinforced his pragmatism and realism. His fundamental mottos were about being practical—“crossing the river by touching the stones”—and the most famous maxim of all: that he didn’t care whether a cat was black or white so long as it caught mice.10
Following Mao’s death and after a brief struggle with the radical “Gang of Four,” Deng secured his position as paramount leader. He could now initiate the great transformation that would lead to China’s integration with the global economy—which the 11th Congress of the Communist Party, in 1978, would proclaim as the historic policy of “reform and opening.”
The oil industry was central to the opening. By that time, China—no longer “poor in oil”—was producing petroleum in excess of its own needs and could start exporting it. There was a waiting market nearby—Japan—which wanted to reduce its reliance on the Middle East and, at the same time, develop export markets in China for its own manufactures. Buying Chinese oil would help on both counts.
As the door began to open to the outside world, the Chinese oil industry discovered, to its shock, how wide was the technology gap that separated it from the international industry. But now, bolstered by its oil-export earnings, it could buy from abroad the drilling rigs, seismic capabilities, and other equipment that would lift its technical abilities.
While Mao’s death and Deng’s ascension were critical to the opening of China, those events did not put an end to the turmoil. Inflation, corruption, and inequality emboldened opponents of reform. So did the bloody 1989 confrontation with students in Tiananmen Square. In the aftermath, amid the indecision of the leadership, the efforts to continue market reform stagnated. Seeking to jump-start the faltering reforms, Deng, in January 1992, launched his last great campaign—the nanxun, or “southern journey.” This trip showcased the booming Special Economic Zone of Shenzhen, which was becoming a manufacturing center for exports, and sought, fundamentally, to erase the stigma from making money. His message was that “the only thing that mattered is developing the economy.” It was during this tour that Deng also made a stunning revelation—he had never actually read the bible of communism, Karl Marx’s Das Kapital. He never had the time, he said. He had been too busy.11
WORKSHOP OF THE WORLD
In the years after Deng’s “southern journey,” China consolidated its course of reform and moved toward integration with the global economy. The 1990s was a decade of a new, much more interconnected economy. On January 1, 1995, the World Trade Organization was established to bring down barriers and facilitate global trade and investment. World trade was growing much faster than the global economy itself. American and European companies were setting up supply chains that gathered components from different parts of the world, assembled them in still other parts, and then packed the finished goods into containers and shipped them across oceans to customers anywhere in the world. Although China did not formally join the WTO until 2001, it had by then already become the linchpin in this new system of global supply chains.
As factories went up all along the coastal region, the inscription “Made in China” became ubiquitous on all sorts of products shipped all over the world. China had now become what was said of Britain two centuries earlier—“the workshop of the world.” In due course, these new trade and investment linkages would have much greater impact on world energy than anyone might have imagined. For any workshop needs energy on which to run, and this new workshop of the world would run on fossil fuels.
THE END OF SELF-SUFFICIENCY
Already, however, a few years earlier, China had crossed a great divide in terms of energy. By 1993 petroleum production could no longer keep up with the rising domestic demand of the rapidly growing economy. As a result, China went from being an oil exporter to an oil importer. Though not at first noticed by the rest of the world, it was for China an immediate shock. “The government thought it was a disaster,” remembered one Chinese oil expert. “It was very negatively received. From an industry point of view, we felt very shamed. It was a loss of face. We couldn’t supply our own economy. But some scholars and experts told us, ‘You can’t be self-sufficient in everything. You import some things, and export others.’ ”12
This added greatly to the urgency to further modernize the structure of the oil industry—to move from the all-encompassing ministries of the petroleum and chemical industries, based on rigid central planning, to a system based on companies and rooted in the marketplace. The foundation for this shift had already been laid in the 1980s. The three state-owned companies had emerged from the ministries: the China National Petroleum Company, CNPC; Sinopec, the China Petrochemical Corporation; and CNOOC, the China National Offshore Oil Company. The next move, beginning in the late 1990s, was to dramatically restructure the three companies into more modern, technologically advanced companies—and more independent enterprises. “They would need to earn a living,” said Zhou Qingzu. It was at this point that they would go through IPOs, opening partial ownership to shareholders around the world. CNPC’s subsidiary was given a new name—PetroChina—while Sinopec and CNOOC used their existing names for their listed subsidiaries. There was also an enormous cultural change. “Now you’d have to be competitive,” said Zhou. “You never had to be competitive before.”13
THE “GO OUT” STRATEGY: USING TWO LEGS TO WALK
China has become a growing presence in the global oil and natural gas industry. This new role goes by the name of the “go out” strategy. It was enunciated as policy around 2000, though the policy’s roots extend back to the original reforms of Deng Xiaoping.
The first steps abroad were very small ones, beginning in Canada, then Thailand, Papua–New Guinea, and Indonesia. In the mid-1990s, CNPC acquired a virtually abandoned oil field in Peru. By applying the kind of intense recovery techniques it had honed to coax more oil out of complex older oil fields in China, it took the field from 600 barrels a day to 7,000. But these projects were small and did not get much attention. It took time and experience for the confidence to build for significant international activities. “We knew that, from its beginning in the mid-nineteenth century, the oil industry was always an international industry,” said Zhou Jiping, the president of PetroChina. “If you wanted to become an international oil company in the real sense, you had to go out.” By the beginning of the new century, a policy consensus had formed around the idea of international expansion, along with confidence in the capabilities of the Chinese companies to implement it.14
In general, the “go out” phase meant the internationalization of Chinese firms—that they should become competitive international companies with access both to the raw materials required by the rapidly growing economy and to the markets into which to sell their manufactures. For energy companies more specifically, it meant that the partly state-owned, partly privatized oil companies should own, develop, control, or invest in foreign sources of oil and natural gas. For the oil industry, this was complemented by another slogan—“using two legs to walk”—one, to further development of the domestic industry; the other, for international expansion.
Today the impact of the “go out” strategy is evident worldwide. Chinese oil companies are active throughout Africa and Latin America (as are Chinese companies from other sectors). Closer to home they have acquired significant petroleum assets in neighboring Kazakhstan and have achieved some positions in Russia after repeated tries. They are developing natural gas in Turkmenistan. As latecomers into the international industry, the Chinese come equipped not only with oil field skills but a willingness and the financial resources to pay a premium to get into the game. Also, particularly in Africa, they make themselves partners of choice with very significant “value added.” That is, they bring government-funded development packages—helping to build railroads, harbors, and roads—something that is not in the tool kit of traditional Western companies. This has engendered controversy. Critics charge that China is colonizing Africa and using Chinese rather than local labor. Chinese reply that they are doing much to create markets for African commodity exports, and that export earnings are better than foreign aid and do more to stimulate lasting economic growth. (Some of these packages have fallen apart.) Chinese banks, in coordination with the Chinese oil companies, have also made multibillion-dollar loans to a number of countries that will be paid back in the form of oil or gas over a number of years. (One such deal took fifteen years to work out. )15
The energy security strategy is also taking an obvious route—building pipelines to diversify, reduce dependence on sea-lanes, and strengthen connections with supplier countries. A new set of pipelines, built in record time, brings oil and gas from Turkmenistan and Kazakhstan to China. Russia’s $22 billion East Siberia–Pacific Ocean Pipeline will, in addition to supplying oil to the Pacific (Japan and Korea primarily), also deliver Russian oil to China—guaranteed by a $25 billion loan that China advanced to Russia. In September 2010 Chinese president Hu Jintao and Russian president Dmitry Medvedev jointly pushed the button to start the flow of oil over the Russian-Chinese border. The potential for a large trade in natural gas was also hailed. At the ceremony, Hu proclaimed a “new start” in Chinese-Russian relations. A relationship that was once based upon Marx and Lenin was now rooted in oil and possibly gas. 16
“LIKE THROWING A MATCH”
But the greatest controversy over the “go out” strategy came not in Africa but in the United States. In 2005 Chevron and CNOOC—Chinese National Offshore Oil Corporation—were locked in a battle royal to acquire the large U.S. independent company Unocal, which had significant oil and gas production in Thailand and Indonesia but also had some in the Gulf of Mexico. The competition between the two companies was very tough, with sharp arguments about the financial terms and the role of Chinese financial institutions, as well as the timing of the respective offers. For some in Beijing, a global takeover battle was not only unfamiliar but disconcerting. The price that CNOOC put on the table was greater than the entire cost of the huge Three Gorges Dam project, which had taken decades to build. After months of battle, Chevron emerged victorious with a $17.3 billion bid.
But in the course of takeover battle, a fiery political controversy erupted in Washington that was out of scale compared with the issues. After all, Unocal’s entire production in the United States amounted to just 1 percent of the total U.S. output. Much of it was in the Gulf of Mexico, in joint ventures with other companies, and the only market for that output was the United States. Yet when the contest got to Washington, as one of the American participants said, it was “like throwing a match into a room filled with gasoline.” For it became the focus of a firestorm of anti-Chinese sentiment on Capitol Hill that was already supercharged by the contentious hot-button issues of trade, currencies, and jobs. The heated rhetoric showed the intensity, at least in some quarters, of suspicions of China’s motives and methods. One critic told a congressional committee that CNOOC’s bid fit “into a pattern” of “activity around the globe” that is “ominous in its implication.” Another charged that CNOOC’s bid was part of China’s strategy for “domination of energy markets and of the Western Pacific.” Whatever the specifics of the takeover battle, the takeaway for the Chinese at the end of the political battle was that the United States itself was less hospitable to the openness toward foreign investment that it preached to others and that the Chinese companies should redouble their investment effort—but elsewhere. “The world was shocked that a Chinese company could make this kind of bid,” said Fu Chengyu, at the time the CEO of CNOOC. “The West was saying that China is changing in terms of such things as building highways. But it was not paying attention to China itself and how China had changed.”
In the years that followed, the changes became much more evident. China’s president made highly visible state visits to a number of oil and commodityexporting countries in the Middle East and Africa, beginning with Saudi Arabia. And when China convened a summit of African presidents to discuss economic cooperation, 48 of the presidents made the trip. “China should buy from Africa and Africa should buy from China,” said Ghana’s president. “I’m talking about the win-win.”
The world moves on. In 2010, five years after the fiery battle over Unocal, Chevron and CNOOC announced that they were teaming up to explore for oil not in the Gulf of Mexico but in the waters off China. “We welcome the opportunity to partner with CNOOC,” said a senior Chevron executive. 17
“INOCs”
In the decade-plus since the shaky days of the original IPOs, the Chinese companies have become highly visible players in the world oil market.
Their international roles have instigated a vigorous debate outside China as to what drives them. One agenda is established by the government (which remains the majority shareholder) and the party, both of which maintain oversight. They are to meet national objectives in terms of energy, economic development, and foreign policy. The CEOs of the major companies also hold vice ministerial government rank—and many also hold senior party rank.
At the same time, the companies are driven by strong commercial, competitive objectives that are similar to those of other international oil companies, and, increasingly, their commercial identities define them. They are indeed benchmarked against the world economy and other international oil companies by the investors in their listed subsidiaries, and they have to be responsive to their investors’ interests. In addition, they are subject to international regulation and international governance standards. And they manage large and complex businesses that, increasingly, are operating on a global scale.
As Zhou Jiping put it, “As a national oil company, we have to meet the responsibilities of guaranteeing oil and gas supply to the domestic market. As a public company listed in New York, Hong Kong, and Shanghai, we must be responsible to our shareholders and strive to maximize shareholder value. And, of course, we have a responsibility to the 1.6 million employees of our company.”
In short, Chinese oil companies are hybrids, somewhere between the familiar “international oil companies,” IOCs, and the state-owned national oil companies, NOCs. They have become a prime example of a new category called INOCs—the international national oil companies. “There has been a great change in people’s overall psychology and philosophy since the IPO,” said the CEO of one of the companies. “We used to focus on how much we produced. Now it’s the value of what we do.”
Today walk into the headquarters of some of the companies in Beijing and what one sees are not exhorting slogans but the epitome of the international benchmarking—flashing displays of the stock price in New York, Hong Kong , and Shanghai. Yet in the lobby of CNPC, one is also greeted by a very strong reminder of how the industry was built—a massive statue of Iron Man Wang.
What is the balance in these INOCs? The Chinese companies are sometimes portrayed mainly as “instruments” of the state. A new study from the International Energy Agency concludes otherwise—that “commercial incentive is the main driver” and that they operate with “a high degree of independence” from the government. As the IEA puts it, they are “majority-owned by the government” but “they are not government-run.” As they become increasingly internationalized, they operate more like other international companies.
For all concerned, the development of the Chinese companies has been an evolution. Fu Chengyu, now the chairman of Sinopec, summed up the changes this way: “Evolving so completely from full state-ownership to join the ranks of major international corporations is a huge transformation—one that, back when I started in the oil business in the oil fields of Daqing , we never thought could be possible. Back in those days, China’s largest source of foreign exchange was not manufacturing, but in fact sales of oil to Japan! Today everything around us has changed. But so have we.”18
PROPORTION
Chinese companies will likely become bigger, more prominent players; they will certainly compete; but they will also be sharing the stage with established American, European, Middle Eastern, Russian, Asian, and Latin American companies—and often in partnerships.
For all the talk about China “preempting” world supplies, its entire overseas production is less than that of just one of the supermajor companies. It’s very hard to conceive of China ever being in a position to preempt world supplies. Moreover, while some of Chinese overseas production is shipped to China, most of it is sold into world markets at the same prices as similar grades of petroleum. Destination is determined by the best price, local and international, taking into account transportation costs. And that is all the more true of oil from joint ventures, in which much of China’s international oil is produced.
There is a further critical consideration. Chinese investment and effort in bringing more barrels to the markets contribute to stability in the global market. For were those barrels not forthcoming, the growing demand from China (and elsewhere) would add more pressure and lead to higher prices. Additional investment means more supply and adds to energy security. The Chinese oil companies are committing more capital and resources to expanding Iraq’s oil output, and taking more risk, than the companies of any other nation.
Indeed, it would be quite surprising if a country in China’s position—rapidly rising demand, rapidly growing imports, a well-established domestic industry, huge holdings of dollars—did not venture out into the rest of the world to develop new resources. Indeed, were they not doing so, they would likely be roundly criticized around the world for not investing.
Moreover, “go out” is not the sole strategy of the Chinese companies. About 75 percent of the companies’ output is within China. Altogether, China’s domestic oil production makes it the fifth-largest in the world—ahead of such large producers as Canada, Mexico, Venezuela, Kuwait, and Nigeria. Within the Chinese industry itself there is talk about the “second age of Chinese oil.” This means the application of new technologies and new approaches to the discovery and development of domestic petroleum resources, as well as a much greater focus on what are increasingly seen as abundant but undeveloped domestic resources of natural gas, including shale gas.
These are the new commercial realities—China as a growing consumer of oil, China as an increasingly important participant in the world oil industry. But there is also a security dimension, which arises from growing dependence for a country for which “self-reliance” had been such a strong imperative for so many years.
It was one of those sharp, cold nights in Beijing when the smell of burning, crisp and a little sweet, wafted through the dark. This was the very end of the 1990s when the swelling hordes of cars were beginning to fill the new eight-lane highways and push the bicycles to the side. The burning still mainly came not from the cars but rather from the many hundreds of thousands of oldfashioned coal ovens throughout the city that people were still using to cook and heat their homes.
The dinner had gone on for a long time in the China Club, once the home of a merchant, and then a favorite restaurant of Deng Xiaoping, who had launched China’s great reforms at the end of the 1970s. Coal may have been in the air that night, but oil was on the agenda. With the dinner over, the CEO of one of China’s state-owned oil companies had stepped out into the enclosed courtyard with the other guests. Everybody’s overcoats were buttoned to the top against the cold. He and his management team were facing something he would never have anticipated when he started as a geologist in western China, more than three decades ago. For now they were charged with taking a significant part of China’s oil and gas industry—built to serve the command-and-control centrally planned economy of Mao Tse-tung—and turning it into a competitive company that would meet the listing requirements for an IPO on the New York Stock Exchange.
The reasons for this sharp break with the past were clear—the specter of China’s future oil requirement and the challenge of how to meet it—although that evening they could not visualize how rapidly consumption would grow. As the group paused in the courtyard outside the restaurant, the CEO was asked a pertinent question: Why go to all the trouble of becoming a public company? For then the management would be responsible not only to the senior authorities in Beijing but also to young analysts and money managers in New York City and London, and in Singapore and Hong Kong , all of whom would scrutinize and pass judgment on strategies, expenses, and profitability—and on the job they all were doing.
It wasn’t at all obvious that the CEO relished such an “opportunity.” But he replied, “We have no choice. If we are going to reform, we have to benchmark ourselves against the world economy.”
That was still the time when China was moving from being a minor player in the world oil market to something more, although how much more was not at all clear. What was clear, however, was that China was fast integrating with the world economy and beginning to transition to a new and far larger role in it.
Over the years that followed, these changes would transform calculations about the world economy and the global balance of power. Would all of this mean a more interdependent world? Or, people would ask in the years to come, would it lead to intensified commercial competition, petro-rivalry, and a growing risk of a clash of nations over access to resources and over the sea-lanes through which those resources are borne?
“CHINA RISK”
None of these questions were much in the air that night, on the very eve of the new century, at least in terms of energy. Indeed, at that moment, the prospects for the IPOs of the three state-owned companies looked, at best, quite problematic, and even somewhat dubious.
The IPO for PetroChina, the new subsidiary of China National Petroleum Corporation (CNPC), the largest of the companies, would be the first one successfully out of the gate. But getting ready for the IPO was proving harder than might have been imagined. Financial accounts that could satisfy the requirements of the U.S. Securities and Exchange Commission had to be carved out and formulated from the undigested, confusing, and poorly organized data of a vast Chinese state organization that had never had to pay attention to any such metrics—and certainly never had any reason to heed to the U.S. agency that regulated the New York Stock Exchange. Management knew that a whole new set of values and norms had to be inculcated into the organization. Add to this the fact that some of the company’s overseas investments were generating protests, and the picture became exceedingly unclear. It took a long prospectus—384 pages—to spell out all the risks.1
For their part, the international investors in the United States and Britain, and even those closer to China, in Singapore and Hong Kong, were skeptical. They worried about the China risk—uncertainty about the political stability and economic growth of the country. Also, this was an oil company at a time when the new economy—the Internet and Internet stocks—was booming. By contrast, the oil business was seen as quintessential old economy—stagnant, uninteresting, and stuck in what was thought to be the doldrums of permanent overcapacity and low prices.
As 2000 began, the appetite of global investors appeared tepid. The IPO was scaled back, substantially. But, finally, in April 2000 it went forward, though just barely, and PetroChina was launched as a public entity, partly owned by international investors but still majority owned by CNPC.
Over the next year, it was followed by the IPOs of the other two companies also cut from the once-monolithic ministries—Sinopec (the China Petroleum and Chemical Company) and CNOOC (China National Offshore Oil Corporation). They received the same tepid welcome. But as the years went on, the skepticism among investors disappeared, and with good reason. A decade after its IPO, PetroChina’s market capitalization had increased almost seventy times over. Its market value by that point was greater than that of Royal Dutch Shell, which is a century older, greater than Walmart’s, and was second only to ExxonMobil.
That increase in value calibrates the growing importance of the People’s Republic of China (PRC) in the balances of world energy and the rise of China itself. Since reforms began in 1979, more than 600 million Chinese people have been lifted out of gripping poverty, with as many as 300 million people in the middle-income level. Over that same time, China’s economy has grown more than fifteenfold. By 2010 it had overtaken Japan’s to become the second-largest economy in the world.2
“THE BUILD-OUT OF CHINA”
This great economic expansion has changed China’s oil position. Two decades ago China was not only self-sufficient in oil but an actual exporter of petroleum. Today it imports about half of its oil, and that share will go up as demand increases. The People’s Republic of China is now the second-largest oil consumer in the world, behind only the United States. Between 2000 and 2010, its petroleum consumption more than doubled. All this reflects what happens when the economy of a nation of 1.3 billion expands at 9 or 10 or 11 percent a year—year after year after year.
As China continues to grow, so will its oil demand. Sometime around 2020 it could pull ahead of the United States as the world’s largest oil consumer. It is an almost inevitable result of what can be described as the “great build-out of China”—urbanization at a speed and scale the world has never seen, massive investment in new infrastructure, and mass construction of buildings, power plants, roads, and high-speed rail lines—all of it reshaping China’s economy and society.
This build-out of China over the next two or three decades will be one of the defining forces not just for China but for the world economy. It is certainly one of the main explanations for a long-lasting boom in commodities. China’s urban population is growing very fast. In 1978 the country was only 18 percent urbanized. Today it is almost 50 percent urbanized, with more than 170 cities over a million people, and a number of megacities with populations exceeding 10 million. Every year another 20 million or so Chinese move from the countryside looking for work and housing and a higher standard of living. Asked by George W. Bush what worry kept him up at night, President Hu Jintao said that his biggest concern was “creating 25 million new jobs a year.” That was the basic requirement for both development and social stability.3
As a result of this build-out, the country has become a vast construction site for homes and factories and offices and public services, requiring not only more energy but also more commodities of all kinds—a seemingly endless demand for concrete, steel, and copper wiring. An expansion on this scale will likely mean real estate booms and bubbles and busts. It is only when it is largely finished and China, mainly urbanized, sometime in the 2030s and 2040s, that the tempo of demand will slow.
All this growth, all this new construction, all these new factories, all these new apartments and their new appliances, and all the transportation that comes with this—all of it depends upon energy. This is on top of the huge energy requirements of all the factories that make China the world’s leading manufacturing country and supplier of goods to the global economy. It all adds up—more coal, more oil, more natural gas, more nuclear power, more renewables. Today coal remains the backbone of China’s energy. But in terms of the relationship with international markets and the world economy, the dominating factor is oil.
GROWTH AND ANXIETY
China’s rapid growth in oil demand generates great anxiety, both for China and for the rest of the world. For Chinese oil companies, and the government, assuring sufficient oil supplies is a national imperative. It is crucial to Beijing’s vision of energy security—guaranteeing that shortages of energy do not constrain the economic growth that is required to reduce poverty and tamp down the social and political turbulence that could otherwise ensue in such a fast-changing society. At the same time, a sharp awareness has developed that rising energy demand must be balanced with greater environmental protections.
In other countries, some fear that the Chinese companies, in their quest for oil, could preempt future supplies around the world—and deny access to other countries. Some also worry that the inevitable growth in Chinese demand, along with that of other fast-growing emerging markets, will put unbearable and unsustainable pressure on world oil supplies—leading to global shortage.
These anxieties suddenly burst into view in 2004—the year of the global demand shock, when world oil consumption grew in a single year by what normally would have been the growth over two and a half years. The surge in Chinese consumption was one of the central elements in the jump in demand.
The demand shock forced perceptions to catch up with a fundamental reality. Until then, many had seen China mainly as a low-cost competitor, a manufacturer of cheap goods, a challenge to wages in industrial countries, and the supplier for the shelves in Walmart and Target and other discount stores around the world. China, with its low costs, had become the Great Inflation Lid, giving central bankers the comfort to allow faster economic growth than they otherwise would feel safe doing.
But now one also had to look at China as a market of decisive importance, with the heft to significantly affect the supply and demand—and, therefore, the price—of oil, along with other commodities and all sorts of other goods. Until 2004 it would never have occurred to motorists in the United States or Europe that the prices they paid at the pump could be so strongly influenced by bottlenecks in coal supplies and shortages of electricity in China that would force a sudden switch to oil. And it certainly would never have occurred to the management of General Motors, the prototypical American car company, that within just a few years it would be selling more new cars in China than the United States. But such is the new reality of today’s global economy. This is also true for trade in general. China is the biggest export market for countries like Brazil and Chile—not necessarily surprising for countries that export commodities. For countries like Germany, China is now also a key export market.
For the oil market, there is only one meaningful analogy for China’s rapidly growing importance. It was the massive growth in petroleum demand—and imports—in Europe and Japan in the 1950s and 1960s that resulted from the rapid economic growth during the years of their economic miracles. That growth in demand certainly had a transformative impact on the world energy scene and on global politics.
But there is a risk around this change in the balance in the world oil market: that commercial competition could turn into a national rivalry that gets cast in terms of “threats” and “security,” disrupting the working relationships that the world economy requires. As always in international relations, the danger is that miscalculation and miscommunication can in turn escalate security “risks” into something more serious—confrontation and conflict.
This emphasizes the importance of not recasting commercial competition into petro-rivalry and a contest of nation-states. After all, change is inevitable as a result of China’s rapidly growing economy and from the new balance that will inevitably result. Moreover, the global oil and gas markets do not exist in a vacuum. They are part of a much larger and ever more dense network of economic linkages and connections, including huge trade and financial and investment flows—and, indeed, flows of people. These connections, of course, generate their own tensions, particularly around trade and currencies. Yet overall, the mutual benefits and common interests much outweigh the points of conflict.
Whatever the tensions today, this degree of integration and collaboration would have been inconceivable in the earlier era of confrontation, when Mao proclaimed that “the east is red” and the Bamboo Curtain closed off China from the rest of the world.
“POOR IN OIL”
On a Sunday night, from the top floor of the China World Hotel, one looks down at an endless stream of headlights, gliding in multiple streams, from the four lanes in each direction of Chang’an Avenue, Beijing’s most important road, onto the elevated Third Ring Road expressway, which is constantly at capacity. This is the new China. Satisfying these streams of demand is part of China’s preoccupation when it comes to oil.
There was no way that Zhou Qingzu, the venerable chief economist of China National Petroleum Company, could have imagined the panorama he was watching, twenty floors down, when he joined the oil industry as a geologist in 1952. At that time, China’s entire production was less than 3,500 barrels a day. As his first assignment, he was sent to China’s far west to join an early exploration effort. He was one of just a small handful of geologists going into an industry whose prospects were hardly promising. Decades earlier, after World War I, a Stanford University professor had delivered what had been taken as the definitive verdict: “China will never produce large quantities of oil.” The meager experience of the succeeding decades seemed to bear out that conclusion.
Yet after the Second World War, no one could doubt that oil was essential for a modern economy—and for military might and political power. But China had virtually no oil of its own and had to depend on imports to meet its needs. Following the victory of Mao Tse-tung’s communist revolution in 1949, the United States sought to limit Western oil exports to China and then, after the outbreak of the Korean War, to cut them off altogether, which constrained Chinese military operations during the war. “Self-reliance” became an urgent imperative, and Mao’s five-year plans made the development of the oil industry a very high priority. Despite disappointing results from exploration, the Chinese leadership simply refused to accept that China was “poor in oil.”
The Chinese Revolution did have one asset on which to draw in the search for oil—its fraternal relations with its communist brethren, the Soviet Union, which was a large oil producer. “We were just getting started,” recalled Zhou. “Our major teachers were the Russians. We called the Russians ‘our big brothers.’ ” The Soviets sent experts, equipment, technology, and financial aid to China, and a whole generation of young Chinese went off in the other direction, to Moscow, to be trained in petroleum.4
Some new fields were developed in the remote west, with Soviet help, but the overall results, as Zhou found from personal experience, were almost negligible. Pessimism was so rife that some Chinese experts thought the country should turn to synthetic oil, making petroleum from its abundant coal resources, as the Germans had done during the Second World War.
DAQING : THE “GREAT CELEBRATION”
But then, unexpectedly, in the grasslands of the northeast, in Manchuria, a vast new oil field was found. It was called Daqing—which means “Great Celebration.”
The development of the field, arduous as it was, became even more difficult when the “brotherhood” with the Soviet Union splintered and the two countries became bitter rivals for leadership of the communist world. Moscow abruptly pulled out its people and equipment, and demanded repayment of debts. Mao repaid the Soviets in vituperation, denouncing them as “renegades and scabs . . . slaves and accomplices of imperialism, false friends and double-dealers.”
The Chinese were now on their own for Daqing. No modern technology. No nearby urban areas. No housing. Thousands and thousands of oil field workers were hastily dispatched like troops in a military campaign. Despite the harsh cold, they slept in tents or huts or holes in the ground or just out in the open; they used candles and bonfires for light and heat; they scrounged the countryside for wild vegetables. Operations were headquartered in cattle sheds. And they worked terribly hard. To make matters worse, the Soviets reduced their oil exports to China. “Once imports are cut off, airplanes could be forced to stop flying,” warned one senior official, “certain combat vehicles could be forced to stop operating.” He added, “We should not rely on imports again.” From then on, self-sufficiency and the determination represented by the “Spirit of Daqing” became the guiding principles of China’s oil development.5
“IRON MAN” WANG
The embodiment of the Spirit of Daqing became a driller named Wang Jinxi. He achieved fame across China as the “Iron Man of Daqing oilfield” and was celebrated as the “national model worker.” According to legend, when Wang had once visited Beijing , he had seen buses with large units on top that burned coal to make gas to power the vehicles. To Wang , this clear evidence of China’s shortage of oil was an outrage. “I simply want to now open the earth with my fist,” he declared, “to let the black oil gush out and dump our backwardness in petroleum into the Pacific.”
Wang’s team drilled at a furious rate. Wang himself would not be stayed. After one injury, it is said, he crept out of the hospital and went back to the drilling site, where he directed operations from his crutches. In his most famous exploit, in order to prevent a blowout that would have destroyed the drilling rig , he ordered bags of cement to be poured into a pit. Since there was no mixer, Wang jumped in and mixed the cement with his legs, forestalling the blowout and further injuring himself. Following the success of Daqing, Premier Zhou En Lai welcomed Iron Man Wang and his fellow Daqing workers to Beijing as national heroes. Mao himself declared that Chinese industry should “learn from the Daqing oil field.”
Many other fields followed, the pace pushed by a famous oil minister and later vice premier, Kang Shien. China succeeded in becoming self-sufficient in petroleum, which, the People’s Daily announced, had “blown the theory of oil scarcity in China sky high.” Another publication declared that, “The so-called theory that China is poor in oil only serves the U.S. imperialist policy of aggression and plunder.” The United States was not the only antagonist. The victory in the oil campaign was also hailed as a fusillade against “the Soviet revisionist renegade clique.”6
RED GUARDS
In the mid-1960s, Mao recognized that he was being pushed aside because of the dismal failure of his disastrous economic policy, the Great Leap Forward, which had caused an estimated 30 million people to die from starvation. In 1966 he counterattacked and declared war on the Communist Party itself, charging that it had been captured by renegades with “bourgeois mentality.” To carry out his “Cultural Revolution,” Mao mobilized youthful zealots, the Red Guards, who waged a vicious battle against all the institutions of society, whether enterprises, government bureaus, universities, or the party itself. Prominent figures were humiliated, paraded around with donkey heads, beaten up, sent to do manual labor, or killed. Universities closed, and young people were dispatched to factories or the countryside to toil with the masses. The nation was in turmoil.7
But because of the oil industry’s importance to national security, Premier Zhou En Lai took it under his personal protection, using the army to insulate the industry and ensure that it kept working. This led to notable incongruities. “During the day, I organized production as usual,” recalled Zhou Qingzu, the chief economist at CNPC. “At night, I would sit in front of the students and workers and say I was wrong and apologize and write out my errors and apologies. I would listen very attentively to their criticism and write notes. During the day, I was a boss. At night, I was a nobody.”8
Eventually the Cultural Revolution went too far even for Mao, in terms of the chaos it had created, and he used the army to throttle back the Red Guards.
“EXPORT AS MUCH OIL AS WE CAN”
Henry Kissinger, President Nixon’s special assistant for national security, fell ill during a dinner in his honor in Pakistan in July 1971. Pakistan’s president, the dinner’s host, strenuously suggested that Kissinger, in order to escape the heat and thus speed his recovery, should recuperate in an estate up in the much cooler hills. This was very definitely a diplomatic illness. The supposed trip to the hills was a ruse, to provide cover for Kissinger’s real purpose. Meanwhile, Kissinger himself—now code-named “Principal Traveller”—was given a hat and sunglasses to disguise himself at the airport prior to taking off for his actual destination, although the disguise might have seemed a little excessive since it was 4 a.m. in the morning.9
Only a week later did the sensational news break. From Pakistan, Kissinger had flown secretly over the Himalayas to Beijing, creating an opening in the Bamboo Curtain that had surrounded China since the communist victory in 1949. Half a year later, President Richard Nixon went through that opening. In the course of his historic visit to Beijing , Nixon supped with Mao, clinked glasses with Zhou En Lai, and dramatically reset the table of international relations.
For both sides it was a matter of realpolitik. The United States, looking for a way out of the stalemated Vietnam War, wanted to create a balance against the Soviet Union. For China, this was a means to strengthen its strategic position against the Soviet Union and reduce the risk of a “two-front war” with the Soviet Union and the United States. This was no mere theoretical matter, for Russian and Chinese military forces had already clashed on the border along the Amur and Ussuri rivers.
The Chinese had a second set of reasons as well. The most virulent phase of the Cultural Revolution was over. Vice Premier Deng Xiaoping and others were trying to get the country working again. They knew that self-reliance could not work. China needed access to international technology and equipment to modernize the economy and restore economic growth. But a very big obstacle stood in the way: How to pay for such imports?
“Petroleum export–led growth”—that was Deng’s answer. “To import, we must export,” he said in 1975. “The first to my mind is oil.” The country must “export as much oil as we can. We may obtain in return many good things.”
By this time, Deng was already becoming the manager-in-chief of the new strategy of opening toward the world. A stalwart communist since his student and worker days in France after World War I, he had emerged as one of the top leaders after the communists came to power. He then became one of the foremost targets of the Cultural Revolution and of his leftist rivals. His family had suffered much; his son had been pushed out of an upper-floor window and left paralyzed. Deng himself had spent those years variously working in a tractor repair shop and by himself, in solitary confinement. He had spent many hours pacing his courtyard, asking himself what had gone so wrong under Mao and how China’s economy could be restored. In some ways, he had always been a pragmatist. (Even while organizing underground communist activities in France after World War I, he had also started and run a successful Chinese restaurant.) The traumas of the Cultural Revolution—national and personal—only reinforced his pragmatism and realism. His fundamental mottos were about being practical—“crossing the river by touching the stones”—and the most famous maxim of all: that he didn’t care whether a cat was black or white so long as it caught mice.10
Following Mao’s death and after a brief struggle with the radical “Gang of Four,” Deng secured his position as paramount leader. He could now initiate the great transformation that would lead to China’s integration with the global economy—which the 11th Congress of the Communist Party, in 1978, would proclaim as the historic policy of “reform and opening.”
The oil industry was central to the opening. By that time, China—no longer “poor in oil”—was producing petroleum in excess of its own needs and could start exporting it. There was a waiting market nearby—Japan—which wanted to reduce its reliance on the Middle East and, at the same time, develop export markets in China for its own manufactures. Buying Chinese oil would help on both counts.
As the door began to open to the outside world, the Chinese oil industry discovered, to its shock, how wide was the technology gap that separated it from the international industry. But now, bolstered by its oil-export earnings, it could buy from abroad the drilling rigs, seismic capabilities, and other equipment that would lift its technical abilities.
While Mao’s death and Deng’s ascension were critical to the opening of China, those events did not put an end to the turmoil. Inflation, corruption, and inequality emboldened opponents of reform. So did the bloody 1989 confrontation with students in Tiananmen Square. In the aftermath, amid the indecision of the leadership, the efforts to continue market reform stagnated. Seeking to jump-start the faltering reforms, Deng, in January 1992, launched his last great campaign—the nanxun, or “southern journey.” This trip showcased the booming Special Economic Zone of Shenzhen, which was becoming a manufacturing center for exports, and sought, fundamentally, to erase the stigma from making money. His message was that “the only thing that mattered is developing the economy.” It was during this tour that Deng also made a stunning revelation—he had never actually read the bible of communism, Karl Marx’s Das Kapital. He never had the time, he said. He had been too busy.11
WORKSHOP OF THE WORLD
In the years after Deng’s “southern journey,” China consolidated its course of reform and moved toward integration with the global economy. The 1990s was a decade of a new, much more interconnected economy. On January 1, 1995, the World Trade Organization was established to bring down barriers and facilitate global trade and investment. World trade was growing much faster than the global economy itself. American and European companies were setting up supply chains that gathered components from different parts of the world, assembled them in still other parts, and then packed the finished goods into containers and shipped them across oceans to customers anywhere in the world. Although China did not formally join the WTO until 2001, it had by then already become the linchpin in this new system of global supply chains.
As factories went up all along the coastal region, the inscription “Made in China” became ubiquitous on all sorts of products shipped all over the world. China had now become what was said of Britain two centuries earlier—“the workshop of the world.” In due course, these new trade and investment linkages would have much greater impact on world energy than anyone might have imagined. For any workshop needs energy on which to run, and this new workshop of the world would run on fossil fuels.
THE END OF SELF-SUFFICIENCY
Already, however, a few years earlier, China had crossed a great divide in terms of energy. By 1993 petroleum production could no longer keep up with the rising domestic demand of the rapidly growing economy. As a result, China went from being an oil exporter to an oil importer. Though not at first noticed by the rest of the world, it was for China an immediate shock. “The government thought it was a disaster,” remembered one Chinese oil expert. “It was very negatively received. From an industry point of view, we felt very shamed. It was a loss of face. We couldn’t supply our own economy. But some scholars and experts told us, ‘You can’t be self-sufficient in everything. You import some things, and export others.’ ”12
This added greatly to the urgency to further modernize the structure of the oil industry—to move from the all-encompassing ministries of the petroleum and chemical industries, based on rigid central planning, to a system based on companies and rooted in the marketplace. The foundation for this shift had already been laid in the 1980s. The three state-owned companies had emerged from the ministries: the China National Petroleum Company, CNPC; Sinopec, the China Petrochemical Corporation; and CNOOC, the China National Offshore Oil Company. The next move, beginning in the late 1990s, was to dramatically restructure the three companies into more modern, technologically advanced companies—and more independent enterprises. “They would need to earn a living,” said Zhou Qingzu. It was at this point that they would go through IPOs, opening partial ownership to shareholders around the world. CNPC’s subsidiary was given a new name—PetroChina—while Sinopec and CNOOC used their existing names for their listed subsidiaries. There was also an enormous cultural change. “Now you’d have to be competitive,” said Zhou. “You never had to be competitive before.”13
THE “GO OUT” STRATEGY: USING TWO LEGS TO WALK
China has become a growing presence in the global oil and natural gas industry. This new role goes by the name of the “go out” strategy. It was enunciated as policy around 2000, though the policy’s roots extend back to the original reforms of Deng Xiaoping.
The first steps abroad were very small ones, beginning in Canada, then Thailand, Papua–New Guinea, and Indonesia. In the mid-1990s, CNPC acquired a virtually abandoned oil field in Peru. By applying the kind of intense recovery techniques it had honed to coax more oil out of complex older oil fields in China, it took the field from 600 barrels a day to 7,000. But these projects were small and did not get much attention. It took time and experience for the confidence to build for significant international activities. “We knew that, from its beginning in the mid-nineteenth century, the oil industry was always an international industry,” said Zhou Jiping, the president of PetroChina. “If you wanted to become an international oil company in the real sense, you had to go out.” By the beginning of the new century, a policy consensus had formed around the idea of international expansion, along with confidence in the capabilities of the Chinese companies to implement it.14
In general, the “go out” phase meant the internationalization of Chinese firms—that they should become competitive international companies with access both to the raw materials required by the rapidly growing economy and to the markets into which to sell their manufactures. For energy companies more specifically, it meant that the partly state-owned, partly privatized oil companies should own, develop, control, or invest in foreign sources of oil and natural gas. For the oil industry, this was complemented by another slogan—“using two legs to walk”—one, to further development of the domestic industry; the other, for international expansion.
Today the impact of the “go out” strategy is evident worldwide. Chinese oil companies are active throughout Africa and Latin America (as are Chinese companies from other sectors). Closer to home they have acquired significant petroleum assets in neighboring Kazakhstan and have achieved some positions in Russia after repeated tries. They are developing natural gas in Turkmenistan. As latecomers into the international industry, the Chinese come equipped not only with oil field skills but a willingness and the financial resources to pay a premium to get into the game. Also, particularly in Africa, they make themselves partners of choice with very significant “value added.” That is, they bring government-funded development packages—helping to build railroads, harbors, and roads—something that is not in the tool kit of traditional Western companies. This has engendered controversy. Critics charge that China is colonizing Africa and using Chinese rather than local labor. Chinese reply that they are doing much to create markets for African commodity exports, and that export earnings are better than foreign aid and do more to stimulate lasting economic growth. (Some of these packages have fallen apart.) Chinese banks, in coordination with the Chinese oil companies, have also made multibillion-dollar loans to a number of countries that will be paid back in the form of oil or gas over a number of years. (One such deal took fifteen years to work out. )15
The energy security strategy is also taking an obvious route—building pipelines to diversify, reduce dependence on sea-lanes, and strengthen connections with supplier countries. A new set of pipelines, built in record time, brings oil and gas from Turkmenistan and Kazakhstan to China. Russia’s $22 billion East Siberia–Pacific Ocean Pipeline will, in addition to supplying oil to the Pacific (Japan and Korea primarily), also deliver Russian oil to China—guaranteed by a $25 billion loan that China advanced to Russia. In September 2010 Chinese president Hu Jintao and Russian president Dmitry Medvedev jointly pushed the button to start the flow of oil over the Russian-Chinese border. The potential for a large trade in natural gas was also hailed. At the ceremony, Hu proclaimed a “new start” in Chinese-Russian relations. A relationship that was once based upon Marx and Lenin was now rooted in oil and possibly gas. 16
“LIKE THROWING A MATCH”
But the greatest controversy over the “go out” strategy came not in Africa but in the United States. In 2005 Chevron and CNOOC—Chinese National Offshore Oil Corporation—were locked in a battle royal to acquire the large U.S. independent company Unocal, which had significant oil and gas production in Thailand and Indonesia but also had some in the Gulf of Mexico. The competition between the two companies was very tough, with sharp arguments about the financial terms and the role of Chinese financial institutions, as well as the timing of the respective offers. For some in Beijing, a global takeover battle was not only unfamiliar but disconcerting. The price that CNOOC put on the table was greater than the entire cost of the huge Three Gorges Dam project, which had taken decades to build. After months of battle, Chevron emerged victorious with a $17.3 billion bid.
But in the course of takeover battle, a fiery political controversy erupted in Washington that was out of scale compared with the issues. After all, Unocal’s entire production in the United States amounted to just 1 percent of the total U.S. output. Much of it was in the Gulf of Mexico, in joint ventures with other companies, and the only market for that output was the United States. Yet when the contest got to Washington, as one of the American participants said, it was “like throwing a match into a room filled with gasoline.” For it became the focus of a firestorm of anti-Chinese sentiment on Capitol Hill that was already supercharged by the contentious hot-button issues of trade, currencies, and jobs. The heated rhetoric showed the intensity, at least in some quarters, of suspicions of China’s motives and methods. One critic told a congressional committee that CNOOC’s bid fit “into a pattern” of “activity around the globe” that is “ominous in its implication.” Another charged that CNOOC’s bid was part of China’s strategy for “domination of energy markets and of the Western Pacific.” Whatever the specifics of the takeover battle, the takeaway for the Chinese at the end of the political battle was that the United States itself was less hospitable to the openness toward foreign investment that it preached to others and that the Chinese companies should redouble their investment effort—but elsewhere. “The world was shocked that a Chinese company could make this kind of bid,” said Fu Chengyu, at the time the CEO of CNOOC. “The West was saying that China is changing in terms of such things as building highways. But it was not paying attention to China itself and how China had changed.”
In the years that followed, the changes became much more evident. China’s president made highly visible state visits to a number of oil and commodityexporting countries in the Middle East and Africa, beginning with Saudi Arabia. And when China convened a summit of African presidents to discuss economic cooperation, 48 of the presidents made the trip. “China should buy from Africa and Africa should buy from China,” said Ghana’s president. “I’m talking about the win-win.”
The world moves on. In 2010, five years after the fiery battle over Unocal, Chevron and CNOOC announced that they were teaming up to explore for oil not in the Gulf of Mexico but in the waters off China. “We welcome the opportunity to partner with CNOOC,” said a senior Chevron executive. 17
“INOCs”
In the decade-plus since the shaky days of the original IPOs, the Chinese companies have become highly visible players in the world oil market.
Their international roles have instigated a vigorous debate outside China as to what drives them. One agenda is established by the government (which remains the majority shareholder) and the party, both of which maintain oversight. They are to meet national objectives in terms of energy, economic development, and foreign policy. The CEOs of the major companies also hold vice ministerial government rank—and many also hold senior party rank.
At the same time, the companies are driven by strong commercial, competitive objectives that are similar to those of other international oil companies, and, increasingly, their commercial identities define them. They are indeed benchmarked against the world economy and other international oil companies by the investors in their listed subsidiaries, and they have to be responsive to their investors’ interests. In addition, they are subject to international regulation and international governance standards. And they manage large and complex businesses that, increasingly, are operating on a global scale.
As Zhou Jiping put it, “As a national oil company, we have to meet the responsibilities of guaranteeing oil and gas supply to the domestic market. As a public company listed in New York, Hong Kong, and Shanghai, we must be responsible to our shareholders and strive to maximize shareholder value. And, of course, we have a responsibility to the 1.6 million employees of our company.”
In short, Chinese oil companies are hybrids, somewhere between the familiar “international oil companies,” IOCs, and the state-owned national oil companies, NOCs. They have become a prime example of a new category called INOCs—the international national oil companies. “There has been a great change in people’s overall psychology and philosophy since the IPO,” said the CEO of one of the companies. “We used to focus on how much we produced. Now it’s the value of what we do.”
Today walk into the headquarters of some of the companies in Beijing and what one sees are not exhorting slogans but the epitome of the international benchmarking—flashing displays of the stock price in New York, Hong Kong , and Shanghai. Yet in the lobby of CNPC, one is also greeted by a very strong reminder of how the industry was built—a massive statue of Iron Man Wang.
What is the balance in these INOCs? The Chinese companies are sometimes portrayed mainly as “instruments” of the state. A new study from the International Energy Agency concludes otherwise—that “commercial incentive is the main driver” and that they operate with “a high degree of independence” from the government. As the IEA puts it, they are “majority-owned by the government” but “they are not government-run.” As they become increasingly internationalized, they operate more like other international companies.
For all concerned, the development of the Chinese companies has been an evolution. Fu Chengyu, now the chairman of Sinopec, summed up the changes this way: “Evolving so completely from full state-ownership to join the ranks of major international corporations is a huge transformation—one that, back when I started in the oil business in the oil fields of Daqing , we never thought could be possible. Back in those days, China’s largest source of foreign exchange was not manufacturing, but in fact sales of oil to Japan! Today everything around us has changed. But so have we.”18
PROPORTION
Chinese companies will likely become bigger, more prominent players; they will certainly compete; but they will also be sharing the stage with established American, European, Middle Eastern, Russian, Asian, and Latin American companies—and often in partnerships.
For all the talk about China “preempting” world supplies, its entire overseas production is less than that of just one of the supermajor companies. It’s very hard to conceive of China ever being in a position to preempt world supplies. Moreover, while some of Chinese overseas production is shipped to China, most of it is sold into world markets at the same prices as similar grades of petroleum. Destination is determined by the best price, local and international, taking into account transportation costs. And that is all the more true of oil from joint ventures, in which much of China’s international oil is produced.
There is a further critical consideration. Chinese investment and effort in bringing more barrels to the markets contribute to stability in the global market. For were those barrels not forthcoming, the growing demand from China (and elsewhere) would add more pressure and lead to higher prices. Additional investment means more supply and adds to energy security. The Chinese oil companies are committing more capital and resources to expanding Iraq’s oil output, and taking more risk, than the companies of any other nation.
Indeed, it would be quite surprising if a country in China’s position—rapidly rising demand, rapidly growing imports, a well-established domestic industry, huge holdings of dollars—did not venture out into the rest of the world to develop new resources. Indeed, were they not doing so, they would likely be roundly criticized around the world for not investing.
Moreover, “go out” is not the sole strategy of the Chinese companies. About 75 percent of the companies’ output is within China. Altogether, China’s domestic oil production makes it the fifth-largest in the world—ahead of such large producers as Canada, Mexico, Venezuela, Kuwait, and Nigeria. Within the Chinese industry itself there is talk about the “second age of Chinese oil.” This means the application of new technologies and new approaches to the discovery and development of domestic petroleum resources, as well as a much greater focus on what are increasingly seen as abundant but undeveloped domestic resources of natural gas, including shale gas.
These are the new commercial realities—China as a growing consumer of oil, China as an increasingly important participant in the world oil industry. But there is also a security dimension, which arises from growing dependence for a country for which “self-reliance” had been such a strong imperative for so many years.
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