China's Axis of Oil

The country is making deals with rogue states like Iran, Myanmar and North Korea to satisfy its voracious appetite for energy.

In a steamy jungle clearing in Myanmar, a lone drilling rig topped by limp red flags bears testimony to China’s insatiable thirst for oil. A century ago, British-owned Burmah Oil Co. made a fortune for its shareholders from oil fields that lie beneath the teak forests and golden-spired Buddhist pagodas of the country formerly known as Burma. In today’s Myanmar—a military dictatorship under Western economic sanctions—there’s little hope of striking another gusher, says Ma Guiming, 36, a stocky, crew cutted project leader for China National Petroleum Corp.

“Gou qiang,” Ma says of the search for oil, using a Beijing slang term that literally means it will be chokingly difficult. “But we have no choice. This is something we have to do.”

As recently as 1992, China was self-sufficient in oil. Today, the world’s most-populous country is importing 40 percent of its needs—a figure that will rise to 75 percent by 2025, the U.S. Department of Energy predicts. China’s oil consumption has al- most quadrupled to 7.4 million barrels a day, making China the No. 2 consumer, behind the U.S. and ahead of Japan. As demand soars, production at Chi- na’s biggest oil field, Daqing, is in decline. (See “A Boomtown Fades,” page 138.) “There’s no gentle way of saying this,” says Han Wenke, 51, deputy director of the Beijing-based Energy Research Institute, an arm of China’s planning ministry. “We need to find oil fast.”

In its search, China is scouring the backwaters of the world, from monsoon-lashed Myanmar to the deserts of Iran, to the deep seas off Sudan and North Korea, cutting deals with nations the U.S. and many other countries consider pariahs. China’s oil diplomacy is putting the country on a collision course with the U.S. and Western Europe, which have im- posed sanctions on some of the countries where China is doing business. “China is so desperate for energy resources that they will take the heat from the international community,” says Mike Green, an analyst at the Washington-based Center for Strategic and International Studies.

Case in point: Iran. The U.S. and Europe are pushing the United Nations to impose sanctions because of its refusal to suspend uranium enrichment programs. Although China, a permanent member of the Security Council, supported the U.N.’s demand that Iran curtail the program, it has threat- ened to veto any measures imposing sanctions. “This is the first test of whether the world can influence China, or China influence the world,” Green says.

‘China is so desperate for energy resources that they will take the heat from the international community,’ says Mike Green, an analyst at the CSIS in Washington.

U.N.’s demand that Iran curtail the program, it has threatened to veto any measures imposing sanctions. “This is the first test of whether the world can influence China, or China influence the world,” Green says.

Around the globe, from Angola to Venezuela, China is locked in competition for oil resources with Western nations and another emerging-market giant, India. Jaspal Singh, a Washington-based World Bank adviser, compares this struggle with the Great Game: the 19th-century rivalry between the British and Russian empires in Central Asia. “The world is entering the post, post–Cold War era, where securing a stable energy supply will be the main theme of the Great Game,” he says.

China’s top oil official, Zhang Guobao, says the U.S. and China should cooperate on some oil and gas projects. “We share the responsibility of ensuring energy security and the stability of the international oil market,” Zhang, 59, vice chair- man of the National Development and Reform Commission, told a U.S.-China forum in Hangzhou in September.

China’s search for oil is driven by its growing economic might. Over the past 28 years, China’s economy has grown at an average of 9.7 percent a year; in the quarter ended in June, it grew at 11.3 percent. The booming economy has created a middle class of about 50 million people that demands consumer goods. In 1983, there were no private cars in China. Last year, China was the third-biggest vehicle market, after the U.S. and Japan, with sales of 5.7 million cars, trucks and buses, according to the China Association of Automobile Manufacturers. By 2015, the number of cars and trucks on China’s roads will more than triple to 100 million from 31 million today, according to New York–based consulting firm McKinsey & Co.

Predictions like that are adding to the pressure on oil prices, which have almost tripled since 2000, to $65.90 a barrel on Sept. 11. “China is a big factor in driving prices to current levels,” says John Koh, 43, who helps manage $950 million in Hong Kong at Daiwa Asset Management, a unit of Japan’s second-biggest securities company, which owns shares in China’s three main oil companies. “It’s not just due to consumption, but projected future demand.”

In the first half of 2006, China imported 522,000 barrels a day from Angola, its largest supplier; 464,000 barrels from Saudi Arabia; and about 338,000 barrels each from Iran and Russia. “I see China and the U.S. coming into con- flict over energy in the years ahead,” says Jin Riguang, 73, a Chinese government oil and gas adviser and member of the Standing Committee of the Chinese People’s Political Con- sultative Conference.

Already last year, U.S. lawmakers cited national security concerns when they rejected an $18.5 billion cash bid by Cnooc Ltd., China’s No. 3 oil company, for El Segundo, California–based Unocal Corp. Lawmakers claimed that Cnooc, which is 66 percent state owned via its parent, China Nation- al Offshore Oil Corp., is really the Chinese government, and said that allowing it to own Unocal could endanger U.S. oil supplies. Chevron Corp., the No. 2 U.S. oil company, eventually bought Unocal for $17.8 billion in cash and stock.

Nowhere is the potential for clashes with the U.S. more evident than in China’s dealings with Iran. When Mahmoud Ahmadinejad, an Islamic fundamentalist, was elected president in June 2005, Hu Jintao, China’s president, was among the first to send congratulations. Under Ahmadinejad, Iran has supplied arms to the Hezbollah militia in Lebanon and begun uranium enrichment programs. And last summer, Ahmadinejad called the Nazi Holocaust an “excuse” by the nations that won World War II to keep Germans ashamed.

China’s second-biggest oil company, China Petrochemical Corp., also known as Sino- pec Group, signed a preliminary agreement in 2004 to buy a 51 percent stake in Iran’s Yadavaran oil field, located in the Western Kurdistan province near the border with Iraq. If completed, the deal would also allow China to buy 150,000 barrels of Iranian crude a day at market rates for 25 years as well as 250 million tons of liquefied natural gas. China could pay Iran as much as $100 billion for the stake and the purchases of oil and gas over 25 years.

The Iran agreement should give investors in China Petroleum & Chemical Corp., the New York Stock Exchange–listed unit of Sinopec, pause, CSIS’s Green says. “These are unstable countries, and if I was a shareholder in Chinese oil companies, I would be asking if it’s worth the risk,” he says. Beijing-based Sinopec Group and its listed subsidiary, known as Sinopec Corp., also operate in Angola, Canada, Colombia, India, Nigeria, Russia, Saudi Arabia and Venezuela.

“Everyone thinks we have the country’s backing,” says Zhou Baixiu, Beijing-based head of Sinopec Group’s overseas oil ex- ploration and production unit. “Well, we don’t. We make our decisions as a company, and we operate like any normal com- pany. People are making too big a deal of what we are doing abroad.” Sinopec Corp. is 71 percent owned by Sinopec Group, which is 100 percent state owned.

Most of China’s most-controversial oil assets are held by state-owned parent companies, which in turn control the publicly traded companies, allowing U.S. investors to buy shares in companies whose parents are operating where sanctions are in place. The public companies and their parents often have the same slate of senior executives.

Mark Mobius, who manages $30 billion of emerging- market shares at Templeton Asset Management in Singa- pore, says he has no objection to Chinese companies or their parents dealing with states such as Iran and Myanmar. “It’s better for businesses to deal with them if it means raising the socioeconomic status of these countries,” he says. “By not dealing with them, one can’t bring about change.” Mobius, 70, says he owns shares of Cnooc, Sinopec and PetroChina Co., China’s biggest listed oil company, in equal quantities and intends to hold on to them. “Ultimately, it’s the Chinese government that’s in control,” he says. “The parent compa- nies are quite profit oriented. So far, we have been very pleased with that.”

China has no option but to deal with regimes the U.S. dis- approves of, says Guan Bin, a Beijing-based analyst at Mer- rill Lynch & Co., the world’s third-biggest securities firm. “China is a latecomer to the oil exploration scene, and the choicest, most-productive areas have been taken by the BPs and Shells of this world,” Guan says.

The countries China is dealing with aren’t easy partners. Talks between Iran and Sinopec about the Yadavaran field purchase have stalled, Sinopec Group President Chen Tonghai said in March. On Aug. 24, when asked by Bloomberg News at a press conference what progress had been made, Chen, 57, replied, “Still negotiating, still negotiating.” On Sept. 11, Sinopec Group Vice Chairman Zhang Yaocang said that his company had agreed to provide engineering services at Yadavaran.

‘China is a latecomer to the exploration scene,’ says Guan Bin, an analyst in Beijing. ‘The choicest areas have been taken by the BPs and Shells of this world.’

Mehdi Bazargan, managing director of Iran’s state-owned Petroleum Engineering & Development Co., which supervises foreign projects, says China doesn’t get any special favors in Iran. “In general, Chinese companies are eager to work in Iran and invest in oil projects, and we welcome this under compet- itive conditions,” he said in an e-mail reply to questions. “For us, the fundamental principles are competitive conditions.”

To ensure they get deals, Chinese companies have been pay- ing premiums for the oil fields and companies they buy, says Jonathan Woetzel, a Shanghai-based McKinsey director. In Ni- geria, Cnooc ended up paying $2.7 billion, 19 percent more than it originally said it would, for an offshore block. “On average, the country’s national oil companies pay at least 10 percent more for foreign reserves than major international oil companies do,” Woetzel says.

In the past five years, Chinese oil companies have spent $15 billion buying oil fields and oil companies in 100 countries, according to an August report by McKinsey.

Among those deals are some less-controversial ones closer to home, in Russia and Central Asia. Last year, China National Petroleum paid $4.18 billion for PetroKazakhstan Inc., a company that produces about 12 percent of the crude in Kazakhstan, which borders China and has more oil reserves than the U.S. In August, PetroChina said it would pay $2.74 billion to buy 67 percent of PetroKazakhstan from its parent. Last December, the first direct China-Kazakhstan pipeline was opened. China and Russia, the world’s second-biggest oil producer, are also negotiating a cross-border pipeline.

China’s oil investments haven’t been hurting oil company stock prices. Shares of PetroChina surged 30 percent this year, to 8.29 Hong Kong dollars on Sept. 11 from HK$6.35, compared with a 14 percent rise in the benchmark Hang Seng Index in the same period. On Aug. 23, PetroChina, whose parent, China National Petroleum, owns stakes in oil fields in Myanmar and Sudan, reported that first-half profit rose 29 percent to a record 80.7 billion yuan ($10 billion) from 62.4 billion yuan. PetroChina’s second-largest share- holder is Warren Buffett’s Berkshire Hathaway Inc., which owns just over 1 percent of the company; state-owned China National Petroleum owns 90 percent. Buffett, 76, wasn’t available to comment for this article, according to Debbie Bosanek, his spokeswoman.

Since 1996, China National Petroleum has been develop- ing oil fields in Sudan, where 300,000 people have died and 2 million have been made homeless in the civil war in Darfur—a conflict the UN has described as the world’s worst humanitarian crisis. Last year, China National Petroleum won the right to develop Sudan’s first offshore fields in the Red Sea. The company said it produced 329,000 barrels a day in Sudan last year and also owns 50 percent of an oil re- finery in Sudan’s capital, Khartoum.

China National Petroleum said it wouldn’t include the Sudan assets in PetroChina when it listed the company on the New York Stock Exchange in 2000. At the UN, China has repeatedly blocked sanctions against Sudan and op- posed plans to force President Umar Hassan al-Bashir to accept a UN peacekeeping force in Darfur.

China has extended its oil diplomacy throughout Africa, the source of 30 percent of its imports. In April, President Hu, at the end of a state visit to the U.S., stopped off in Nigeria, Africa’s biggest oil producer; Morocco; and Kenya. In June, Hu’s No. 2, Premier Wen Jiabao, visited Angola, Egypt, Ghana, Republic of the Congo, South Africa, Tanzania and Uganda. The leaders and other Chinese politicians offered their hosts multibillion-dollar loans and new oil refineries, railways and roads.

A leading beneficiary of that largesse is the former Portu- guese colony of Angola, scene of a civil war that killed as many as 1.5 million people from 1975 to 2002, according to CIA figures. When the fighting stopped, the government in Luanda sought International Monetary Fund and World Bank loans to rebuild. After initially agreeing to an IMF program, Angola cut off negotiations last year, when the IMF insisted on know- ing more about how it was spending its $10 billion in annual oil revenue. Angola, which ranks among the world’s most- corrupt nations, according to Berlin-based research group Transparency International, turned instead to China.

China’s state-owned Export-Import Bank offered Angola a $2 billion loan in 2004; during Wen’s visit in June, that loan was increased to $4.4 billion, according to the state-owned Angola Press Agency. Last year, Sinopec Corp. teamed up with Angola’s state-owned oil producer, Sonangol SA, and other partners to make a $2.4 billion winning bid for offshore oil blocks in Angola, where it competes with BP Plc, Exxon Mobil Corp., Total SA and Chevron. Angola, which has the world’s 19th-largest oil reserves, is the No. 7 supplier of oil to the U.S. Nigeria has also scored big from deals with China, which has pledged $2 billion to improve one of the country’s four oil refineries and invest in other projects, such as a railroad, according to Tony Chukwueke, head of Nigeria’s Department of Petroleum Resources. In April, Cnooc won a 45 percent stake in Nigeria’s off- shore Akpo field with a $2.7 billion bid. Its rivals for the stake included India’s state-owned Oil & Natural Gas Corp., which pulled out after its government said the deal was too risky.

China has also made overtures to Venezuelan pres- ident Hugo Chávez, a critic of the U.S. In August, Chávez visited Chinese leaders in Beijing and an- nounced that he wanted to triple oil exports to China in a bid to reduce his country’s dependence on the U.S. mar- ket, which currently buys two-thirds of Venezuela’s ex- ports. Chávez said China would invest $2 billion in the country’s oil industry and $9 billion to help Venezuela build a 1,000-kilometer (621-mile) railroad.

Whatever the deal achieves, it’s unlikely to be profits, says James Brock, a senior adviser in Beijing for Cam- bridge, Massachusetts–based Cambridge Energy Re- search Associates Inc. While China can sell Venezuela tankers and rigs at 30–40 percent less than Japan, Sin- gapore or South Korea, Brock says, Venezuelan oil is heavy in metals and sulfur and unsuitable for existing Chinese refineries. The distance between South America and China would also make the cost of refining the oil prohibi- tive, he says.

China’s ability to link oil deals with government-funded investments in construction projects gives it a big advantage over Western rivals, says Antony Goldman, a London-based in- dependent oil consultant specializing in Africa. “It’s not the kind of thing Chevron and Shell, with their obligations to sharehold- ers, can do,” Goldman, 39, says. “What’s different about China is that it can operate in ways its commercial rivals in the West simply can’t.” Chevron and Royal Dutch Shell Plc would also have a problem dealing with North Korea, which is under U.S. sanctions and is facing UN Security Council demands that it suspend its missile program. Not China. In June, Chinese gov- ernment spokesman Liu Jianchao disclosed that China had agreed to jointly explore for oil and gas in the Bo Hai Sea, an oil- rich expanse of water between the Korean peninsula and north- eastern China. The sea holds 1.5 billion barrels of oil, or 8 percent of China’s proven reserves, according to the U.S. energy department. Both PetroChina and Cnooc own exploration stakes in the area. Liu gave no other details of the deal.

Since the military seized power in 1962, Myanmar has been better known for producing drugs such as opium and heroin than for producing oil.

U.S. companies are also barred by government prohibition from making new investments, selling arms or offering financial services in Myanmar, which is also under EU sanctions. After the military massacred 3,000 pro-democracy supporters following a student-led uprising in 1988, the U.S. withdrew its ambassador and has since been represented by a chargé d’affaires. More than 1,000 political prisoners remain in Myanmar’s jails. Torture, rape and forced Bloomberg Markets November 2006 labor are rife, according to a U.S. State Department report to Congress in April. So are AIDS, malaria and avian flu.

Myanmar’s most-prominent citizen, Nobel peace prize winner Aung San Suu Kyi, the leader of the democratic opposition, remains in solitary confinement 16 years after her party, the National League for Democracy, won elections with 82 percent of the vote. Oxford- educated Suu Kyi, 61, is the daughter of Aung San, a independence hero whose statue can be found in almost every Myanmar town.

Since the military seized power in a coup in 1962, Myanmar has been better known for producing drugs than oil. It’s the world’s No. 2 producer of opium and heroin, after Afghanistan, according to a U.S. government report posted on the embassy Web site, and one of Asia’s leading exporters of amphetamine-type stimulants. The country has become so impoverished that it ranks among the world’s 50-least-developed nations, the U.N. says. Gross domestic product per capita is $1,800, less than that of Bangladesh. No Western banks have branches in Myanmar; since 2003, the government has closed three of the local ones after they were accused of laundering drug money. Even though the country produces 10,000 barrels of oil a day, according to Total, gasoline is scarce. Officially priced at $1 a gallon, it’s virtually unobtainable except on the black market—at three times the official price.

“Burma, like many resource-rich countries with bad governance, suffers from a ‘resource curse’—where the prof- its from an abundance of oil, gas and minerals help prop up authoritarian rule instead of being used to help its impoverished citizens,” says George Soros, chair- man of New York–based Soros Fund Management LLC, which oversees the $9.6 billion Quantum Endowment hedge fund. Soros, 76, founded the phil- anthropic Burma Project, which supports democratic change and has spent $12 million on education and training for Burmese, mostly among the 120,000 refugees on the Thai and Indian borders.

Interfering foreigners are not welcome in Myanmar. Directly opposite the U.S. embassy, a former colonial mansion front- ed by a security barrier of oil drums, the regime has placed a sign declaring, “Crush all internal and external destructive elements.” The same sign stands at the en- trance to University Avenue, where Suu Kyi is imprisoned in solitary confinement behind the wooden fence surrounding her now dilapidated lakeside home.

Myanmar’s capital, Yangon, a city of once-grand British colonial-era buildings, is crumbling. Rather than restoring it, the military junta led by army general Than Shwe, 76, suddenly announced last November that it has been secretly building a new capital city in the jungle 400 kilometers to the north. Opponents of the regime say there’s little hope of change for the better. “With Burma, the pessimist will always win the game,” says Aung Zaw, 38, a former leader of the 1988 student revolt who now runs a campaign- ing magazine and Web site, The Irrawaddy, from his exile base in Chiang Mai, Thailand.

Still, Western companies—including Paris-based Total and its minority partner, San Ramon, California–based Chevron—are exploiting Myanmar’s gas at an offshore field called Yadana. Total and Chevron, which inherited its stake when it acquired Unocal, aren’t in breach of U.S. and European sanctions because they were there before Myanmar was declared an international outcast by the West. Korea’s Dae- woo Corp. also has a stake in a separate field.

Now, Myanmar’s three closest neighbors, China, India and Thai- land, are competing for slices of the rest. China, Myanmar’s largest trading partner, has also proposed oil and gas pipelines from the port of Sittwe to southwestern China’s Yunnan prov- ince. In addition to providing a new source of oil and gas, pipe- lines through Myanmar would allow China an alternative importation route and make it less reliant on the shipping lanes of the Malacca Strait, a notoriously congested choke point that could easily become blocked by accident or design.

Myanmar’s three closest neighbors, China, India and Thailand, are competing for slices of the country’s oil and gas resources. China is also planning to build pipelines.

Since 2001, small exploration teams from China National Petroleum, Cnooc, Sinopec and a China National Petroleum subsidiary, Chinnery Assets Ltd., have been looking for oil and gas. When China National Petroleum’s Unit 70155 arrived in Myanmar, its 30 members went to an oil field near the 4,000 ruined temples of Bagan, one of Southeast Asia’s major historical sites. When no oil was found there, they moved their camp outside of Pyay, a sleepy, pagoda-dotted town beside the broad, brown Irrawaddy River, 300 kilometers north of Yangon.

In June, just as the wet season set in and the 30-kilometer track leading to the main Yangon-Pyay road became boggy, Ma Guiming and his crew set up their rig and camp of converted shipping containers. By mid-August, with the clearing turned into a mud bath, they had drilled 1,000 me- ters (3,281 feet). Ma says he’ll know before the end of the year whether a shadow found on seismic surveys is a reservoir of oil. Even if Unit 70155 strikes a gusher, it will be only a drop com- pared with China’s overpowering thirst for oil.

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