Crisis on the China Rim: An Economic, Crude Oil, and Military Analysis

"There is a crisis rising on the China Rim, a crisis made of economic imbalances, energy insecurities, ancient hatreds, and unsettled scores. The catalyst for this crisis is success itself, the success of the People’s Republic of China in its de facto rejection of a failed experiment in communism and its rapid transformation into a thriving market economy. The inseparable companion of this success, though, is an insatiable hunger and thirst for precious resources... most important among these, crude oil."

2005.04.14 | 85 pages | download

In NYMEX trading today, the near-term contract for light, sweet crude oil hit $60.00 per barrel, an all-time record, as the market's focus shifted from weekly US supply (inventory) data to long-term demand in China and the US.

(This shift in focus was given added momentum as China's CNOOC Ltd. announced Thursday morning Beijing time its proposal of a US$18.5 billion all-cash merger with US-based Unocal Corporation.  CNOOC's chairman and CEO, Fu Chengyu, issued a statement Friday morning Beijing time indicating his pleasure at Unocal's announcement that it will review CNOOC's merger bid.  CNOOC management estimates that a merger with Unocal would double CNOOC's oil and gas production and boost its energy reserves by nearly 80.0% to roughly 4.0 billion barrels of oil equivalent.  CNOOC's principal financial advisors are J.P. Morgan and Goldman Sachs.  This new merger proposal from CNOOC competes with a 2005.04.04 agreement between Unocal and Chevron Corporation calling for Unocal to be acquired by Chevron in a US$18.0 billion stock and cash transaction.  The Chevron-Unocal transaction has not yet been consummated.   Today's CNOOC merger proposal helped crystallize the intensifying competition between developed and developing countries for increasingly scarce natural resources, particularly crude oil.)

In our 2005.04.14 "Crisis on the China Rim..." (CCR) analysis, Laguna Research Partners pointed to increased crude oil demand from China and India as key factors likely, we feel, to move crude oil prices to US$100.00 per barrel by early 2008.  Here are two excerpts from page 2 of CCR:

"Sharp economic expansion has already created an annual crude oil production deficit of more than 0.7 billion barrels in China, despite the fact that China’s annual per capita crude oil consumption is still only 1.6 barrels, 93.7% less than the US’s 25.4 barrels.  As China’s economy continues to expand, and its per capita crude oil consumption continues to increase, the competition for crude oil supplies along the historically violent China Rim appears likely to escalate and provide considerable support for a sustained increase in crude oil prices.  At worst, this competition could deteriorate into armed conflict.

"The simultaneous economic rise of China and India will have a huge impact on worldwide crude oil markets.  Specifically, an increase of only "one barrel" in per capita crude oil consumption in China and India combined will boost annual worldwide consumption by 2.4 billion barrels, or 8.6%.   This incremental demand, we feel, is likely to provide considerable support for a sustained increase in crude oil prices.  Our calculations indicate that, as of mid-2004, China and India had a combined population of 2,363,918,231 and average per capita crude oil consumption of 1.2 barrels, just 17.4% of the world per capita consumption level of 4.3 barrels annually.  This also compares with annual per capita consumption of 25.4 barrels in the US, 15.9 barrels in Japan, and 10.3 barrels in the UK."

We continue to expect that crude oil prices will remain volatile as the market shifts its focus between near- and long-term demand and supply factors.  Here's an excerpt from page 4 of CCR:

"The aggressive crude oil price targets issued by some industry analysts are often modified with the word "spike" or even "super spike". Given that the word "spike" implies a lack of sustainability, it is, in our view, misleading.  We expect crude oil prices to become increasingly volatile as the market’s time horizon swings back-and-forth between near-term inventory analysis and the emerging crisis on the China Rim, and as the market transitions towards emphasizing a new set of demand and supply drivers.   Nonetheless, as indicated above, we anticipate that the trend in multi-month crude oil price averages will provide a substantial and sustainable surprise to the upside."

Posted by:
Kevin B. Skislock
Partner and CEO
Laguna Research Partners
[bio] [disclaimer]

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