Oil Pipeline From Kazakhstan To China

[Chinahand]

This piece of news has slipped out pretty quietly without much news coverage, but I think it’s very significant.

 

China has just opened up an oil pipeline between Kazakhstan and its western region of Xinjiang. Find out more: Here!. The geopolitics of Central Asia and the fate of its oil reserves are going to be major news stories of the next 50 years and China’s growing intervention in the oil markets will be a big part of that story.

 

China started courting the Central Asian Republics about a decade ago and has formed a security alliance with them and Russia called the Shanghai Cooperation Organization. This alliance of pretty repressive regimes was partly formed out of fears about Islamic radicalism with the member’s respective armies training together in anti terrorism exercises and the treaty allows for the hot pursuit of “terrorists” and such like if they flee across borders.

 

Nearly every country in Central Asia has had problems with Islamic extremism; China included. But for the Chinese the security role was only part of the story; they were also looking to gain a share of the area’s mineral and energy wealth. This effort has been reasonably successful with the oil pipeline now added to an earlier gas pipeline and a rail route to bring in mineral wealth.

 

There are many implications for the geopolitics of Central Asia as a result of this growing connection with China. There will also be consequences for China’s western regions. I’ve just posted a book review about China’s most Islamic and western province Xinjiang: Here. These poor, wild and windswept areas of the world aren’t well known, but they could become pivotal in the world’s energy supplies in the next 30 or so years.

[VinnieK]

There's been fairly extensive and, compared with other publications, coverage of this (particularly focusing on Xinjiang) in the Economist over the past couple of years or so.

 

China's growing influence on the oil markets will of course be a major focus of comment in the coming few years and decades, but this of course is in addition to the effect of China's rapid industrial growth on other markets, notably gas and mineral, worldwide.

 

I'm still not convinced however that China's influence is going to be as dominant and world changing as is often made out by the BBC and the like. Other commentators have pointed out that it's just as likely, if not more, that China's economy is at present overheating and heading for eventual crash, lacking both the financial infrastructure and transparency required to ultimately service and sustain its present rates of industrial growth. Even the gold rush mentality that initially gripped foreign investors has begun to fade a little, with some beginning to view that Chinese markets and industries as less appealing in reality than they appear on paper.

[LoneWolf]

There's been fairly extensive and, compared with other publications, coverage of this (particularly focusing on Xinjiang) in the Economist over the past couple of years or so.

 

Most of the energy market bulletins have exhibited something verging on hysteria for quite some time.

 

China's growing influence on the oil markets will of course be a major focus of comment in the coming few years and decades, but this of course is in addition to the effect of China's rapid industrial growth on other markets, notably gas and mineral, worldwide.

The problem for an already nervy oil market is China's growing demand creates uncertainty on the supply side. Result of uncertainty = volatility

I'm still not convinced however that China's influence is going to be as dominant and world changing as is often made out by the BBC and the like.

Its all about uncertainty again Vinnie. China and to a lesser extent India are both expanding their economies apace. This is putting increased pressure on the supply side of the energy markets. Oil and gas ,in particular, which are essentially the same product anyhow [courtesy of the mighty dollar] are both sensitive to supply side uncertainty.

In addition there is now irrefutable evidence peak oil is either imminent or has already occurred so China doesnt have to become the dominant economic power to disrupt the world's energy markets. A steady growth in demand will be sufficient.

However, i think Vinnie is correct in so much as China alone wont be the only driver to change the energy markets.

Iran has already attempted to establish an oil bourse based on the euro. This was motivated by a desire to destabilise the dollar and didnt go anywhere.

There are and there always will be other geopolitical events to introduce uncertainty to nervous markets.

Just look at the enormous effect a small gang of terrorists in Nigeria have had on oil prices this year.

[Albert Tatlock]

I think we're all missing the point here. Remember that film when the Chinese were diggin a big tunnel underneath us all to take over the world? Sneaky yellow...

[Chinahand]

Now now Albert ... sit down, have a beer and calm down a bit

[Albert Tatlock]

Now now Albert ... sit down, have a beer and calm down a bit

I did have a beer or two 2nite...either my bar stool collapsed...I'd had too much to drink...or someone was digging a tunnel underneath me. Either way I blame the chinese (or will in the morning! - phaaaaaaaaaaaaaarp!).

[VinnieK]

In addition there is now irrefutable evidence peak oil is either imminent or has already occurred so China doesnt have to become the dominant economic power to disrupt the world's energy markets. A steady growth in demand will be sufficient.

 

I agree entirely, and there will be a considerable amount of disruption caused by China's rise, but I'm more inclined to believe that this uncertainty and volatility will be more short term (if no less dramatic) than is currently being suggested by the mainstream media.

 

Particularly, I don't believe China's growth will be steady. Instead I think it's heading towards some form of crash, or at least a sustained period of depression in China's economy which will alleviate some of the pressure it's placing upon global resources and markets, before it adopts a more measured and stable rate of growth. Whether the markets can comfortably accomodate a more 'reasonably' growing China is debatable, but it should at least provide a bit of time and space in which exploration and the freeing up of resources can at least attempt to improve to meet the extra demand.

[Chinahand]

Is China's long boom so exceptional?

 

Not really! Below is from a recent Financial Times article about China's growth.

 

 

As you can see China is performing better than India: they both started out at similar levels in the late 1970's but now China is considerably richer both in total and on a per person basis. However both Japan and South Korea, starting from a higher basis, were able to sustain growth for a considerably longer period than China has so far achieved. Sustaining growth as a country gets richer is difficult, its China's current challenge, but Japan and South Korea achieved it, as did Taiwan [i'm a bit surprised the journalist didn't include Taiwan in the figures, its example is important].

 

I totally agree that straight line projections are totally simplistic and China's political and economic challenges are huge, but it isn't inconsievable that on average, after occassional booms and busts, that it does keep on going.

 

The CPC has a big advantage in the size of China's population and economy. They've recently successfully cooled the economy, or more accurately reduced its overheating from red hot to just hot. They did this by caveat in the cities: housing and capital projects were simply stopped by dictat, but they also eased restrictions in the countryside. The result was that the money swamping Shanghai dissapated into the countryside and resulted in slightly increased food costs: the peasant producers were happy, they were able to get a slightly higher price for their produce, but the overall effects were small. This huge pool of semi-unused labour gives the economy a huge sink to absorb shocks into. If cities overheat, they suck in peasant labour and if the government want to cool them down they can redirect the funds away into the rural areas where they dissapate. At the other extreme, if there is a downturn, the authorities are perfectly willing and able to round up undocumented workers in the cities and return them to the countryside. They return to be under utilized in the fields, but the cities don't suffer a social crisis from the urban unemployed.

 

Obviously doing this is a very high risk game and there is a high chance of political instability. The richer China becomes the higher the risk this tactic won't work, but its fascinating trying to guess what might happen. I think on balance I agree that China probably won't be able to achieve it and a serious political crisis will develop. However I think this will also have a huge effect on the global economy and result in great geopolitical uncertainty. I think I'd rather have the global shocks caused by a high oil price and an energy transition than political collapse in a country of a billion people! Both will be a challenge to overcome!

[VinnieK]

The comparison with South Korea and Japan, however, is problematic in that it fails to take into account such features as the vast amount of capital that's simply wasted through the endemic corruption and inefficient financial infrastructure that characterises China, or the effect of these features on overseas investors.

 

The Chinese government have shown that they can cool down their economy to a certain extent, but ultimately the problem is not limited to simply the growth of their GDP, but the inherent weaknesses in their economy with regards to the efficient tranfer of capital (both in domestic and international investment), combined with the rapid growth of their industry. Dissipitating money around the country simply alleviates immediate pressure on the urban centres, providing a short term fix whilst crash in the overall economy looms ever closer. Also, China's wealth is based virtually entirely on consumption, that is by manufacturing goods for domestic and international consumers, putting it's economy at the mercy of consumer trends.

 

Secondly, although it's true to say that China has grown faster than India, India's growth looks far more stable and profitable in the long term, depending as it does on high income, education based service industries. Although China is getting richer faster, I'm willing to bet that in the end we'll see India being the first to make the transition to a fully 'modern' economy that's fuelled by a solid base of both overseas investment and consumption, and which encourages investment in domestic education.

 

That and P.G. Wodehouse is quite popular in India, which is a clear indication of its greatness as a nation.

[Chinahand]

I absolutely agree you've got to be careful about international comparisons. However I'm not convinced that Japan and South Korea are such bad comparisions. Don't forget the Chaebol, Keiritsu and state controlled lending of these two countries aren't exactly paragons of efficient investment models. Corruption was a serious problem in Japan and still is a very large issue in South Korea with the Chaebols having a very unhealthy relationship with the bureaucracy and banks. These countries propspered without particularly efficient investment markets and with the corruption VinnieK rightly says is a serious problem in China. They show what China could achieve even with the cronyism the CPC is creating.

 

I also think VinnieK is a bit out when it comes to China's economy; though his conclusion isn't too far out, he's right but for the wrong reasons. China's economy is not in any shape or form based on consumption ... quite the opposite. Consumption is very low as a proportion of GNP in the Chinese economy. Chinese save a very high proportion of their income. Various arguements are being made that the current imbalances in the world economy are being caused by a savings glut in China and the rest of Asia. The CPC government is trying to increase consumption and reduce the influence of exports and investment within the Chinese economy.

 

This high savings rate creates two consequences: a large current account surplus and the end result that the Chinese economy is based on investment not consumption: banks etc recycle what isn't spent and lend it to companies to invest [and the government uses it to buy American government bonds, but thats a whole new long boring post!]. And the efficiency of this investment is a big worry. One of the few areas where India does out perform China is return on money invested. BUT this is from a much lower base with even greater unmet demand. VinnieK is right to point out that there could be big problems with investments in China not being as successful as hoped.

 

But I still go back to the size of China's population as mitigating this effect. China has had 40 years of chronic under investment under communism. The huge splurge of investment in housing etc is only scratching the surface of a huge pent up unmet demand. 60% of the Chinese population still live in the countryside. The housing blocks going up in Shanghai and Guangzhou will be filled: there are 750 million people looking for a better place to live in China!

 

China vrs. India over the next 50 years ... hard to say. India has a pluralistic political system, but the communism has given China much better literacy rates and basic infrastructure. High tech is a hugely successful, but tiny part of India's economy. China has created one of the most open and trade linked economies in the world (the most open for its development stage) and is now turning that engine round to stimulate its own economy and encourage domestic consumption. I think my money's on China, but the risk of a major political crisis creating chaos and collapse isn't impossible. The USSR lost 33% of its economy as it collapsed, it only just recovering 15 years later ... that could happen to China ... but over 50 years that could look like a blip. Who knows!

[VinnieK]

I absolutely agree you've got to be careful about international comparisons. However I'm not convinced that Japan and South Korea are such bad comparisions.

 

They are not merely international comparisons though, but also historical ones. Quite apart from the differences in the economic markets (particulary that of the US) between now and Japan and South Korea's rise, the most obvious disparity is that the dissolution of the soviet union has provided an alternate centre of cheap manufacturing industries to the traditional nexus in South East Asia. Europe, as one of the driving economic forces in the world today is lucky enough to have cheap labour within its own borders and right on its doorstep. In addition to the simple fact that there's more competition around today than there was prior to the 90's, China may find that the volatility in the oil and resource market that she herself has contributed to eventually makes her own goods less attractive, thanks to additional costs of importing them to consumer nations.

 

 

China's economy is not in any shape or form based on consumption ... quite the opposite. Consumption is very low as a proportion of GNP in the Chinese economy.

 

You're mistaking my use of the term 'consumerism'. Direct, domestic consumerism may be low in China, but over half her economy (and growing) is based firmly in manufacturing, which as an industry is particularly dependent upon and vulnerable to trends in consumption (be it domestic or international - in this case international).

 

VinnieK is right to point out that there could be big problems with investments in China not being as successful as hoped.

 

This is already happening, nearly every article in the Economist that I've seen on the subject of investment in China (including the economist's special reports) has intimated that there already are big problems, regularly featuring not just the concerns of potential investors, but the complaints of previous investors. These complaints, it must be stated, are not merely focused on investment being less successful than anticipated, but frequently concentrate on both the difficulty of doing business in China, as well as the the vast sums of money that can simply disappear whilst negotiating Chinese business and distribution networks

 

But I still go back to the size of China's population as mitigating this effect.

 

I'm not quite sure that such a conclusion is justified. It's certainly not an immediate truism that a dense population is beneficial, and I don't believe it to be so in China's case either. Surely it's also possible that the demands of such a population could easily conflict with those of business and industry. Indeed, it has been remarked that the Chinese government is having considerable difficulty maintaining the growth of jobs (partly because of the same reductions in state sponsered construction schemes that you cite as a method of cooling the economy down).

 

but the risk of a major political crisis creating chaos and collapse isn't impossible.

 

Concentrating on specific political upheavals is in my view a mistake, given that a more general, international downturn in the economy is much more likely an eventuality and an influence in China's development for the foreseeable future. China's reliance on manufacturing means that the Chinese economy would be hit disproportionately hard by any global recession and the accompanying downturn in exports. Although you state that China is trying to increase consumer spending within it's borders, it's unlikely to be sufficient to alleviate the country's problems in such a situation. Although it's true that China's GDP per head has risen, most, if not all, of this figure is skewed by and concentrated in the urban centres of China's coastal regions. Even were consumerism to rise, there's only so many toasters, say, that an individual family can buy, regardless of how wealthy they are. This concentration of disposable incomes suggests that China's consumer nascent consumer society would be woefully inadequate when it comes to countering the effects of even a mild downturn in the manufacturing industries and foreign investment that it has come to rely upon.

[Chinahand]

VinnieK I think you are basically correct in your analysis, but too often for the wrong reasons.

 

China is very trade dependent, and its exports disproportionately go to the US. If there was a significant slow down in the US it could harm the Chinese economy and that could create political difficulties for the Communist Party of China. If this is what you are saying I basically agree with you.

 

BUT that risk has many mitigating factors which mean its impact is likely to be reduced.

 

You aren’t correct about manufacturing and the Chinese economy. In 1978 the manufacturing/secondary sector made up 48.2% of the Chinese economy. In 2004, the last year there are finalized statistics, it stood at 46.2%. In the period of reform manufacturing hasn’t increased its dominance in the Chinese economy: communist countries usually have disproportionately large industrial sectors. Reform hasn’t expanded the industrial sector, but it has transformed it in its efficiency and market awareness, good things. In 1978 the service/tertiary sector made up just 23.7% of the economy; by 2004 it was 40.7% a huge and important expansion.

 

So, China’s economic miracle has seen the transformation of its manufacturing sector to make it far more able to respond to changes in market conditions; and the growth of its service sector.

 

Both of these make the economy more able to withstand shocks, by diversifying it and making it more responsive to customers, both at home and abroad. I think that this conclusion is almost the opposite of what you are saying, I think!

 

However I agree with you that China is over trade dependent, and its manipulation of its currency to support this is one part of the currency imbalances that are hanging over the world economy; note only one part: the dollar, the euro and the pound are overvalued in themselves not just compared to the Renminbi and so China’s gradual revaluation is only reducing some of the distortions. See the Economist’s Big Mac Index.

 

China runs a huge trade surplus with the US, but has much smaller trade imbalances with the rest of the world. Until recently it had a trade deficit with Japan and the amount of machine tools and other goods Chinese companies purchase from Europe mean that its trade pattern with this part of the world is reasonably normal. China’s bilateral trade with South East Asia is highly significant and growing, but rarely concentrated on by Western analysts, but the trade nexus within this region is highly important and provides further diversification.

 

As the currencies realign it is highly likely that Chinese companies will sell less goods to the US, but it is also likely they will increase trade with other parts of the world, offsetting this decline. This could cause pain, but I doubt it’ll result in the break down your last paragraph alludes to.

 

I also firmly think you are underestimating China’s attempt to kick off a consumer culture in its own economy. This is mainly through the creation of a home owning middle class who will go out and equip their homes with all the latest mod cons. This is far more than buying toasters. I doubt if you’ve seen a pre reform tenement block, but let me assure you everything in them from the lighting, to the plumbing, to the heating etc etc is grim. The service and quality ethic Chinese consumers are demanding as they equip and furnish their own homes is something to see and a massive fillip to the Chinese economy. Something like 300 million people are currently doing this, yes thats less than 25% of China's economy, but absolute numbers are important here as I've repeatedly said. China's huge population, not population density as you state, is enabling it to pull itself up by its boot straps.

 

This is still a work in progress, but is needed to make the Chinese economy more balanced: again I think this is totally the opposite of what you say: China’s economy needs to be more consumer orientated than it currently is.

 

Responding briefly to other points you’ve made: I don’t think Europe is particularly a driving force in the world economy, its contribution to economic growth over the last 25 (40?) years has been well below expectations etc.

 

The collapse of the USSR has massively expanded trade by ending the autarkic and trade block policies of the Soviet system. This has created more opportunities than risks and is I believe helping the world’s, and China’s, economy expand.

 

Your statements about companies loosing money in China are partially accurate, but be careful. A lot of the studies you’ve read have been about joint ventures with Chinese partners failing to make money for Western Multinationals. These situations are partly zero sum games as the Chinese partner has made a killing out of gullible foreigners. Multinationals etc may have lost millions, but the investments they have put in have helped expand the Chinese economy successfully and benefited the Chinese partner. However I agree with you that poor asset allocation is a serious issue and could cause problems.

 

As I said at the start, I think we are in basic agreement, but on some specifics I think you are misinformed and so thought I’d respond in detail! Long winded aren't I!