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Petrokaz: China's difficult search for Central Asian energy
Stephen Blank, The Jamestown Foundation, China Brief
12/12/2005

On October 25, a Canadian court dismissed Lukoil’s lawsuit against China National Petroleum Company (CNPC)’s purchase of Petrokaz, a firm headquartered in Canada that owns several Kazakh oil fields. Immediately after the decision, however, Nelson Resources Ltd., a Bermuda-based energy firm that is to be acquired by Lukoil, moved to block CNPC from taking complete control of the North Buzachi oil fields in Kazakhstan, in which CNPC and Nelson each hold a 50 percent stake. These legal battles illustrate the obstacles China faces in obtaining secure and reliable energy access from Central Asia, and evoke memories of China National Oil Company (CNOOC)’s abortive bid for Southeast Asian fields owned by the American UNOCAL company earlier this year. Indeed, the reasons for opposition are quite similar.

Neither the United States nor Kazakhstan want China to own their firms or energy fields and gain undue political influence over them. Nor will they accept China having what they regard as undue access to their strategic energy assets. Lukoil’s intervention shows that Russia also opposes China’s quest for equity in Central Asian or Russian energy companies. Russia’s energy producers and government have steadily rebuffed China’s efforts toward that end, and are determined to maintain autarchic control over energy—Russia’s strategic resource. Although they will sell China energy supplies, Russian officials fear they will become merely China’s source for raw materials and thus demand equal status in economic-technological exchanges with China.

Previously, Russia also blocked the sale of Slavneft to China in 2002, successfully destroyed Yukos—which favored a direct Russo-Chinese oil sale and pipeline from Angara to Daqing—and for some time appeared to be winning the policy struggle over oil sales to Asia by proposing a much more expensive, but partly Japanese-subsidized, pipeline to Nakhodka. Chinese buyers would then have to buy from Japan rather than directly from Russia. Since China cannot obtain equity stakes in those holdings it must depend, against its instincts, on foreign producers and sellers.

Therefore it is hardly surprising that China has sought increased leverage in Central Asia, especially Kazakhstan, which neighbors the critical province of Xinjiang. Xinjiang is becoming a primary source of energy for the Chinese economy—and the region’s oil resources are vital to China’s future energy security (People’s Daily, September 23). Indeed 73 percent of Sino-Kazakh trade is trade between Xinjiang and Kazakhstan (People’s Daily, October 18).

Dependence upon Russia conflicts with China’s policy of maximizing the reliability of long-term supplies through control of the product or of equity stakes in the producing company from wellhead to terminal. China increasingly ties equity investment to long-term supply contracts to ensure reliable supply and guard against price shocks. As Phillip Andrews-Speed and Sergei Vinogradov concluded in Asian Survey (2000), “The key driving force from the government’s point of view is the desire to enhance the security of the country’s petroleum supply through owning both the resource in the ground and, where relevant, the transport network.” Normally China seeks a share of annual oil output by becoming a direct investor or shareholder to shield itself against significant price fluctuations for oil imports. Building up a strategic petroleum reserve also aims to ensure reliable supplies at accessible prices. China also invests heavily in buying pipeline networks at home and abroad to control the oil and gas shipped from Central Asia, the Gulf, and Russia.

Yet failing to obtain reliable access and control, China’s only avenue of escaping excessive dependence upon any one producer or region is to diversify its sources of global access to energy. China also consistently sells arms and even missile or nuclear technology to energy producers, e.g. Iran, Iraq, Saudi Arabia, and Sudan. China’s willingness to provide military assistance and even to commit its own forces beyond its borders to Central Asia closely conforms to this pattern and suggests a potentially forceful response or increased support for missile and even nuclear proliferation in reply to threats to its energy supplies.

China’s Energy Investment in Central Asia

China’s record of achievement in Central Asia is spotty. China has bought equity in fields in Azerbaijan and Kazakhstan, but its purchases in Azerbaijan hardly give China a commanding position in the country’s energy holdings and do not overcome the difficulty of getting reliable access to pipelines. China’s quest for leverage and access to Kazakhstan’s holdings is equally checkered. In 1997 CNPC purchased a 60 percent stake in the Aktobemunaigaz firm of Kazakhstan, which would become the source for a pipeline from Aktyubinsk in Aktobe province to Alashankou. Yet this project encountered so many difficulties that by 1999 there was talk of its cancellation. Since then the project has been revived, not least because of Russia’s failure to deliver on its promised oil pipeline. With this increased priority, the pipeline is being built to Keniak in Xinjiang, from where it will eventually connect to Atyrau and China’s interior. This is the centerpiece of China’s present holdings in Kazakhstan, but it costs an enormous amount to build this pipeline through rugged and austere terrain and to secure it against natural and man-made disruptions. It also indicates that China is willing to pay top dollar, perhaps even above market prices, for rather risky projects in order to ensure absolute, secure energy access.

This project also highlights the other problems inherent in seeking equity in Central Asian energy. Once this contract was signed and the difficulties of terrain and of labor strife began to appear, Russian companies like Yukos intervened to offer China oil and gas, depriving Kazakhstan of an enormous market and forcing China into greater dependence upon Moscow. That outcome suited neither Beijing nor Astana.

In 2003, however, the situation changed for China and Kazakhstan. The full significance of China’s dependence upon foreign gas and oil from Russian sources became clear. The war in Iraq revealed the vulnerability of Persian Gulf supplies just as President Putin destroyed Yukos for domestic political reasons and terminated the pipeline from Angara to Daqing. As energy prices steadily rose, Kazakhstan’s economy exploded, outgrowing the shackles that Moscow had tried to fasten for it. China also learned a major and unpleasant lesson in 2002–03 when Western companies excluded it from bidding for lucrative holdings in the Kashagan fields in Kazakhstan and the Caspian Sea. Both states re-forged their energy ties in 2003.

CNPC’s stake in Aktobemunaigaz also offered China opportunities for further purchases of equity holdings in Central Asian gas finds and existing fields. Pipeline construction on the Atasu-Alashankou pipeline, which is part of the pipeline from Aktyubinsk to Alashankou, likewise accelerated. Kazakh oil and gas became more attractive because of heightened possibilities for oil swaps with Caspian and Iranian producers to cut costs.

China will probably retain its interests in all these programs to maintain ties to Kazakhstan and avoid excessive dependence upon any one supplier or pipeline. However, there is much local resentment of Chinese high-handedness toward the local population, labor policies, economic penetration of one of Kazakhstan’s poorest provinces, and fears that Chinese workers will privatize the land that the government is now selling. Thus Kazakhstan wants a 51 percent share in any oil pipeline construction to China. It remains uncertain that all will go well with this troubled project—for which China greatly overpaid in the first place.

China’s recent effort to purchase Petrokaz from its Candian owners raises other issues as well. Just as Washington reacted strongly and negatively to Chinese efforts to buy UNOCAL and gain access to its Southeast Asian oil fields, Kazakhstan’s reaction has turned increasingly negative with legislative and political pressure being brought to bear upon the government to take control of this and other energy firms so that Kazakhstan’s cherished energy assets do not pass into foreign hands. Lukoil’s legal maneuvers further indicate Moscow’s unrelenting opposition. While it is unclear if friction over energy supplies can undermine the Russo-Chinese strategic and anti-American partnership in Northeast and Central Asia, it does indicate that not all is well in China’s ties either with Russia or Kazakhstan and that it has limited success in securing its vital interests of reliable energy supplies under its control. Given the centrality of this issue for China’s domestic stability and for its foreign policy, the future course of its quest for Eurasian energy supplies will exercise a profound impact upon energy markets and international relations.

Stephen Blank is a professor at the Strategic Studies Institute of the US Army War College at Carlisle Barracks, PA. The views expressed here do not represent those of the U.S. Army, Defense Department, or the U.S. Government.

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