After going on for nearly two years, the Trump administration’s trade war with China has taken a new turn with a so-called phase-one agreement. Among the terms of the deal is China’s pledge to buy about $200 billion more in U.S. goods over the next two years, including $52.4 billion in U. S. energy goods. Now, as the ink dries on the document, some ask if those energy sales are likely to happen.
In this edition of Columbia Energy Exchange, host Bill Loveless visits with Dr. Erica Downs, a Senior Research Scholar at the Center who specializes in Chinese energy markets and geopolitics. Erica is a former Senior Research Scientist in the China Studies division of the CNA Corp. Among her other credentials, she was an Analyst at the Eurasia Group, the Brookings Institution and the Central Intelligence Agency.
Bill caught up with Erica soon after President Trump signed the agreement with China at the White House to get her take on its implications, especially as it relates to U.S.- China energy trade, which had looked promising until trade troubles between Washington and Beijing erupted. She also provides fascinating insight on China’s oil and gas industry, which has recently made self-reliance a major commitment, and explains why Russia has a lot to gain now as an oil and gas supplier to China.
In preparing for the conversation, Bill found very helpful a paper Erica wrote for the Center on Global Energy Policy in the fall called “High Anxiety: The Trade War and China’s Oil and Gas Supply Security.” If you have a minute, download it from the center’s website. It’s worth a look.
Bill Loveless: After going on for nearly two years, the Trump administration's trade war with China has taken a new turn with a so called Phase One Agreement. Among the terms of the deal is China is pledged to buy about 200 billion dollars more in US goods over the next two years, including 52.4 billion in US Energy goods. Now as the ink dries on the document, some ask if those energy sales are likely to happen.
Hello, and welcome to Columbia Energy Exchange, a weekly podcast from The Center on Global Energy Policy at Columbia University, from Washington, I'm Bill loveless. Our guest today is Erica Downs, Senior Research Scholar at the Center who specializes in Chinese Energy Markets and Geopolitics. Erica is a former senior research scientist in the China Studies Division of the CNA Corporation. Among her other credentials, she was an analyst at the Eurasia group, the Brookings Institution and the Central Intelligence Agency.
I caught up with Erica soon after President Trump signed the agreement with China at the White House, to get her read on its implications, especially as it relates to US-China Energy Trade, which had looked promising until trade troubles between Washington and Beijing erupted. She also provides fascinating insight on China's Oil and Gas Industry, which has recently made self-reliance a major commitment and she explains why Russia has a lot to gain now as an Oil and Gas supplier to China and preparing for the conversation, I learned quite a bit from a paper Erica wrote for the Center on Global Energy Policy in the fall called High Anxiety, the trade war and China's oil and gas supply security. If you have a minute download it from the Center's website, it's worth a look. Well, here's our conversation, I hope you enjoy it. Erica downs, welcome to Columbia Energy Exchange.
Erica Downs: Thank you. I'm very happy to be here.
Bill Loveless: Erica, let's talk a little bit about you first. You've been a close observer of China for many years, including work you've done at the CIA, Brookings Institution, and the Eurasia group. How'd you get involved in this line of work?
Erica Downs: I got involved accidentally. In the summer of 1998, I was working at the RAND Corporation on a project on China's defense modernization, and by the time I showed up all the core topics associated with that had already been written on. Meanwhile, the year before China's National Oil Companies had made a big splash on the world stage by buying up upstream assets in places including Venezuela, Sudan and Kazakhstan, and the person running the program was interested in these purchases and asked me to look into them. Before that, I hadn't actually done any work on China's Energy Sector, but I so enjoyed working on that topic that I ended up writing my dissertation topic on it.
Bill Loveless: And there's been no looking back since then.
Erica Downs: No looking back.
Bill Loveless: Well, the big news, of course, is the partial trade deal that's been announced by the Trump administration and by China. What do you make of this agreement and especially as it pertains to energy trade with the United States?
Erica Downs: The trade agreement signed on Wednesday is a step in the right direction for revitalizing energy trade between the two countries. Before the trade war, the United States was on track to become a major supplier of oil and LNG to China. However, the trade tensions essentially put that relationship on hold, especially with respect to LNG. Now, if you look at the actual energy targets in the trade agreement, they're huge. Over the next two years, China has agreed to purchase 52.4 billion dollars’ worth of energy from the United States.
Bill Loveless: And we're talking largely oil and natural gas.
Erica Downs: Yes and just to put that in perspective, during the first 11 months of 2019, the total value of China's crude and LNG imports from the United States was 4.3 billion dollars. So this agreement really envisions a step change in the bilateral energy relationship, so I think we can expect to see China purchasing more crude oil, more LNG, oil products, maybe some coal, but there are going to be some challenges to hitting these targets, especially in the case of LNG.
Bill Loveless: And my impression is one of the biggest potential impediments here are the tariffs that China still maintains on oil and natural gas imports.
Erica Downs: Absolutely, so right now China still has in place a 25% tariff on US LNG, and a 5% tariff on US Crude as long as those tariffs remain in place. I suspect that Chinese buyers, including the National Oil companies are going to be reluctant to dramatically ramp up their purchases. And another challenge in the LNG space is the whole issue of does the United States actually have enough LNG to sell China over the next two years, I say that because if you look at US Energy Information Administration Data on the value of all US LNG exports to all countries over the period January to October 2019, the total value of those exports was around 7 billion.
Bill Loveless: That's interesting. So you're talking about whether or not there's simply the capacity of the United States to meet any substantial increase in demand for LNG from the United States and China?
Erica Downs: Yes, certainly over the next two years. As you probably know, it takes a while to construct new LNG export terminals, so looking over the two year period that's covered by the trade agreement, there are some limits I think, both on the China side in terms of the tariffs and the US side in terms of LNG available for export that might limit the role that LNG plays in meeting these targets. As a result of that, I expect we will see a ramp up in US crude exports to China, not only is the tariff, they are much lower and if it remains in place easier to absorb, but right now, China probably values the fact that US crude oil does not flow through the Strait of Hormuz. There's been a lot of instability in the Persian Gulf over the past year, that is of concern to China, given the amount of oil they import from the region and so diversifying their portfolios away from the Middle East is most likely viewed as something that will enhance energy supply security. And in fact, if you go back and if you look at what Sinopec which is the Chinese company that imports the most crude, if you look at what they said about imports from the US when they started them up back in 2016 was that they valued them because it allowed them to diversify their import portfolio away from the Middle East.
Bill Loveless: You know, you feel as though there's still that same sentiment in Beijing today?
Erica Downs: I think there's that same sentiment. I think one of the lessons that China's oil companies and China's leaders probably have taken from events over the past year has been that you don't want to be too dependent on any one supplier, so diversity of one's portfolio is key to energy security.
Bill Loveless: I'll just mention some numbers here and these come from report you did recently for the Center on Global Energy Policy, but regarding LNG and oil inputs from the United States to China, after peaking at 506,000 tons in January 2018, China's purchase of US LNG from lower 48 states fell to zero in September 2018 and remained lower for the rest of the year due to China's 10% tariff on US LNG that September and of course, as you mentioned that tariff has increased to 25%. Since then, China's imports of oil--US oil began in 2016, hitting 247,000 barrels a day in 2018. From January to September last year, China's imports of US oil were down 57%.
Erica Downs: Yes, and I expect that in the case of China's crude oil imports from the United States, the reason those haven't fallen off quite as dramatically in the case of LNG has to do with various geopolitical risks. I think that Chinese oil companies have been concerned about US secondary sanctions on Iran and Venezuela as curbing some of China's supplies from those countries and certainly with the attacks on Saudi oil infrastructure back in September 2019, there's been a sense that China probably still needs to buy some US crude because of a little bit of uncertainty related to what they might get from some of these other suppliers.
Bill Loveless: Well, you know, one thing that's going to help put this conversation into perspective is a report you did back in the late fall, as I recall, it was called High Anxiety, the trade war in China's Oil and Gas Supply Security. Let's take a step back to the summer of 2018 and when China's President Xi Jinping was facing pressure from the US-China Trade War, he intervened in a long running debate within China and within China's oil industry, about the extent to which national security concerns or market forces should determine domestic oil production, what happened?
Erica Downs: So in July 2018, President Xi instructed China's oil companies to increase the exploration and production of domestic oil and natural gas to enhance National Energy Security. Now this instruction did not come out of the blue, and it is part of a broader push by President Xi to reduce China's reliance on imports for critical inputs to the Chinese economy in the face of the US-China Trade War, and US sanctions on China's National Champion Telecommunications Companies, Huawei and ZTE. After the Department of Commerce blacklisted ZTE in April 2018, the company actually ceased to operate for a while, because it was so dependent on US suppliers. Even though the Department of Commerce reversed this decision in July 2018, the damage was still done in the sense that one of the big lessons that President Xi and others in China have taken away is that it's dangerous to be highly dependent on other countries for critical inputs, especially the United States and this thinking did trickle down into China's oil industry. Over the past, you know, year and a half Chinese oil executives and analysts have expressed concern that the United States might pull a ZTE on them and cut China off from technology and equipment that it imports to explore deep water and to explore and develop unconventional resources.
Bill Loveless:Yeah, and this was a rather dramatic shift as I understand it, I mean, he tipped the scales in terms of how these issues had been dealt with, and, you know, towards what he was looking towards was prioritizing self-sufficiency over cost, is that right?
Erica Downs: Well before the trade war started, and so before Xi even offered his instruction, there was a debate going on in China's oil industry about the extent to which the country should rely on imports versus producing oil at home. Now, this is a long standing debate in China that has been going on for many, many years and what rekindled at this time was that in 2015, China's domestic oil production peaked, and then you know, it continued to fall in 2016, 2017, and 2018, and so there was a lot of concern and China about that, especially since the production fell below what they--some people consider to be a red line of 4 million barrels per day and so there was this debate playing out, you can see it in certain Chinese oil industry publications where some people were saying, you know what, it makes perfect sense to just rely on the market and to buy the oil that we need, especially in times of low oil prices and some people did calculations to show, you know, the extent to which, you know, China's oil import bill fell with a collapse in crude prices in the second half of 2014 and then there were other people participating in this debate who just said, well, you know, that's fine, but that's not a good strategy for the long term, that in the long term, it's just too risky, and we need to be prepared to rely on ourselves. And so, when Xi issued his instruction, he effectively ended up intervening in that debate and not surprisingly, he did get results and that China's National Oil Companies, you know, immediately started thinking about what can we do to respond to this instruction, and they increased their CapEx to the highest levels in about five years, some of that's International, but a portion of it is domestic as well and they also issued their first ever seven year plans for accelerating the exploration and production of domestic oil and natural gas.
Bill Loveless:Yeah and the objective there was to stabilize oil output and to increase gas production.
Erica Downs: Yes and for those of you who've been following China's oil industry closely, it may seem confusing that President Xi had issued this instruction to increase oil and gas self-sufficiency because China is highly dependent on imports for both and so the target that the companies are aiming for is what you just said that they want to stabilize oil production, they don't want to see it fall and to the extent that they can incrementally have some growth, that's a good thing and for gas, where there's a view that there is more room to increase domestic production, they are aiming to do that as well.
Bill Loveless: And these had some positive results in terms of oil and gas production. I recall from your report that from January to September last year, oil output was 3.8 million barrels a day and that's about a percentage point or so over the same period, the prior year gas output from January to August last year 128 billion cubic meters, that's up 9.5%?
Erica Downs: Yeah, absolutely. The data that we have, does indicate that they are succeeding in, you know, achieving the goal of stabilizing oil production and continuing to grow natural gas output.
Bill Loveless: Well, you know, we told we went back to 2018 for perspective, let's go back even further, as you've reminded me in the past, and that was a period, you know, some 60 years ago when once again there was this huge push for oil production in China, tell us about that.
Erica Downs: Sure, one of the things that struck me when I was reading articles from the past two years about this renewed push to increase domestic oil and natural gas production was the extent to which some of the leaders in China's oil industry, we're using sort of the same language of combat or war to talk about the current effort to stabilize oil production and increase gas production, as they did in the 1960s to talk about China's tremendous effort to bring the Daqing Oilfield online, China discovered Daqing, their largest oil field in 1959 and the timing of this could not have been better for China and that their relationship with the Soviet Union, which had supplied them with a lot of engineers was deteriorating. At the same time, China was isolated from the west, going back to the relationship with the Soviet Union for a moment as that relationship continued to deteriorate in the 1960s, the Soviet Union, which was the sole supplier of the refined products used by China's Air Force, they cut back in those deliveries and so China was feeling a real sense of oil insecurity. And so, what the Chinese government ended up doing is after Daqing was discovered in early 1960, they talked about waging a great battle for Daqing and a lot of the language that was used to talk about bringing that field online, talks about fighting a war, fighting a battle, and if you fast forward to today, there are people in China's oil industry talking about the need to sort of, you know, fight an offensive war to increase domestic production.
Bill Loveless: The rhetoric is very similar. I mean, the means of achieving that goal is different, as I recall from your work back for Daqing, when that was being developed some 60 years ago, I mean, it was a tremendous amount of physical labor, right?
Erica Downs: Absolutely and that reminds me, the context is also different in the sense that back in the early 1960s, China was obviously consuming less oil than they did today and by developing Daqing, they had, you know, a real chance of reducing their dependence on the Soviet Union for Refined Oil Product Exports. And in fact in 1963, China's premier at the time Zhou Enlai did make a big announcement that China was basically self-sufficient in oil. And of course, today, self-sufficiency isn't a realistic possibility and certainly China's leaders and the individuals who lead China's oil companies have no illusion about that, but when President Xi gives the companies in order, they have to comply and certainly this is taking place in another international environment in which China was feeling a bit insecure and feeling a bit of pressure from the United States in the trade war.
Bill Loveless: Let's talk a little bit more about how, you know, China's reliance on imports of oil and gas not only from the United States, but from throughout the world going forward. You said despite this tremendous push to boost domestic oil and gas production, it's unlikely China will reverse its reliance on oil and gas inputs, though the source of those imports may change?
Erica Downs: Yes, China National Petroleum Corporation, which is China's largest producer of oil and natural gas, every year releases an Energy Outlook similar to the World Energy Outlook put out by the International Energy Agency, so I often think of CNPC outlook, as you know, their version of the World Energy Outlook, and their latest one came out in August 2019 and in that report, the company projects that China's dependence on both crude oil and natural gas will continue to rise. This of course is a year after Xi gave us instructions to up domestic exploration and production and if you look at the numbers in the CNPC study, they project that China's dependence on oil imports will increase slightly from 70% in 2018 to 72% in 2030 and that accounts for about a million barrels per day increase in crude imports and in the case of natural gas, they expect China's natural gas imports to grow from 44% in 2018, and worth of 50% in 2035.
Bill Loveless: Interesting, do they talk much about sources of that oil and gas?
Erica Downs: The report itself does not talk a lot about sources of oil and gas, but if you look at China's energy mix in recent years, almost half of their crude oil imports have come from the Persian Gulf, and virtually all of those barrels flow through the Strait of Hormuz.
Bill Loveless: Interesting and you mentioned before, there's been other concerns in Beijing over the potential for geopolitical issues that could pose risks for their oil supplies, especially from the Middle East. Do you think events that have taken place recently only raise those sorts of concerns in Beijing?
Erica Downs: Absolutely and I think that's another sort of factor that is going to be supportive of increased US crude exports to China that China has worked very hard over the years to try to limit its dependence on the Persian Gulf to try to limit its dependence on any one supplier, country or region, and while they probably don't want to end up being too dependent on the United States, certainly given concerns about what's going on in the Persian Gulf, more barrels from the United States would be welcome in their important portfolios.
Bill Loveless: You know, amidst these twists and turns in US China trade relations, we wonder where Russia fits in. When it comes to energy supplies for China, you've looked a lot at the Chinese-Russian relationship in these areas as well, what's going on there?
Erica Downs: In my view, Russia is China's most important energy supplier. Russia was China's top supplier of crude oil in 2016, 2017, and 2018, and it looks like they are going to be number two in 2019, behind Saudi Arabia, which had occupied that top spot for many years before Russia took over in 2016, so they're a major supplier of oil to China, believe they supplied about 15% of China's crude oil imports last year and China values this oil from Russia, not just because it diversifies their portfolio, away from the Persian Gulf, away from the sea lines of communication and the Straits of Hormuz and Malacca, but also because that oil comes overland or it travels a short distance by sea, so there is a sense that it's more secure that it's, you know, less vulnerable to the types of disruption that might happen, you know, in Hormuz or Malacca. So not only is Russia a huge supplier of crude oil to China, but they are poised to become a major supplier of natural gas.
Last month, China and Russia launched the power of Siberia Natural Gas Pipeline, which is scheduled to eventually deliver 38 bcm of natural gas to China. The ramp up is going to take a number of years, but once that pipeline is operating at full capacity, Russia is going to be a dominant supplier of natural gas to China. Moreover, Russia is also an LNG exporter. Their first LNG export terminal above the Arctic Circle, Yamal LNG has Chinese stakeholders including China National Petroleum Corporation, which also has a supply agreement with Yamal and the summer we saw CNPC and CNOOC take stakes in another Arctic LNG project that Russia is developing, this as the Arctic LNG 2 project the company's indicated NOVATEK, the Russian operator has indicated that they expect, you know, 80% of the output from that project is to go to Asia, so expect a lot of that gas or some of that gas will end up in China and so bringing this back to where we started with the trade war and the current trade agreement, if the Chinese National Oil Companies and other buyers are hesitant to contract large volumes of US LNG, you know, because of the tariffs, because of, you know, concerns about uncertainty in the broader political relationship, then Russia may stand to benefit as someone who can come in and contract some of the uncontracted LNG that China's going to need going forward.
Bill Loveless: And China, of course, provides capital too to Russia for some of these major energy projects.
Erica Downs: Absolutely and the best example of that is the Yamal LNG project, that there's simply no way that project would have finished, you know, on time and on budget without debt and equity financing provided by Chinese entities at a time when that company was under Western sanctions.
Bill Loveless: Yeah, it just seems that the Energy Relationship between China and Russia only grows stronger right now as the one between the United States and China still remains kind of unsettled?
Erica Downs: Yes, I think it's probably safe to say that there has been a dramatic deepening of the China-Russia relationship since 2014, when not only we have the collapse of crude oil prices, but we also saw Russia come under Western sanctions for the annexation of Crimea and because of--then after that, Russia increasingly looked to China for capital that it otherwise might have received from the west and so in addition to the financing for Yamal LNG, we've also seen you know, loans made to other Russian entities. We've seen Beijing Gas Invests in the Russian upstream and so that need for capital has helped forge a closer energy relationship between the two countries.
Bill Loveless: It's also complicated and likely to remain so going forward, that is the energy relationship between the US and China and, you know, the broader global implications of these trade developments as they pertain to, you know, the world's largest consumers and in the case of the United States producer of oil and gas, Erica Downs, thank you very much for working through this with us.
Erica Downs: Thank you.
Bill Loveless: Well, I enjoyed the talk with Erica Downs and I learned a lot, I hope you did too. For more on Columbia Energy Exchange and The Center on Global Energy Policy, go to our webpage at energypolicy.columbia.edu or check us out on social media @ColumbiaUEnergy. Take a minute too to give us a rating on your favorite podcast platform, it helps us grow. For Columbia Energy Exchange, I'm Bill Loveless, we'll be back again next week with another conversation.