China’s Instability Paradox

Heightened levels of risk in politically unstable oil-producing countries allow relatively easy access for major Chinese oil companies in markets that would otherwise be tougher nuts to crack.

What better way to get your foot in the doors of oil producers than in the absence of Western counterparts?

For example, Chinese officials energetically struck deals in Guinea, merely a week after the West African dictatorship launched a forceful crackdown against opposition protestors.

Instability comes in many guises for oil majors to contend with. Hostile insurgencies, civil wars, terrorism, targeted use of political violence and civil unrest sit on one side of the political risk ledger. Expropriation, contract renegotiation, international sanctions and resource nationalism sit on the other side.

China isn't particularly fussy about what internal problems any major oil producer has to deal with. Chinese diplomats and oil executives only want to know what geological surveys in those nations can tell them, regardless of the political risk entailed.

The pattern of Chinese involvement around the world is very clear. Beijing has not hesitated to energetically pursue deals for oil, food, metals and other natural resources in Uganda, Chad, Somalia, Sudan, Nigeria, Burma, Venezuela, Russia, Iran and Iraq, whatever the level of political risk its companies have to face in any of them. The Chinese are even ready to deal with North Korea for natural resource extraction.

Money certainly isn't a problem. China spent $25 billion on such investments in 2007, $52.2 billion in 2008 and is expected to record a far higher figure in 2009.

The reason is clear: Beijing has decided to turn its $2 trillion in foreign reserves into a commodities hedge as the dollar weakens.

But here's the catch — instability is only “good” for business for so long. Winning concessions and cementing political and commercial positions are all critically important to China in the short- to medium-term to help shift the energy balance “East.” But in the long run, this must still translate into consistent, stable supplies heading for Chinese ports.

The Chinese government also has to satisfy its immense domestic demand at an acceptable price. This goal remains a critical one for a political regime still staking its future on delivering economic growth rather than democratic legitimacy. It goes to the heart of the Chinese government's quest to create a “moderately well-off” and “harmonious” society by 2030.

Therefore, what might play well in the short- to medium-term could cost China dearly down the line.

If China turns a blind eye to growing instability in states it increasingly relies on to provide natural resources, it risks major disruptions in supplies if those states collapse, devolve into civil war or undergo wrenching and disruptive regime changes.

This means that China has generated a political instability paradox when it comes to producer states.

Time vs. space

China is not deliberately exporting instability for its own commodity ends. However, Chinese policymakers and corporate executives have decided to only look at one side of the energy current account balance without considering what political debts they may be generating that will cause them problems in the future.

Iran and Sudan provide the most telling examples of the long-term problems being generated by China's decision to put its short-term energy interests first, without regard for any sense of stewardship for the international order. That means Beijing's political credibility could suffer considerably in Africa and the Middle East in the longer term.

And China is likely to suffer further major blows to its international standing when many of the corrupt and repressive regimes it is forging close ties with across central, eastern and western Africa also collapse and become failed states.

The obvious question is why should China really care? It's not as if the West has an ethically pure balance sheet in its dealings with repressive regimes across Africa, Latin America, the Middle East and Southeast Asia. Indeed, Beijing doesn't really have any option but to play its game at a time when some argue that global mastery of oil is potentially shifting from the West to the East.

Clearly, a strategic presence across multiple producer states provides China with some useful bargaining chips down the line should it need to cash in some assets in order to retain others.

Being regarded as a good “international citizen” would certainly be nice for China. But it isn’t essential right now. Beijing's core concern is that some of its spread bets on natural resources convert into winning tickets in time to meet domestic energy demand.

Therefore, China's focus is still very much on striking more supply-side contracts with politically shaky regimes.

Beijing's strategic goal is to guarantee plentiful and reliable supplies of natural resources, not to stabilize producer states already doing business with it. Creating stability in supplier states is still only seen by Chinese policymakers as a far-off potential option to be seriously considered (if at all) only after concessions have been signed for and Beijing's market dominance is secured.

Such a strategy is entirely understandable to increase and secure China's “energy space” in the world. But this strategy may well prove to be ultimately flawed.

For the supply clock is ticking down for the Chinese Communist Party. Reserves simply have to become production for the Chinese, but as any political risk analyst will tell you, political instability simply does not augur well for long-term, stable supplies.

If China assumes it will be able to find a “magic button” capable of turning bastions of instability to oceans of calm just at the critical point when it needs the oil to flow thick and fast, it is likely to be disappointed.

China has put the energy cart in front of the stability horse to secure long-term reliable supplies.

But this strategy means Beijing is increasing the bargaining power of producer states to play fast and loose with contractual terms. The Chinese therefore face the future prospect that production of their vital materials will be disrupted when previously stable regions are faced with growing and unresolved regional or geopolitical tensions.

Once that starts to happen, we should expect China's current “non-intervention” norm to die an early death — from a diplomatic perspective at the very least.

A credible Plan B?

China does have something of a Plan B. It has been building stronger relations with energy powerhouses, most notably Saudi Arabia, Kuwait and the United Arab Emirates — all nations that do have a long track record of delivering the goods to major customers.

But even here, it remains uncertain that such supplies will stay online if China continues to nudge Iran towards the nuclear brink. Arab states still put politics ahead of oil on crucial issues. This is a factor that Beijing will have to consider as the cheapest, largest and most easily accessible global oil reserves remain in the Gulf region.

Clever use of joint ventures by putting local energy players on the political front line in Africa also appears a canny option for Beijing to hedge its political and reputational risks.

But that approach assumes that local companies like Sonangol, the partially state-owned national oil company of Angola, will be more adept at steering African countries in which they operate towards greater stability and at securing long-term oil production than Beijing itself would be. Instead, “using proxies” this way could complicate regional politics further.

Therefore, as China's global energy footprint grows, Beijing can no longer afford the luxury of remaining politically aloof from its major commodity suppliers.

Consequently, it is critical that Chinese strategists understand the local and regional contexts within which their energy companies are operating and the broader strategic implications of their activities.

Western diplomats and interlocutors should not try to make this case to the Chinese on some spurious grounds of supporting international order, as that would be massively hypocritical of the West to suggest.

However, the case for conducting a more politically responsible foreign policy towards supplier nations could be suggested, but purely in terms of the Chinese Communist Party's own survival.

In conclusion

While it might look politically appealing in the short-term to sign new energy deals, planting the Chinese flag in resource-rich states could prove disastrous for Beijing if such actions generate growing instability.

The Chinese need to learn that the natural resources they need could remain buried in the ground if “above-ground” political risks are ignored for too long.

China is racing between time (bringing oil reserves and other natural resources online) and space (increasing its global footprint in politically broken states). Ultimately, that race will be lost if the instability paradox is not resolved.

Currently, China's leaders do not worry about growing instability in their producer states. The challenges of energy (in)security will only become a major issue for them when the messy political realities of energy geopolitics play out.

But there is still time for Beijing's policymakers to learn that treading more carefully now could pay significant dividends for their country in the future.