China's Historic Oil Deal with Somalia 5 Years Ago Today

The Financial Times reported on July 13 that the Chinese National Offshore Oil Corp (CNOOC) had signed a deal with Somali President Abdullahi Yusuf to explore the northern Puntland region for oil. The initial agreement was signed in May, and it was endorsed at the China-Africa summit held in Beijing last November.

A meeting between CNOOC and Somali officials was held on June 24 to finalize the deal. The terms indicate that the Somali government would retain 51% of the oil revenues under a production-sharing arrangement. Further reporting from The Financial Times, however, revealed that Somali Prime Minister Ali Mohamed Gedi was not aware of the contract, suggesting that the oil deal remains vulnerable to political infighting.

China's willingness to invest in Somalia – before the Transitional Federal Government (TFG) completes work on a national oil law and as the security situation in the East African country continues to deteriorate – shows that Beijing has not been deterred by the growing backlash across Africa at Chinese policies and remains willing to take on political risks that Western firms will not tolerate.

Threats to China in Africa

Chinese investments have come under attack in recent months, and a general wariness about closer ties with Beijing has become part of the political dialogue in most African countries where China does business. Days after the June meeting in Somalia, a Chinese mining executive was kidnapped in Niger. The incident followed the killing of nine Chinese workers in Ethiopia, near the border with Somalia, in April. Chinese workers have also come under attack in Nigeria in recent months.

Politically, Chinese investments have become a touchy subject. Michael Sata's opposition campaign in Zambia received strong backing after he attacked Chinese investments and threatened to renew ties with Taiwan. He ultimately failed in his bid for the presidency, however, after China threatened retaliatory measures if he was elected. Similar complaints have been raised in Nigeria and South Africa.

China began this year to address the growing unease in Africa toward its investments. President Hu Jintao in February visited Zambia and South Africa, where he pledged further investments and a greater focus on community development plans. China has also publicly used its leverage in Sudan to press Khartoum to accept the terms of last year's United Nations Security Council resolution on the Darfur crisis.

Nevertheless, China's fundamental goals in Africa have not changed. China is looking to secure access to the natural resources it needs to keep its economic expansion humming, as well as support for its policies at the UN. The CNOOC deal in Somalia is evidence that China's appetite for risk has not decreased as it pursues these goals in Africa.

Investing in Somalia

Somalia has no proven oil reserves, and only 200 billion cubic feet of proven natural-gas reserves. Companies including Agip, Shell (Pecten), Conoco and Phillips (now merged), and Amoco (now part of BP) spent more than US$150 million on onshore exploration in the 1980s and early 1990s, but no oil reserves were discovered. Still, Range Resources, a small Australian-based oil firm with close contacts to the government in Puntland, estimates that the region could hold 5 billion to 10 billion barrels of oil based on an analysis of the previous exploration reports.

Puntland province claims autonomy from the government in Mogadishu, but not independence like Somaliland. The region has been relatively calm compared with central and southern Somalia since 1991, but the political situation remains uncertain. President Yusuf was certainly involved in the negotiations with the Chinese firm, as he hails from Puntland province and maintains close ties with the local leadership, but the prime minister of the TFG was left out of the loop.

The fact that Prime Minister Gedi was kept out of the negotiations suggests that the terms of the deal are not beneficial to the TFG or Somalia's other provinces. This could exacerbate already strained ties between Gedi and Yusuf.

Gedi appears to have led an effort within the TFG to pass a national oil law that would allow Western firms to return to Somalia under production-sharing agreements, which require oil firms to share their production with the government after initial costs are covered. He told the Dow Jones Newswire in April that a national oil law would be passed within two months, a deadline that has slipped.

The oil law in question seems to be similar to the one pushed in Iraq by the United States, which has also not been passed. China may have wished to sign the deal for exploration rights in Puntland before the law was passed, to avoid competition with Western majors, but the emergence of a national oil law could threaten the investment.

The fact that China would enter an agreement in such an uncertain legal and political environment, to say nothing of the security concerns, shows that it is still willing to take on risks that the Western oil majors cannot tolerate. This remains the main competitive advantage for China in the race to secure natural resources around the world – while Chinese firms do not have the technology to drill in some of the conditions that Western firms can, they do not have the same political and financial constraints that prevent them from investing in regions considered off-limits to Western firms.

Last month, for example, China National Petroleum Corp (CNPC) signed a deal to co-develop an offshore block in Sudan, where China has been the dominant player in the oil sector after sanctions caused Western firms to suspend their operations or pull out completely. Sudan now supplies up to 10% of China's oil imports. In Angola, China provided $2 billion in soft loans to the government that allowed it to avoid implementing reforms requested by Western donors. In return, Angola ensured that it would provide continuous oil supplies to Beijing.

CNOOC said this year that it would boost output to 78 million tonnes from 40.3 million tonnes last year. To maintain growth rates near this level, Beijing will need to continue to help its oil companies invest in regions where Western firms cannot. This means that China will fund infrastructure projects in countries under Western sanctions, such as Sudan, or where security concerns dissuade Western firms from investing more, such as Nigeria.

The decision to invest in Somalia's Puntland region is part of this strategy. Only a small firm, such as Range Resources, would be able to take on a similar risk level, and that firm has spent several years courting the local government officials there. With the financial and political backing of the Chinese government, CNOOC and CNPC have a distinct advantage over the smaller Western firms.

Conclusion

China's move into Somalia's oil industry is a further example of its strategy for securing access to natural resources around the world. Rather than purchasing oil on the global markets, as the US does for the most part, China prefers to secure control of the resources it needs at the source. However, because China's oil firms lack the technical capabilities and political clout of the Western majors, Beijing prefers to deal with regions that are out of reach to the competition.

This practice has sparked a growing backlash across Africa to China's policies. Many locals see Beijing's actions as protecting corrupt and often dictatorial leaders. Beijing has attempted to counter this perception recently by investing in infrastructure projects in regions where the backlash is strongest, leaking reports of its unhappiness with the most controversial leaders, and granting local businesses better access to China's markets in some industries.

The investment in Somalia's Puntland province still looks risky, even by Chinese standards. The deal appears to have been struck with the local officials in the province, which claims autonomy from the transitional central government. However, the president of the TFG, who is from the region, was involved in the deal. The prime minister of the TFG appears to prefer another model to attract investments, passing a national oil law that will clarify the legal questions that prevent Western firms from returning to Somalia. The Chinese deal may well fall victim to the political infighting that is likely to follow.

Still, the TFG's claim to control Puntland appears to be weakening as the central government remains frozen in a state of political collapse. Two days after The Financial Times first reported about the Chinese oil deal, the much-awaited national-reconciliation conference had to be delayed because security for the meeting could not be guaranteed in Mogadishu.

Given the TFG's uncertainty, Beijing's decision to work with the local representatives in Puntland may well prove to be enough, and China could soon be pumping Somali oil, if it even exists.