IEA Economist Speaks on China's Oil Conundrum

After blistering economic growth over the past decades, China has become the world's largest energy consumer and second-largest oil consumer. In the World Economic Forum held in Davos, Switzerland in January, Caixin talks to Chief Economist of Fatih Birol, chief economist at the International Energy Agency, about China's oil imports and oil price reforms, as well as the ideal conditions to propel domestic growth of renewable energies.

China's oil consumption has risen significantly in recent years, increasing by 5% year-on-year in the first 11 months of 2011, according to the National Development and Reform Commission. As China needs more oil to power its rapid economic growth and industrialization, a reduction of consumption, or even a slower growth of that, is not likely.

In this interview, Dr. Birol spells out the obstacles China faces in securing oil supplies, the need for it to improve energy efficiency, the challenges for alternative energy in the country, as well as the impact of geopolitics on the world's oil supply.

Caixin: We know that China has become the second-largest oil consumer in the world. For China, how can China secure its oil sources from the world?

Birol: I think there are two, three things that China can do. First of all, in China, most of the oil is consumed, used in the transportation sector: cars, trucks and so on. And still, they are not very efficient. China can improve the efficiency of the cars so that they use less oil and oil is saved. This is one. Second, today in China, car ownership levels are very low. For example, in Europe, 500 persons out of 1,000 persons own a car.

In the United States 700 persons out of 1,000 persons own a car and in China only 30 persons out of 1,000 persons own a car. So Chinese will buy a lot of cars with the increasing income levels and money in the pocket for convenience and prestige reasons. So it is important that China looks at the alternative car technologies, such as electric cars, such as hybrid cars and others. So this is the second thing. Third, China also needs to look more and more to public transportation means, to make it much more attractive for Chinese citizens. These are the areas that China can do on the demand side.

On the supply side, China is making a lot of effort to increase its own domestic production, but it is very limited. But at the same time, China has a very good policy to have a lot of access to some oil producing countries, such as in Africa or even in North America, to secure supplies. This is also very good. And the final issue is oil and geopolitics are becoming more and more interwoven. We may see, as we did in the last years, sudden supply disruptions of oil. And as I said, more than 90% of the growth in oil production will need to come from only a very few number of Middle East countries. And we all know that the Middle East is going through a very difficult time period.

So I think it will be very interesting if China puts more and more emphasis on having stocks, building stocks at home. China is already doing it, but acceleration of these efforts would be very important, and I know that the International Energy Agency, my agency, works very closely with the Chinese government and they have a lot of interests, common interests, in that respect to build stocks for oil. So to sum up, there's a demand side, what China can do to slow down the demand growth, and the supply side to get more supplies domestically and outside of China, and finally, to find a solution to the sudden supply disruption, a stocks building policy is very important.

Caixin: Like you said, another thing is China's oil prices domestically and energy prices overall are almost completely controlled by the state and also the state-owned companies. From the demand side, do you think those reforms need to happen in those areas?

Birol: Definitely. Because if the prices are not in line with the international prices, it is a way to give protection to consumers. And if it is cheaper than its real value, consumers will use it in a wasteful manner. Therefore, it is very important that the oil product prices, it can be gasoline or diesel or LPG, would reflect the international oil prices, and I'm sure Chinese government will take some steps in order to reform the markets in that direction.

Caixin: Like you said, China has a lot of corporations with the IEA. Do you think China should also join the IEA, become one of the members of the IEA?

Birol: I hope one day. I would be delighted to do so. However there are still some problems. There are still some areas to be looked into together, but we work very closely with China, lots of cooperation in the energy policy, energy analysis, and technology. These are building stocks through the way going towards a membership. But I think we still have some ways to go to have China as a member of IEA. For the time being, joint work is going very well, and therefore, I appreciate the Chinese government's effort in that direction.

Caixin: Can you take some examples? What areas we should work together more so that process could be smooth?

Birol: Exactly. For example, one of them is the stocks we have discussed. This is a very good joint work there. Second, IEA member governments went through many reforms in their energy sector. Some of them did right things; some of them did wrong things. When they did wrong things, they reform it again, re-reform it. There are a lot of experiences, and we can easily share this experience with the Chinese so that they don't make the same mistakes that we have done, so this is a second one. Third one is our member governments and the industries in our countries are developing a lot of energy technologies. We should share these experiences with China. This is also very important. Fourth, we are having international dialogues with many producing countries, consuming countries. And it's been very important to have China play a key role in that respect as well. We can all together, I think, in those meetings, in those dialogues, have much more meaningful approaches if China is there. If China is not there, whatever we decide, whatever we talk, will have less weight.

Caixin: Like you said, it's more about the geopolitics these days. How do you see the so-called Arab Spring will affect the world oil market?

Birol: When it comes to energy, I have some concerns. Because, as I said, most of the growth in the world needs to come from that region because outside of that region, oil production is in a decline. The growth needs to come from there. However, in order for production to increase, we have to invest; we have to make an investment there. But I see that some governments are changing their mindsets in terms of investments. For example, some governments are now putting the money on some social, additional social spending, for additional unemployment benefits, subsidies and infrastructure things in order to please their people. Some governments are postponing their investment decisions in order to leave the oil for the next generations. So I am a bit worried that what happened in the Arab Spring leads to slower than expected growth in oil production from that region and therefore, we will have tighter oil markets and therefore, we will see higher prices than now.

Caixin: So talking about investment, can China play a role in this, helping these countries to invest?

Birol: I think China is one of the very few countries who can go and invest in these countries. However, there are two problems. One of them is in some of these countries, it is by constitution forbidden for foreigners to go and invest, some of these countries. They cannot do it. It is only the nationals, national oil company of these countries can do it. And second barrier I see is that some of those countries, they want to increase the investments much more slowly. But when I look at the world, if I look at the rich countries, if there's an opportunity in Middle East which rich countries can go and be able to put money and accept it, their nations accept it by those countries, China comes as the first country to my mind.

Caixin: We also hear some complaints from the Middle East countries and African countries that they see Chinese investments as predatory. Since sometimes China's state-owned companies coming and getting the resources out, and they don't care too much about the local people, local markets there. How should we see this problem and how can Chinese companies improve?

Birol: I think there are some rules, international rules, which are not legally binding, but it is important that all the countries behave in a socially responsible manner, this can be a Chinese company, this can be an American company, this can be an English company. I am sure Chinese companies by the time will improve their social responsibility footprint. However, this can be improved. What cannot be improved is that if you don't have money to invest, you don't have money to invest. You can't find the money. But Chinese companies have the money, but they are very strong. But they have to improve how they operate. They have to learn from their mistakes and I am sure those countries in Africa or in the Middle East will be very happy to have Chinese money or other money, because money doesn't have nationality.

Caixin: I have to come back to geopolitics again because Iran right now is a big issue there. So how do you expect that this issue would develop ahead?

Birol: As I said, I am not a politician. I don't know what will happen. However, I know that there are countries who get a lot of oil from Iran currently. But the good thing is the embargo which is going to be set for Iran will be in effect as of July 1st and there is a lot of time between now and July 1st. Some key Gulf producers said that if there is a need for additional oil in the markets, they are ready to provide this oil. And therefore, I think countries who would like to get more oil as a result of, if there is a problem with Iran, they will be able to make the agreements in time, they have enough time. There is enough oil to solve this problem. But I hope this problem will be solved in a peaceful manner.

Caixin: Does that mean that there will be a bigger opportunity for China and OPEC countries to cooperate together?

Birol: Definitely. I think what I see is that even if we leave the current geopolitical issue aside for a moment, I see that there will be a major new trade access being built between China and the Middle East. This will be perhaps the most strongest trade access of all of our times in terms of oil exports from Middle East side and oil imports from China side. And I hope this trade will also improve further relationship between China and the Middle East. The recent visit of Chinese Premiere to the Middle East is a good example for that. When he was in Abu Dhabi and when he gave his very good speech, I was in that meeting and I think I heard all the good signals that the Chinese are very keen to improve this relationship for the Middle East countries and that it also once again highlights my point that the trade between China and the Middle East will be a crucial one, for these two countries and also for the global trade.

Caixin: Just now you also said from the supply side, maybe China should develop more on alternative energies. But the thing is we hear everybody is talking about alternative energy, new energy, clean energy, but it seems that the market conditions are not there for this market to be a self-driven, self-fulfilling, it can run by itself. What are the obstacles or what are the problems there?

Birol: The main problem is cost. Cost is the main problem. For example, China is one of the leaders of the renewable energies; wind, solar and others. However, wind cannot compete with coal if there is not government support. When you just compare the cost of it, there is a major difference there. Therefore, if the Chinese government would like to see more renewable energies, they have to support further with subsidies for the renewable energies, otherwise it wouldn't work.