Market Forces Rule

I see China’s Commerce Minister, Chen Deming, was in Riyadh last week. The Saudis might as well leave the red carpet unrolled, so common are visits by Chinese officials. It isn‘t surprising, of course, given China’s thirst for oil.

But I would resist the temptation to claim a special strategic relationship between the two.

I‘ve spent the past few months researching a chapter for a book, sponsored by the U.S. Naval Academy, on China’s relationship with Saudi Arabia. Most of that time has been spent talking with oil analysts─the sort of people who live and breathe this stuff. The conclusion? Market forces rule.

It’s a remarkably simple explanation. Saudi Arabia needs to sell vast amounts of oil every day. China needs to buy much the same. Both countries have large domestic challenges, so they are looking for stable partners happy to sign long-term contracts and, most importantly, not provide any surprises.

Why would Saudi Arabia want to lock itself into long-term contracts? It sounds odd with oil prices rising steadily. But it would be a mighty task to try and sell 9 million barrels of oil, or 12% of the world‘s supply, into the market every day, negotiating with customers, signing contracts, and arranging transport.

It’s also for this reason that Saudi Arabia only sells to end-users, rather than traders. This way it has a better sense of real, as opposed to speculative, demand. After all, the last thing an oil producer wants is to be dependent on speculative traders whose demand might vanish overnight.

And that’s the appeal of China. It buys almost exclusively for end-use.

It also helps that the United States simply isn‘t buying as much oil these days. Its oil demand peaked in 2005 and has fallen around 1 million barrels a day since. So, even if Saudi Arabia wanted to sell more oil to the United States, it would struggle. China has stepped up to neatly plug the gap.

And it’s going to keep plugging that gap.

China’s oil demand will grow by 9 million barrels by 2030, according to the International Energy Agency’s latest forecasts, accounting for or 43% percent of the increase in world demand. The Middle East’s oil supply will meanwhile grow by 14 million barrels, accounting for 64% percent of the increase in world supply.

Now, China is attempting to restructure its industrial sector to conserve energy. But not fast enough. And while the Middle East already accounts for one in every four barrels of China’s daily oil consumption, it’s going to account for an even larger share in the future just as fears harden that the world is running out of oil.

Indeed, I was intrigued to read this article, by the UK’s Guardian. It was published in November, the day before the International Energy Agency’s annual report, and quotes unnamed officials as saying the agency has been deliberately understating the world’s oil reserves for years, to avoid creating a panic.

“Many inside the organisation believe that maintaining oil supplies at even 90 million to 95 million barrels a day would be impossible but there are fears that panic could spread on the financial markets if the figures were brought down further”, says one official.

Scary stuff.

If it’s true, then market forces, not strategic interests, will do an even better job of explaining China’s strengthening relations with Saudi Arabia in the coming years. It’s also no surprise that China’s Commerce Minister decided it was time to make the trip to Riyadh. It’s not going to be his last visit to the region.