May 2005
Energy Issues in U.S.-PRC Relations
The growth of China’s economy and energy consumption have played an important role in recent increases in petroleum prices--and this may be only the beginning of long-run changes in global energy markets resulting from Chinese growth. How are the governments of the People’s Republic of China and the United States addressing new challenges in energy policy, use, and conservation, and how will their policies affect larger economic and security issues in U.S.-PRC relations? Experts from the PRC’s Central Committee Party School (CCPS) and from AEI, joined by former U.S. secretary of energy Spencer Abraham, discussed these issues as part of AEI’s annual meeting with the CCPS on May 9.
James K. Glassman
AEI
In the current issue of Fortune, Daniel Yergin writes that “the global oil industry was not prepared for last year’s supercharged increase in demand. Global economic growth of five percent propelled a surge in world oil usage of 2.5 million barrels a day, more than double the average annual growth between 1994 and 2003. Part of that growth--about 500,000 barrels a day--was in the U.S.,” Yergin writes, “most at the gasoline pump. But 930,000 barrels, nearly 40 percent of the rise in global oil demand, came from China. And it’s not just cars. Oil is China’s quick fix for generating electric power in the face of coal shortages and blackouts. China is in shock from becoming so dependent on the world oil market so fast.”
That spike in demand could have major consequences for many parts of the world, including the United States. Today we will consider what China should do to meet its energy needs, how China’s actions could affect the rest of the world, and whether the United States should do anything to help.
Energy is the driving force of the modern economy and is essential to economic growth. It is no different from any other resource: its price is subject to the laws of supply and demand, and has risen in the face of supply constraints imposed by governments and geopolitical conditions. Yet this does not imply an exhaustion of resources. As the late Julian Simon daringly wrote in 1981, the statistical history of energy supplies shows a trend toward plenty rather than scarcity. The Stone Age did not end with the exhaustion of stones, nor will the oil age end with the exhaustion of oil.
Consumers in democratic market economies constantly search for ways to use energy more efficiently and with less damage to the environment. The United States has had considerable success here: between 1970 and 2003, U.S. GDP grew 176 percent and vehicle miles increased by 155 percent. Yet over the same period, energy consumption grew only 45 percent and total emissions of six principal air pollutants dropped by 51 percent. There is no reason that China cannot replicate such success. Indeed, China should be able to perform better, benefiting from the technology and learning from the experiences of public policies that have gone before.
Zhenhua Zhao
CCPS
China’s energy reserves account for nearly 11 percent of the world’s total, and output has grown considerably in the past few decades. And although China has made progress in energy conservation--economists estimate that China conserved 1.26 billion tons of coal between 1981 and 2002--the world’s advanced economies are more efficient in their energy consumption.
China relies primarily on coal and petroleum but has begun to invest in renewable energy sources. Studies show that wind can generate enormous amounts of power, and China has installed more than forty wind power generation plans. Still, wind power accounts for only a fraction of a percentage of China’s energy consumption, far less than that of the United States, Spain, India, and Germany. China has the greatest hydro resources in the world but has yet to exploit those resources to their fullest potential. Solar and biomass energy sources are also being explored, but to this point have barely been utilized.
Energy enterprises in China are not consistent with a market economy. Competition in the coal industry is intense but disordered, where small mines compete at the expense of efficiency and safety. In other industries, such as electric power and petroleum, the presence of oligopolies or government planners has led to too little competition. China is also out of step with the international market, where a price integration in crude and refined oil has yet to be realized. Doing away with the outdated management mechanism, which has compromised efficiency, and nurturing new talents and advanced technologies would put China on track for a better energy system.
The Chinese government has unveiled new laws and regulations on energy resources, including one laying the basis for exploitation, utilization, and protection of renewable resources, which will take effect on June 1, 2006. The Renewable Energy Law of the People’s Republic of China provides priority tax treatment and financial support to renewable energy projects. The government has also implemented new policies to encourage rural areas to use clean energy resources, such as biogas, solar water heaters, and solar cells.
Environmental protection is becoming a priority in China. Outdated technologies for energy production have contributed to pollution, resulting in acid rain and other environmental damage. This is part of the reason that the government is interested in developing clean energy resources.
The Chinese government believes that international cooperation on energy matters is essential to ensuring a clean and prosperous future.
Spencer Abraham
Hoover Institution
China is not alone in driving the increased demand for energy. Recent estimates suggest that in the next two decades, worldwide demand for oil could increase by more than 50 percent, demand for electricity by 100 percent, and natural gas by 67 percent. This means that the high prices are probably going to continue--that the theory that high prices will lead to corrections on both the supply and demand sides may not be applicable here. This is because many countries will constrain production in an attempt to meet environmental goals, and many consumers will not slow consumption in response to higher prices.
The United States and China have been working together on energy issues for a few years. We launched a U.S.-China Energy Working Group between the U.S. Department of Energy and its counterpart agencies in the PRC. We have also developed a joint venture to make the 2008 Beijing Olympics environmentally sound and are contributing to that effort with technology and consultation. We have worked with various agencies in China to assist in energy efficiency and new technologies.
Agencies in China and the United States are working together on renewable energy projects, clean coal technology, and carbon sequestration technology research. The United States has had excellent success in improving energy efficiency, and we are working with China to explore new technologies and strategies that will increase efficiency in both countries. Fuel cell research is also underway, and could be a promising alternative to traditional energy sources in the future.
Fuel diversity is imperative. It is worrisome to have a world marketplace so fixated on oil and natural gas. It is also critical to preserve our abundance of coal resources, which is why clean coal technology is so important. Renewable energy and hydrogen technology could play a significant role in the future. It is also important to understand that it will be virtually impossible to meet the projected growth in demand if nuclear energy does not become more widely used. The emissions targets put forth in the Kyoto Protocol and those suggested by the president can only be achieved by sacrificing significant economic growth unless nuclear power plays a much more dominant role. This again is a possible area of future cooperating between the United States and China.
Kevin A. Hassett
AEI
Malthusian tendencies are especially potent with regard to energy because energy is legitimately important, and history shows that price spikes can have serious economic consequences. High oil prices do cause recessions, but they also encourage conservation better than a government campaign ever could.
Economic literature has found that oil prices affect the economy in an asymmetric way. Sharp increases in price reduce growth, but sharp declines do not increase growth at all. Nine out of the ten times that we have had an oil price spike has been either during or just before a recession. Interestingly, the current spike has not yet caused a recession. Past spikes have been caused by a disruption on the supply side, but this one came about because of soaring demand, which may explain why we have not had a recession to this point.
Bill Gale of the Brookings Institution and I recently wrote a paper exploring why output declines after a sharp spike in oil prices. We concluded that business-fixed investment drops significantly because uncertainty about the direction of prices causes firms to delay the purchase of new capital. As the price path resolves itself, the problem dissipates. If the price stays high, businesses will invest in more efficient equipment. Uncertainty, not high prices, is responsible for these recessions. Higher prices will guide firms and individuals to rational investment decisions and increased demand for alternative sources of energy. There is no reason to expect that the long-run output path is going to be dramatically different or lower because of costly energy.
Xiaojun Ma
CCPS
Except for Brunei, Vietnam, and Indonesia, East Asian countries are oil importers. Rapid development in the region has caused an enormous increase in consumption--in fact, consumption in Northeast Asia has surpassed that of the fifteen EU countries and approaches that of the United States. And while East Asia consumes 27 percent of the world’s oil, production in the region accounts for only 9 percent of the world’s supply.
Petroleum is an important strategic material. Historically, the supply and pricing of oil is not only controlled by economic rules, but by political factors as well. Producer countries can use oil as a weapon in foreign relations, as OPEC did during the Arab-Israeli War. Today, globalization has made it more difficult to predict how politics can effect oil supplies. Since the war in Iraq, the United States has tightened its control of the Middle East and is now pressuring Iran, another major oil producer, which creates uncertainty about oil supplies to East Asia. Terrorism and piracy can also disrupt supplies, especially for the Asian nations that receive much of their oil by sea transport.
East Asia does not have a strong position on energy issues internationally. The 1974 agreement that established the International Energy Agency (IEA) has allowed industrialized countries to negotiate with OPEC and avoid malicious competition among oil importers, which creates more stability in the oil market. In East Asia, however, the lack of cooperation on energy issues has hindered the region’s ability to influence prices. Clearly cooperation in the region is necessary to promote stability and negotiate effectively with oil producers.
Unstable relations in East Asia are to blame for the lack of cooperation on energy issues. Japan has never expressed regret for World War II in the way that Germany has, and Japan has often incited anger and demonstrations in other East Asian countries by hiding, and even glorifying, its war crimes in the history books. Sino-Japanese relations are cool politically, although hot economically. Territorial disputes are also a factor, and the resulting lack of trust has made it difficult to compromise on energy issues.
Japan’s arrogance is most evident in its reaction toward China’s development. Since the 1980s the Japanese economy has been stagnant, while China has maintained a high rate of growth. Japan has adopted a tough attitude toward South Korea and China, especially on matters of energy. This is why Japan paid a high price to persuade Russia to set aside its construction of an oil pipeline to China. If China continues to rely on Middle East oil, it could severely restrict economic development.
The United States is also a major player. Reinforcing its control of global energy resources is a way for the United States to contain challenges from other countries. To reinforce its control of production, the United States initiated the war in Iraq and fought with Russia for oil in the Caspian Sea region. If East Asian energy cooperation is realized, both Japan and South Korea will have to consider the reaction of the United States.
Energy cooperation is not an urgent issue for Japan. Although Japan relies solely on oil imports, the country has established a secure oil import system. Japan has maintained good relations with Middle East countries, and its sea transport of oil is superior to China’s. Japan is also a member of the IEA, which serves as additional insurance for its oil supply. Although the Japanese do not see East Asian energy cooperation as an urgent priority, Japan certainly would not want to be excluded from any such cooperation.
East Asian energy cooperation would make Russian imports easier to obtain and would encourage the countries to work together to secure the Malacca Strait by cracking down on terrorists and pirates. The region has experienced rapid economic development in recent years and now cooperates regularly on trade and investment. This could clear the way for increased cooperation on energy matters as well. Indeed, some steps have been taken in recent years that point to a trend of better relations in the area, and it appears likely that the countries will work together to achieve common goals for the good of the region.
Newt Gingrich
AEI
If oil prices rise and stay high, it is because somewhere in the world there is someone who values oil enough to pay that much. There is no natural price of oil just as there is no natural price of coffee--but the price of both commodities reflects their value as defined by consumers. Rising oil prices, of course, send a signal to energy producers, which will lead to substitutes for oil that will cause the market to rebalance.
We should consider if we are, in Peter Drucker’s term, entering a “discontinuity.” We have been in discontinuities before: moving from a wood-based economy in London to a coal-based economy ultimately led to the invention of the railroad. Moving from coal as a source of ship fuel to oil in the late nineteenth century had enormous implications for the Royal Navy, the U.S. Navy, the Japanese Navy, and others.
I believe that the focus on East Asia is overdone. East Asian leadership in a world energy market may be only of limited value. The real fixes are likely to come over time from technology and entrepreneurship. The wrong government policies could prevent the rise of development, and so it is important that politicians create the right incentives and investment strategies.
Professor Ma was exactly right in saying that oil is more than just an economic commodity. It is impossible to read the translation of the Japanese imperial minutes in 1941 without understanding that Japan felt that its survival was at stake when the United States cut off the sale of oil. They reacted by launching the Southern War. I am not defending the Japanese, but I understand that they saw oil as a life-and-death issue.
There is a danger in China building up a navy so large that it could protect the flow of oil from Persian Gulf. A navy of that size will be seen as a threat to the United States because we analyze capabilities, not intentions. The other option for China might be to sign an agreement that the United States will protect the oil supply, and to refrain from taking any action as long as we keep up our end of the deal.
I have no intention of suggesting that we meddle in Chinese internal affairs, but I have one thing to say about Taiwan: a Chinese effort to militarily coerce 24 million free people would almost certainly be interpreted as the equivalent of the remilitarization of the Rhineland in 1936 or the occupation of Belgium in 1914. The view would be that a China so aggressive that it would conquer 24 million people militarily is a China better stopped now than later. If the Chinese people and the American people grow closer together, if we respect each other and work with each other, the future of the human race looks terrific. If we collide in a big way, it will be a mess comparable to the two world wars.
AEI research assistant Courtney Richard prepared this summary.
