Commentary uring the past year, China’s state- induced price fluctuations. The result has been owned oil and gas sector has been a campaign by China’s major energy players Dstriving to secure reliable, long- to conclude contracts with producers term sources of foreign energy capable of overseas and to finance new developments, sustaining strong industrial growth and both for crude oil and natural gas. The most consumer demand. From Australia to significant of these was a June agreement to Kazakhstan, Siberia, Papua, and even the deliver 30 m tons of oil per year from Siberia Sudan, Chinese energy companies are to China’s northeastern industrial heartland by building a network of suppliers that will not 2010, via a yet-to-be-built US$1.7 b pipeline. only have a major impact on the global Another involves an August 2002 agreement petrochemical and gas industry, but reshape to import US$16.6 b of the security environment of Asia. This (LNG) from Australia’s North West Shelf initiative is fuelled by the perception by over 25 years beginning in 2005. China, and shared by other Asian governments, that in the wake of the Iraq conflict, dependence on volatile Middle Industry giants like ExxonMobil and Royal East oilfields must be reduced. In China, Dutch/Shell are competing to invest in analysts expect annual GDP growth rates extraction and distribution projects that feed Canada Asia of 7-8% to continue through to the end of the Chinese market. Meanwhile, the clout of Number 30 the decade. A net importer of crude since state firms like the China National Petroleum August 2003 1993, China is already the world’s third- Corporation (CNPC) in the world largest oil consumer (262 m tons in 2002) marketplace is skyrocketing as China after the US and Japan, and second-largest prepares to become the globe’s dominant importer (92 m tons). By 2010, the energy consumer. But the greatest impact of OECD-affiliated International Energy these developments may well be felt in Agency (IEA) estimates that oil imports political-security affairs, as oil and gas traffic will reach 209 m tons, and account for more from Central and Southeast Asia comes to than half of domestic consumption. Without feature more prominently in China’s military diversifying the source and types of energy calculus, and interdependence with rising it consumes, China will be dangerously suppliers like Russia, and Australia exposed to supply disruptions and OPEC- reduces the likelihood of regional conflict.

China’s Quest for Energy and Northeast Asian Security

Asia occupies a uniquely precarious position among the world’s energy Canada Asia Commentary consumers. The region must import 63% of its oil requirements, much of it from politically is published up to 12 times a year and is unstable areas. For instance, of OPEC’s 11 members, who collectively account for one- available by e-mail and third of global oil production, only four (Kuwait, Qatar, Saudi Arabia and the United Arab on the APF Canada Website: Emirates) enjoy relative social and political stability. Asia’s vulnerability was brought to www.asiapacific.ca the fore during the US-led invasion of Iraq in March: the latter’s daily export of 1.7 m ISSN 1481-0433 barrels was interrupted and world crude prices were briefly pushed close to US$40 a barrel. It is difficult to overstate the impact of such price and supply fluctuations on the Launching a strategic reserve Asian economy. Only net energy exporters Indonesia, Malaysia, Brunei One shorter-term means of avoiding and Australia are self-sufficient. All OPEC-induced price shocks that China is others must pay a premium to Middle considering involves establishing a East suppliers for their high degree of strategic oil reserve similar to those in the US and Japan, which can protect against dependence on this source (88% of 90 days of import disruption. The Chinese imports in the case of Japan and 58% for plan – approved in principle in February China). As a result, oil imports account 2003 – would see a 30-day reserve of 59 m for an average of 4% of GDP among barrels established by 2005 (by contrast, Asian countries, with Singapore’s import the US stockpile currently sits at 609 m dependency running as high as 7.6%. It barrels). Unlike its actions during previous is estimated that in South Korea, whose supply threats, Beijing is rumoured to have dependency rate comes in at just under set aside some reserves prior to the conflict in Iraq, but analysts believe it is 5%, every US$1 increase in the price per likely that the government will wait until barrel adds US$750 m a year to prices drop below the current range of production costs and reduces GDP growth US$27-$30 a barrel before completing this by 0.1 percentage points. With the IEA US$1 b-plus task. predicting that 40% of global growth in energy use between now and 2025 will come ! from developing Asian countries, the region’s vulnerability seems sure to increase.

China’s energy China is perhaps the most vulnerable. A net importer of crude oil since November 1993, needs are soaring the world’s most-populous country has witnessed a sustained boom in industrial growth and consumer demand over the past decade. Double-digit annual GDP growth rates in southeastern coastal areas have consistently lifted national GDP growth to between 7% and 8%, and these levels are widely expected to last through to 2010 at least. The consequences of this boom for oil consumption – which accounts for 20%, and rising, of China’s total energy needs – are staggering. This year, Chinese energy demand is expected to rise 2.7%, the fastest increase in the world; overall Asian demand, by comparison, will grow only 2.1% and North American demand 1.8%. The US government’s Energy Information Agency (EIA) expects China to surpass Japan as the world’s second-largest oil consumer next year. By decade’s end, analysts predict it will consume the equivalent of the Middle East’s entire annual output of crude. Not surprisingly, domestic sources, including the massive Daqing oilfields of northeastern Heilongjiang province, are unable to keep pace. What newer discoveries have been made, largely offshore in the Bohai Sea and the Pearl River Delta, are proving minor supplements to overall supply. The future, as government policy-makers have long known, appears to lie in domestic energy source diversification and foreign expansion.

Oil imports help China’s oil and gas majors, cash-rich from multi-billion-dollar New York and Hong Kong meet demand stock listings in 2000, have responded to this imperative with great zeal. Billions have been funneled into exploration, extraction, pipeline construction, and infrastructure development over the past five years – both at home through gas fields in Xinjiang province and LNG terminals along the southeastern coast, and abroad in drilling projects as far-flung as Australia, Sudan and the Caspian Sea. Already, imports have grown from 27% of total oil consumption in 1999 to 37% in 2002 (see Figure 1). They are projected to hit 45% in 2005. By 2030, the IEA believes China will import somewhere in the neighbourhood of 10 m APF Canada - Canada Asia Commentary #30 2 barrels per day (bpd) – slightly less than what the US imports today – accounting for 84% of total consumption. How will this happen, how are Chinese companies positioning themselves to supply what will be the region’s dominant energy consumer, and what are the security implications of these moves?

Reliability of supply As is usually the case with petroleum – particularly in a country whose oil giants are a security concern majority-owned by the state – new large-scale developments and shipping contracts have a significant impact on military planning for the consuming nation, and on political relations with the supplier. While Chinese firms are not obsessed with shipping every last drop of oil they can find back to China, the nature of state control over this sector means that, in the event of some future energy crisis, Beijing could well direct them to do so. The centrality of reliable oil and gas supplies to China’s continued growth and well-being, combined with the government’s well-publicized push to establish itself as a major player on the world stage, make this sector an important pointer to China’s long-term strategic designs in the region.

Natural gas stressed There are a handful of projects underway in China aimed at diversifying domestic energy as alternative to coal supplies away from crude oil toward natural gas. In part this is because the development of additional domestic oil supplies has stalled: there is heavy overcapacity at redundant state- owned refineries; upgrades are needed at leading refineries to process heavier grades of Middle East crude; onshore fields in the northeast are maturing and newer offshore fields are small. It is also due to the government’s decision to emphasize the use of natural gas as a substitute for coal, the source of 57.4% of China’s total energy in 2000. Gas burns more cleanly and will help alleviate serious air pollution in major urban centres. With 53.3 trillion cubic feet (tcf) in proven reserves, Beijing wants to more than treble the share of natural gas in the country’s energy mix from 2.5% today to 8% by 2010 – mirroring an EIA assessment that gas will be the fastest-growing share of world energy consumption for years to come, surpassing coal by 2025. Experts are already predicting that China will become the world’s largest natural gas consumer by 2030. The result has been an influx of foreign investment into the sector, with CNPC and Sinopec attracting more than US$1 b in 2002 alone.

Figure 1: Chinese Crude Oil Consumption (million tons)

APF Canada - Canada Asia Commentary #30 3 China’s “majors”: The top three

CNPC (China National Petroleum Corporation) Engaged primarily in oil and gas exploration and production prior to a major restructuring of state-owned enterprises in 1998. Following vertical integration and massive layoffs, it now serves as the industry’s “one stop shop” in China’s north and west regions, though it remains tilted toward crude extraction. Most of its high-quality assets were spun off into a subsidiary called PetroChina, which raised US$3 b during an IPO on the Hong Kong and New York stock exchanges in April 2000. Only a 15% minority interest was offered to the public at the time.

Sinopec (China Petroleum & Chemical Corporation) Engaged primarily in refining and distribution prior to 1998, it is now focused on the country’s southeast, though it remains tilted toward refining. Its New York and Hong Kong IPO in October 2000 – a 15% minority interest – raised about US$3.5 b.

CNOOC (China National Offshore Oil Corporation) Accounting for just over 10% of domestic crude production, it almost exclusively handles offshore exploration and production. Highly active overseas, its February 2001 IPO of a 27.5% interest raised US$2 b. The company spun off China Oilfield Service Ltd., which has been listed on the Hong Kong Stock Exchange since November 2002.

Massive gas pipeline The flagship project is a 3,900-km gas pipeline from remote Tarim Basin in western to supply Shanghai Xinjiang province to Shanghai. At a cost of US$5.2 b, it is the country’s second-largest infrastructure project after the Three Gorges Dam and part of a much larger US$51 b plan to develop poorer provinces in the country’s north and west. Started in July 2002, the pipeline will begin transporting gas next year from the more easterly Ordos Basin in Inner Mongolia before extending to Xinjiang in 2005. China has already solicited heavy foreign involvement in the project: Royal Dutch/Shell, ExxonMobil, and Russian giant Gazprom (the world’s largest gas producer) each own a 15% stake in the pipeline, while British Petroleum (BP) has contributed a preliminary US$500 m toward the US$13 b needed for associated infrastructure. Shell and CNPC have also agreed to continue cooperating in local exploration and production over the next 45 years, to the tune of US$3.3 b. Almost as significant a component of China’s domestic energy strategy have been recent agreements to build terminals along the southeast coast to receive shipments of LNG and ethylene from foreign suppliers. BP has secured the supply contract for a massive LNG terminal in Fujian’s Meizhou Bay and will team up with CNPC to supply LNG to customers in Guangdong. Shell, meanwhile, will split the tab evenly with CNOOC for a US$4 b plant in Daya Bay (south of Huizhou) capable of producing 3.1 m tons of ethylene and other high-grade petrochemicals a year when it comes online in 2005. It is expected that the plant’s US$1.7 b in projected annual sales will be generated by marketing directly to customers in Guangdong and other coastal provinces.

WTO opens the way These developments have coincided with the opening of China’s oil and gas market as to foreign capital required by the terms of its entry into the World Trade Organization. In 2002, urban natural-gas distribution was opened to outside investors and approval given to foreign companies to invest in pipeline construction. By 2004, foreign firms will have unfettered access to the refined oil-product market, with the wholesale market to be opened in 2006. By 2005, duties on oil and gas imports will be reduced to about 6%. President Hu Jintao’s

APF Canada - Canada Asia Commentary #30 4 administration has pledged to simplify application and approval procedures to encourage foreign participation in major projects. As a result, Chinese industry officials expect foreign investment in gas infrastructure, petrochemical projects, and fuel retailing to reach US$5 b this year, trebling 2002 levels. Asia’s Pipeline Plans

Tynda. f

Aktyubinsk 12 a . e 4 Angarsk c . . b .Aktau Daqing . . 8 Nakhodka 2 Baku 10 15 14 . 7 9 Urumqi 6 13 . 1 Tarim Basin d .Shanghai 3 11

5

1 Afghanistan 9 Kyrgyzstan Proposed Oil Pipeline 2 Azerbaijan 10 Mongolia Oil Pipeline under Construction 3 China 11 Pakistan Gas Pipeline under Construction 4 Georgia 12 Russia (a) Baku-Tbilisi-Ceyhan oil pipeline (under construction) 5 India 13 Tajikistan (b) Aktau-Baku oil pipeline (proposed) 6 Iran 14 Turkmenistan (c) Aktyubinsk-Urumqi oil pipeline (proposed) 7 Japan 15 Uzbekistan (d) Tarim-Shanghai gas pipeline (under construction) 8 Kazakhstan (e) Angarsk-Daqing oil pipeline (proposed) (f) Angarsk-Nakhodka oil pipeline (proposed)

Security implications

Tarim line will offer The Tarim-Shanghai pipeline will have important consequences for Chinese security policy. “terrorists” a target Authorities have been waging sporadic conflict with a small group of militant separatists among Xinjiang’s ethnic Uighur minority for some years. Though many observers believe the threat is overblown and that Beijing is using the “terrorist” label to suppress legitimate political opposition, the construction of a natural gas pipeline will nevertheless provide the movement with a high-value target and will require a wider deployment and heightened stance for local security forces. It will also bring economic benefits to one of China’s poorest regions, undermining feelings of marginalization and destitution on which Uighur militancy thrives. Energy officials have long entertained the idea of piping natural gas into China from fields in Central Asia. In the likely event this moves beyond the feasibility stage, the Tarim-Shanghai link could serve as the trunk line for spurs to Kazakhstan, Tajikistan, and beyond, further raising the potential risks and windfalls.

LNG imports need LNG imports, meanwhile, will alter China’s military calculus in the South China Sea. safe sea lanes . . . Historically, Beijing has focused on advancing territorial claims in the Spratly Island chain (claimed in whole or in part by four other nations) with the People’s Liberation Army going so far as to build outposts on several reefs and islets. Now, keeping additional ocean lanes open beyond the traditional Singapore-Yellow Sea corridor, and ensuring that ships APF Canada - Canada Asia Commentary #30 5 travelling from Indonesia and Australia pass unmolested, will require a degree of cooperation that precludes a provocative and confrontational posture toward its neighbours. According to the International Maritime Bureau, 32% of all piracy incidents in 2002 occurred in and around Indonesia; Malaysia, Vietnam and the Philippines accounted for a further 10%. With BP’s Fujian terminal supplied from West Papua’s massive Tangguh gas field, and Australian shipments having to weave through the Indonesian and Philippine archipelagos en route to Guangdong, maritime safety will undoubtedly rank among China’s top naval concerns. Joint anti-piracy exercises, personnel exchanges, and other confidence-building measures with regional navies (Indonesia’s in particular) can be expected in the medium term.

. . . and friendly South Securing LNG sources in Indonesia and elsewhere will also relieve pressure on China to China Sea neighbours aggressively pursue sources in the South China Sea itself. One of the main reasons so many countries have laid claim to the Spratlys (besides their strategic location) is the wealth of oil and gas deposits believed to lie under the seabed. If China’s energy demands are being satisfied elsewhere, a more measured and cooperative approach can be taken in managing these resources. China has adopted such an approach in its relations with Vietnam: a December 2000 agreement demarcated territorial and exclusive economic zone boundaries in the Gulf of Tonkin, opening the way for offshore oil and gas exploration. It is also evident in a November 2002 declaration by the foreign ministers of ASEAN and China committing all claimants to refrain from activities that might escalate tensions in the Spratlys.

Foreign expansion: Oil and gas developments overseas

Imports to meet most The behaviour of China’s oil majors over the past two years leaves little doubt that the new energy demand primary means of meeting rising energy demand will be to increase oil shipments from foreign sources – using Chinese channels. Unwilling to accept their country’s import dependence passively (as Japan has been accused of doing), Chinese companies have been fanning out over the globe, bent on entering the profitable exploration and production side of the business. Sinopec alone has set aside US$1.2 b for overseas oil exploration through 2005, ambitiously crossing over into CNOOC’s traditional area of expertise. CNOOC, for its part, has committed US$1.2 b to major gas projects in Indonesia and Australia since 2000.

Chinese investing in In negotiations over the past few years, Chinese companies have made it clear that fields worldwide successful tenderers must offer equity in projects, not simply resources. This aggressive strategy is winning apparent approval from international investors: Berkshire Hathaway’s own Warren Buffet spent US$50 m in April to boost his stake in PetroChina (CNPC’s publicly-traded subsidiary) to 13% of the publicly available equity. This strategy is necessary because, as relative latecomers to the highly competitive global oil market, Chinese companies have had to pursue riskier, more marginal sources neglected by others. CNPC’s overseas concessions, for example, run as far afield as Kazakhstan, Iraq, Venezuela, Azerbaijan, Peru, Iran and the Sudan – all of which have been plagued by some recent instability or civil conflict and are anxious to attract foreign interest. But it is in Russia where the biggest deals are being pursued. The world’s second-largest exporter after Saudi Arabia, Russian oil output is booming for the fifth straight year and is expected to rise another 20% before 2007. With traditional European buyers increasingly wary of excessive dependence on Russian supplies, producers are searching for alternative markets to the east, while promoting capital-intensive infrastructure development around greenfield deposits in eastern Siberia, Sakhalin Island, the Arctic and the Caspian Sea basin. There APF Canada - Canada Asia Commentary #30 6 is now a general consensus among observers that Russia is positioning itself to capture a significant share of China’s market before its energy demands truly explode.

Russian oil may flow Although China gets only 4% of its oil from Russia, shipments to Asia have been growing to China . . . since the US invasion of Iraq: in October 2002, Japan made its first purchase of Russian crude since 1978 and, this year, Asia as a whole bought 9 m barrels in April and May alone. A document adopted May 22 by the Kremlin entitled “Russian Energy Strategy to 2020” reflects this change in priorities, predicting that crude exports to Asia will reach 2.1 m bpd by 2020, or one-third of total exports. At the heart of this vision is a high-profile initiative to build the first oil pipeline from central Russia to East Asia. The problem is that, over the four years since it was first proposed, agreement on where this pipeline should terminate has been elusive. The starting point, by all accounts, will be at Angarsk, a massive crude storage facility just west of Irkutsk, close to eastern Siberia’s largely untapped oil fields. One plan, considered the front-runner, would see a 2,400-km pipeline built to Daqing, China’s largest oil-producing centre, at a cost of US$1.7 b. Assuming construction got underway by year’s end, it would be able to supply 400,000 bpd by 2005 and 600,000 bpd by 2010 once additional fields were brought online. Already, an MoU is in place between Yukos, Russia’s largest producer, and CNPC to supply 5.13 b barrels of oil worth some US$150 b by 2030 – an amount that would account for 20-25% of imports and meet about 10% of China’s total energy needs. It is contingent upon the pipeline being built.

. . . but Japan seeks The Chinese proposal faces stiff competition from Tokyo, which wants to see a more costly oil along its own pipe 3,800-km pipeline built, bypassing Manchuria and ending at the deep-sea port of Nakhodka, just east of Vladivostok. Although it would not be ready until 2007, this pipeline would have an eventual capacity of 1 m bpd and could supply a more diverse set of markets, including South Korea and possibly the US. Japanese officials have been running a full-court press in the last few months to make up for China’s headstart. During a visit to Moscow in January, Prime Minister Junichiro Koizumi offered substantial finance for the pipeline (the cost has been estimated at US$4 b-$5.2 b) as long as the Russian government guaranteed the loans. Japan National Oil Corp president, Yoshiro Kamata, tried to sweeten the deal in March by offering to invest US$1 b over the next four years in the Russian Far East (RFE), including assistance to build an oil sea terminal and refinery. Then in April, Natural Resources & Energy Agency director-general Iwao Okamoto confirmed Tokyo was willing to finance the entire project through the Japanese Bank for International Cooperation.

Beijing and Tokyo bid Both proposals have been the subject of a tug-of-war inside Russia. A Sino-Russian for Moscow’s favour feasibility study launched in 2001 recommended last December that the parties move to the design phase and Presidents Jiang Zemin and Vladimir Putin issued a joint statement at the time pledging to implement the project. Yet in November 2002, Russia’s powerful Federal Security Committee convened a special conference to discuss the RFE’s economic plight and recommended rerouting the pipeline to a Pacific port. The Nakhodka proposal was formally submitted a short time later by state pipeline operator Transneft and is backed by many politicians who cite the lifeline it would throw to the impoverished RFE, and by diplomats who crave the influence it would garner them in Tokyo, Seoul and beyond. Even the cabinet has shown divisions, with Prime Minister Mikhail Kasyanov publicly contradicting Energy Minister Igor Yusufov’s position (favouring China) that the full length of each pipeline need not remain under state control. In March, the energy ministry suggested a compromise plan integrating the two proposals into one US$9 b mega-pipeline capable of transporting 1.6 m bpd – about one-third of total exports and fully one-fifth of APF Canada - Canada Asia Commentary #30 7 Russian output. The main trunk line would run to Nakhodka and a spur would be built at Tynda near the Chinese border toward Daqing. However, Yukos claims there are insufficient proven reserves at this time to justify both pipelines (research from the Russian Academy of Sciences appears to back this up) and it insists it will be easy to build an extension from Tynda to the Pacific once additional reserves are discovered. There are signs that this view may have finally won out. Both Transneft CEO Semyon Vainshtok and Prime Minister Kasyanov publicly accepted the Yukos position in April, and on May 28 the Yukos-CNPC MoU was signed in the presence of Presidents Hu and Putin during their Moscow summit. Only one day earlier, the two leaders had declared that their bilateral energy partnership was “a priority.” Russia thus appears to have locked itself into the Chinese market for now, sacrificing short-term commercial flexibility in order to find an outlet for its landlocked domestic glut.

Security implications

Sino-Russian deal The most obvious consequence of expanded Sino-Russian energy cooperation is that it will seal friendship further underwrites a decade-long improvement in bilateral ties. Relations have not only recovered from the nadir of the late 1960s and early 1970s, when several border disputes nearly flared into war, but they have blossomed into what their leaders have since 1996 dubbed a “strategic partnership” – a status enshrined in their 2001 friendship treaty. If completed, the Angarsk-Daqing pipeline will give commercial substance to the treaty’s lofty rhetoric and signal that collaboration extends to the realm of large-scale infrastructure and the usually touchy subject of regional energy policy. Admittedly, limits to this partnership still exist: witness the recent exclusion of Chinese bids from the privatization of Russian oil major Slavneft. But Moscow, long suspicious of Chinese designs on the region’s vast riches (historically fueled by deep-seated racial prejudice), is espousing a cooperative approach to resource exploitation that greatly increases their interdependence and reduces the likelihood of conflict. This bodes well for Russia’s relations with other countries in the region. While construction of the Nakhodka pipeline may have been postponed, it is unlikely Moscow will scrap it outright. During a May 30 meeting in St. Petersburg, Putin told Koizumi of Russia’s need “to seek a larger market, which would include the Asia- Pacific region” – and presumably start with Japan. Rumours also abound that exports to North America are on Russia’s long-term agenda. For these and other markets (including, perhaps, a peaceful Korean peninsula), a Pacific oil terminal will be needed. Russia’s newfound focus on developing the economy of its neglected Far East and building links with Asian markets will go a long way toward reversing its reputation as an unreliable, indifferent participant in regional trade and security.

Central Asia

Central Asia looks China’s oil-related activities in Central Asia reflect wider changes in Asia’s security to China market . . . alignment. Every country in the landlocked region has declared itself open for business and eager to attract investment from the US, Russia and China. Kazakhstan is particularly welcoming of Beijing’s raised profile since it sees China as an export alternative for Caspian oil. The expected resurgence of Iraqi exports in the wake of Saddam Hussein’s ouster has diminished the importance of the Baku-Tbilisi-Ceyhan (BTC) pipeline currently under construction and has cast doubt over other developments envisaged for the Caspian basin. One of these is a proposal to connect Kazakhstan’s massive Kashagan field and its environs (which, at 13 b barrels of proven reserves, is the largest single discovery of the past 30 years) to the BTC pipeline. At the Caspian Oil & Gas Conference in May, Kazakh representative Uzakbai Karablin warned that, should Western interest in linking the two decline, his country would “turn to the East,” to China’s lucrative market. APF Canada - Canada Asia Commentary #30 8 . . . and Beijing Beijing, for its part, is eager to enhance its strategic and commercial presence in Central returns the interest Asia, a sense of urgency derived from the need of Hu Jintao’s administration to maintain China’s dynamic growth while keeping pace with the expanding US footprint in the region. Serious involvement in the region’s oil and gas industry dates to 1997, when then-premier Li Peng successfully lobbied Kazakhstan’s government for a major stake in two of its largest oilfields, outbidding US and Russian majors. This US$4.3 b deal, which gave CNPC a 60% stake in AktobeMunaiGaz and made it the largest foreign investor in Kazakhstan, included plans to build a 3,000-km pipeline to Urumqi and to explore the feasibility of transporting oil south to Iran for refining. Although the latter projects were shelved in 1999 because of cost worries and doubts that sufficient reserves were available, CNPC has persisted, snatching up the Kazakhstan government’s remaining 25% stake in CNPC-AktobeMunaiGaz on June 5 this year (it had earlier raised its stake to 75%). This sale followed on the heels of President Hu’s state visit to Astana, during which officials from CNPC and state oil and gas producer KazMunaiGas agreed to revisit the feasibility of an Aktyubinsk- Urumqi pipeline now that reserves of 1 b barrels have been confirmed. The proposed pipeline would cost around US$3 b and have an annual capacity of 20 m tons. CNPC-AktobeMunaiGaz currently produces only 5 m tons a year, largely because inadequate infrastructure exists to carry the oil to market. A decision on whether to begin construction is expected by the end of 2003. Some analysts believe that, given the absence of a strategic oil reserve in China and Moscow’s continuing see-saw on the Angarsk-Daqing line, this proposal will be seen as a “national security need” in Beijing and likely proceed.

Not all overtures Chinese firms have also encountered their share of problems in Central Asia. In May, are welcomed CNOOC and Sinopec were blocked from buying half of British Gas Group’s 16.66% stake in the Kashagan field (also known as the North Caspian Sea Production Sharing Agreement) after other Western partners in the project, including Italy’s ENI-Agip and ExxonMobil, exercised their right to buy the US$615 m stake. Analysts suspect that this was prompted by Chinese plans to ship some of the Kashagan oil northeast to the Aktyubinsk-Urumqi pipeline, in order to maximize the latter’s capacity. US companies are still believed to favour a southwestern Aktau-Baku link from Kashagan across the Caspian Sea to the BTC pipeline. Chinese firms have responded by further diversifying their Caspian sources: on June 4, Sinopec subsidiary Shengli Oil Company signed a US$80 m deal with the State Oil Company of Azerbaijan to develop the Pirsaat field south of Baku, estimated to hold about 51 m barrels. Although this deal is quite modest, it shows that Chinese firms are adapting to changes in this unpredictable centre of production and are casting their net as widely as possible.

Security implications

Oil rivalries mirror The volatility of oil developments in Central Asia mirrors the larger political and security security contest situation. China, Russia, and the US are not only the three most commercially active countries in the area, but the most strategically active as well, and their great-power presence only promises to grow. US interest derives primarily from the region’s status as a base for Islamist forces. With many of these groups apparently lying low in the wake of the US-led war in Afghanistan, the US has committed itself to the region for the long term, establishing a major airbase at Khanabad in Uzbekistan and a forward ground base 30 km outside Bishkek, the Kyrgyz capital. Combine this with rumoured covert staging points in Turkmenistan, Tajikistan and Georgia – not to mention America’s status as the leading foreign investor in Central Asia’s energy sector – and it is clear that Washington’s stated intention to promote stability and safeguard energy exports by combating terrorism and arms trafficking goes well beyond rhetoric. APF Canada - Canada Asia Commentary #30 9 China, Russia offer This trend is of concern not only to Moscow and Beijing, but also to Central Asian a counter to the US governments themselves. Local officials are reported to be increasingly annoyed with US criticism on commercial and human-rights issues. Kazakh president Nursultan Nazarbayev, who has exhibited authoritarian tendencies since his election in 1991, has come under pressure from Washington to reform his country’s legal system and make domestic markets more appealing to foreign investors. These calls have been repeated in Turkmenistan and Azerbaijan, also major oil and gas players. The result is a growing wariness of the US presence and a move to dilute Washington’s influence by engaging China and Russia. Through this approach, Central Asia’s leaders believe they can gain additional leverage in their dealings with the US and use the ensuing competition among regional powers to maximize strategic and economic benefits. They reason that by cosying up to Moscow and Beijing, US pressure for political and economic liberalization can be deflected, and a head- on treatment of the principal sources of terrorist disaffection – instability and marginalization – can be delayed.

All the players come China and Russia are largely sympathetic to this thinking. Beijing may be eager to bolster together in SCO its campaign against Uighur separatists, but this is more effectively accomplished by improving relations with Turkic neighbours (who might otherwise abet the struggle) than by teaming up with the US. Similarly, as Chechnya illustrates, Russia prefers homegrown solutions to ethnic and economic instability in its former Soviet republics rather than foreign interference. Thus, the path increasingly favoured in addressing Central Asia’s strategic concerns has been the Shanghai Cooperation Organization (SCO), a body set up with little fanfare in 1996 to defuse regional cross-border tensions and increase military transparency. Now, seven years later, the SCO’s mandate has been expanded to encompass anti-extremism and economic cooperation; it will soon open a joint anti-terrorism centre in Kyrgyzstan. Analysts posit that this realignment reflects a desire in Moscow and Beijing to further frustrate Washington’s burgeoning influence in the region. Rumours are swirling that the SCO may one day encompass India, Pakistan, and perhaps Iran.

China needs trust to For Beijing, the most important aspect of such institutional engagement is the opportunity ensure its oil supply it affords Central Asia’s smaller countries to mitigate fears of Chinese expansionism: the SCO provides a forum where China can bolster its image as a peace-loving nation whose economic growth can benefit all. While Beijing has rarely behaved in a way that might galvanize Central Asian suspicion, it still goes to great pains to project itself as a good neighbour. This includes making significant concessions when territorial claims were resolved following the breakup of the Soviet Union: it ceded 80% of the land disputed with Kazakhstan, 70% with Kyrgyzstan, and most of its claim to Tajikistan’s Pamir mountains. Now as investment and cooperation in the oil and gas industry spearheads deeper Chinese involvement in the region, the importance of Central Asia to Chinese energy security is surging, along with the country’s reputation as a viable counterweight to US influence.

For general information on While every effort has been taken to verify the accuracy of this information, the Asia Pacific Foundation of APF Canada publications Canada cannot accept responsibility or liability for reliance by any person or organization on the use of this Tel: (604) 684-5986 information. This Commentary may be copied whole or in part and/or re-distributed with acknowledgement to “the Fax : (604) 681-1370 Asia Pacific Foundation, Canada’s leading independent resource on Asia and Canada-Asia issues”. Archive e-mail: [email protected] issues of Canada Asia Commentary may be found at http://www.asiapacific.ca/analysis/pubs/commentary.cfm. or visit our website: APF Canada is funded in part by the Department of Foreign Affairs and International Trade and the Canadian www.asiapacific.ca International Development Agency. APF Canada - Canada Asia Commentary #30 10