03/03/2003
China Daily

The government should work more quickly to design and implement a national oil security strategy to minimize potential losses in the event of war in Iraq, analysts said.

Insiders said government officials are having more detailed discussions concerning the creation and operation of a US$10 billion oil fund, the centrepiece of an oil financial system that would be a major part of the oil security system.

Another key element of the system, according to earlier media reports, is the creation of a strategic oil stockpile to fend off risks from price fluctuations and possible supply disruptions.

Insiders say the essence of the oil financial system is closer interaction between China's foreign exchange reserves, oil futures positions in the international market and the much-discussed oil stockpile.

The details are still unknown. "It's being kept within a small loop," one insider said. "And it will continue to be that way."

But China's fast-growing foreign-exchange reserves clearly provide a strong foundation. The world's second-largest foreign reserves amounted to US$286.4 billion at the end of last year, up 34.9 per cent year-on-year.

The creation of "a national strategic oil stockpile" was included in China's 10th Five-Year Plan (2001-05), which was passed two years ago at a plenary session of the National People's Congress. Officials last year revealed a more comprehensive blueprint, which also included upgrading China's energy-consumption structure and the maintenance of the reserves of four major oil and gas fields.

Much attention is now focused on this year's congress plenary session, which begins on Wednesday. A national energy commission is expected to emerge as part of a broad government reshuffle. The commission will presumably shoulder all responsibilities related to oil security.

China faces increasing exposure to international oil price fluctuations as it becomes increasingly reliant on imports. It will have to import more than 30 per cent of the estimated 240 million tons of oil it will consume in 2005. Official predictions put the import ratio at more than 50 per cent by 2010.

The government still decides domestic oil prices in line with the international market but China's absence in the global futures market, which determines prices, leaves little room to protect itself against unwanted price movements. In 2000 alone, oil price spikes in the international market forced China to raise domestic prices on seven separate occasions.

Rising global oil prices, fuelled by expectations of an imminent United States-led war against Iraq, are already forcing the hands of Chinese oil companies and airlines.

China posted its first monthly trade deficit of US$1.25 billion in January as a result of rising oil imports and prices.

Tang Zhenhua, senior adviser to the China International Engineering Consulting Corp, said: "That may suggest they (Chinese oil firms) were on the move already."

Chen Jiulin - managing director of the China Aviation Oil (Singapore) Corp Ltd (Caosco), China's sole importer of aviation fuel - said that he expected international crude oil prices to keep rising in the first quarter of this year and possibly cap US$40 per barrel, taking into consideration the strikes that took place in major oil producer Venezuela.

"And it depends on how long the war lasts and other possibilities - say, if Iraq blows up its oil facilities or sets the oilfields on fire," he said.

Chen's firm imports about one-third of the 5.8 million tons of aviation fuel that China consumes every year. Oil prices may reach US$50 per barrel in the worst case, he said.

Zhang Xueying, senior researcher with the State Information Centre in Beijing, said that oil prices may subside after war breaks out because there will no longer be the uncertainty that has been driving market speculation. Nevertheless, he added: "The impact on China will be significant."

The prices of domestic downstream oil products are likely to rise due to widespread oversupply, said Zhang. If demand fails to accommodate these price increases, then businesses will make lower profits or even losses, he said.

Zhang said possible rises in petrol prices also threatened to undermine car buying, a key engine of this year's economic growth.

Analysts said that, in addition to the planned strategic stockpile, China's hope of reducing its vulnerability regarding oil lies largely in the futures market - a crucial element in its oil financial system.

The government should move quickly to relaunch oil futures contracts in the domestic market so that China may have a greater influence in shaping global oil prices, they said. China should encourage the more frequent use of overseas markets to hedge risks, the analysts added.

Caosco's Chen said oil companies "should participate more actively in the global trading of oil products, including the cash market, futures and paper swaps."

China's three major oil companies -- the China National Petroleum Group, the China National Offshore Oil Corp and PetroChina -- are among the few Chinese firms allowed to hedge on overseas oil exchanges but the trade volume is relatively thin.

According to Tang of the China International Engineering Consulting Corp, another financial solution would be to purchase more stakes in overseas oilfields -- especially those in neighbouring countries such as Russia and Kazakhstan - to guarantee the oil supply and uninterrupted transportation.

Progress in that regard is slow due to strict approval procedures and the limited financial strength of the companies involved. Tang said that two abortive forays over the past years by a major Chinese company - which Tang did not wish to name - prompted the government to shelve an expansion plan.