Venezuela. Algeria. Russia. Even Saudi Arabia. These are countries that always seem to top the list when we consider who was hurt the most economically by OPEC’s multi-year price war on oil. In 2014, when OPEC countries opened the petroleum floodgates in an attempt to break the U.S. fracking industry, it’s not clear they realized how difficult, or how long, the price slide would last. Now, many member nations are now near political and economic collapse, or have drastically cut social programs while running giant deficits in order to hold the rock bottom prices. But with their late September agreement to cut supply and finally allow prices to rise, who is the real winner? The answer might surprise you.
It’s actually China, a non-OPEC country, that stands to gain the most from an increase in world oil prices. That may seem counter intuitive since China imports about half of all of its oil. Rising world prices per barrel should cost the country billions and slow its pace of economic development. But it won’t. Instead, China will reap the rewards of OPEC’s long awaited move to push prices higher, just as it feasted on OPEC’s bargain basement prices the past few years.
For over twenty years the People’s Republic of China has struggled to meet its growing demand for petroleum—but not anymore. Instead of buying the bulk of its imported crude from Saudi Arabia, China has doubled its oil purchases from neighboring Russia over the past five years. The opening of the Eastern Siberia-Pacific Ocean (ESPO) pipeline in 2014 allowed for an increase of over 500,000 barrels a day being sent to China. This dramatic increase not only moved the Saudis into second place, it made China the single largest purchaser of Russian crude, pushing Germany out of the way like yesterday’s Bratwurst.
But how does buying crude from Russia rather than the Middle East help China in a market with rising prices? One would expect the Russians to raise their selling price along with the rest of the world—and they will. But China has an advantage in this deal for a variety of reasons. With their aging fields costing about $50 per barrel at the wellhead, the Chinese found Russian crude to be cheaper than pumping it themselves. Over the past several years China built enormous storage capacity, which is now brimming with cheap Russian crude purchased thanks to OPEC’s artificially low prices. And, as the world price is now flirting with $50 per barrel thanks to OPEC again, the Chinese can switch on their pumps while using the cheaper oil they previously bought.
But this isn’t the end of their cleverness. While amassing storage capacity to hold all of that crude, the Chinese were also dramatically increasing their refining capacity. Russia, faced with a dwindling European market due to sanctions over its activities in Ukraine, was only too happy to send its crude production south to China for refining, but with an interesting twist. In return for the Chinese stepping up to buy and store all of that crude, the Russians agreed in return to buy refined gasoline back from China at prices tied to the world price for oil. In the simplest of terms, Russia sold cheap oil to the Chinese who stored it and will now refine it and sell it back to Russia at OPEC’s inflated price. It’s really quite brilliant.
In the meantime, the artificially low price for oil the past few years has starved Russia of hard currency. Selling to the Chinese got them some of what they needed, but still it wasn’t enough. With China sitting on over one trillion dollars of U.S. Treasuries, Russia not only happily sold domestically produced oil to them for dollars, but also agreed to let the Chinese invest, develop, construct, and own oil fields, pipelines, and refineries in Siberia. This completes the Chinese trifecta. The Chinese now own and control a significant portion of future Russian oil production.
What few realize is that China is closing in on becoming the world’s largest oil producer. Only the U.S, Saudi Arabia, and Russia are larger, but with the new deals in place, China will soon eclipse Russia by using their own oil fields. And while the Saudis still have a lot of oil in the ground, their fields are aging and the cost to extract that oil is rising. Just like the United States, Saudi Arabia is faced with rising production costs and declining reserves while China now has exactly the opposite situation in Siberia.
When OPEC began dumping oil to rein in the United States, they never saw the China-Russia connection coming. And now that they have reversed course after ruining many of their member countries’ economies, it’s too late. Higher oil prices plays right into China’s hand. There’s a new sheriff in town—and he speaks Mandarin.
Kevin Cochrane teaches business and economics at Colorado Mesa University, and is also a Permanent Visiting Professor of Economics at The University of International Relations in Beijing.
