How China is Beating the United States in the Global Oil Game

http://www.moneymorning.com/2008/10/16/iraq-oil-deal/

By Keith Fitz-Gerald
Investment Director
Money Morning/The Money Map Report

Iraq recently signed its first oil deal in 35 years with a foreign company.

And – quite surprisingly to many observers – the company wasn’t one of ours.

Not surprisingly, the U.S. news media barely acknowledged the deal – even though the agreement was major news throughout the rest of the world.

According to reports from Baghdad, the 22-year deal between the Iraqi government and the China National Petroleum Co. involves $55 billion, or 87% of Iraq’s current total revenue at a conservative long-term estimate of $100 a barrel.

The deal is actually a renegotiated version of a 1997 agreement between China and a Saddam Hussein-led Iraq. That original deal included production-sharing rights, but under the new contract China will be paid for its services, but will not share in profits,
The New York Times reported. The payments will be made in cash – and won’t be “in kind” payments of crude oil, the newspaper said.


While this deal, on its face, appears to be just another global oil-services contract, it’s actually a very significant development in the hunt for long-term energy supplies. In fact, it actually demonstrates that – when it comes to nailing down those long-term oil supplies – China is an expert, and is playing a very deep game. And the outcome of that game will certainly have substantial long-term implications for consumers and investors both here in the United States, and in markets abroad. Here’s why:

With estimated reserves of 115 billion barrels, Iraq is tied with Iran for the world’s No. 2 position, trailing Saudi Arabia, which has estimated reserves of 264 billion barrels, according to estimates from the Energy Information Administration.
In a country where electricity is in short supply, the oil produced from the Ahdab Oil Field will help fuel a planned power plant that would be one of the largest in Iraq. By helping Iraq with this key initiative, China can expect to gain a solid foothold in one of the most oil-rich nations in the world, analysts say.
At the end of the day, the deal clearly highlights something that most U.S. investors haven’t focused on yet – namely that the eventual winners in this game may not be such well-known giants as Chevron Corp. (CVX), ExxonMobil Corp. (XOM), or other household names. Deals like this one and the host of others that are undoubtedly close behind suggest that tomorrow’s winners may have names most English-speaking investors can’t pronounce, since they’ll be distinctly Arabic or Chinese in nature. [Two recent installments of Money Morning’s popular new “Buy, Sell or Hold” feature have focused on Chevron. Take some time to peruse the original story, as well as the update.]

China’s Shrewd Long-Term Oil Plan
The important thing for investors to understand now is that oil ownership, as I have said for many years, is an illusion. It does not guarantee price, nor profit. What really matters in the end is having secure supply lines and sources from the Middle East (and other parts of the world).

Under this new contract, CNPC will provide technical advisors, oil workers and equipment to help develop the Ahdab oil field southeast of Baghdad, said Assim Jihad, a spokesman for Iraq’s Oil Ministry.

While China won’t participate in the profits from the oil it helps pump, it is shrewd enough to realize there will be long-term benefits. Analysts who see the bigger picture here agree with our view.

“There are some political profits for China,” Ibrahim Bahr al-Ulum, a former Iraqi oil minister, told The Times. “They need access to Iraq, and when they need oil, at least the Iraqi people will feel that China has done something for them.”

And that’s not all. Before 2003, Iraq had oil agreements with China, Russia, Indonesia, India and Vietnam – three of which included production-sharing agreements, The Times reported. But the big jump in oil prices, the new government and a myriad of other changes that have taken place since that time prompted Iraq to reconsider the terms of those deals, Iraqi officials said.

Iraq continues to negotiate other service contracts with ExxonMobil, Royal Dutch Shell PLC (ADR: RDS.A, RDS.B), Total SA (ADR: TOT), BP PLC (ADR: BP), Chevron, and some smaller oil companies. The deals have been reduced in length from two years to one after Iraq took a lot of flak for not putting the contracts out for competitive bidding.

But China’s contract was the first major one to be completed – and for one simple reason, Jihad, the Iraqi Oil Ministry spokesman, said. CNPC had “wide experience in this field,” and because many foreign oil companies were not willing to come to Iraq.

China has apparently learned how to play the global oil game with a pro’s touch. Ironically, it was the United States that crystallized this vision.

By invading Iraq, the United States dealt China’s central planning commission an embarrassing wakeup call when the second Gulf War summarily wiped out China’s oil interests in Iraq.

When that happened, China’s central planners realized two things:

The status quo in the global oil game had changed.
And China’s double-digit economic miracle could not be sustained with only a few oil suppliers.
What China fears most is that there will not be enough oil to go around in the very near future and that a U.S.-dominated supply chain could effectively “strangle” China’s growth.

So, it has done what the United States and other great powers have done at other times in history and gone on a buying spree from Darfur to Peru that’s turned heads and ruffled feathers all across the world.

What’s been especially frustrating for hapless Western leaders who do not understand that their actions caused this in the first place, is that China’s not afraid to do business with rogue nations like Iran, Sudan and Burma. It has even gotten chummy with Venezuela and Russia – much to the consternation of our present administration.

It’s a virtual certainty that China will maintain this policy going forward. My contacts in China and Africa have told me point blank that China’s leaders “don’t care about human rights or nukes or hostile governments. What matters is anyone who provides oil to China no matter what the rest of the world thinks.”

So, in as much as the U.S. media has dismissed this deal as only one in a long string of recent Chinese oil purchases, it’s arguably the most important deal yet. The reason: It suggests that China will go to extraordinary lengths to obtain the oil it wants and needs.

To add to its stable of captive oil suppliers, China will pay far more money, endure limitless criticism for ignoring human-rights issues and endure harsher business conditions than our companies can or will undertake. While U.S. firms must worry about sanctions, bad publicity or simply security, China worries about one thing, and one thing only – getting oil.

It’s a lesson initially learned from us. Then they refined it. Perhaps it’s time we re-learned this lesson from China.

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