The Chinese Resource Quest: The Impacts and Effects of a Burgeoning Market

The Motley Fool's energy bureau chief, Joel South, spoke with Michael Levi about his new book, coauthored with Elizabeth Economy, By All Means Necessary: How China's Resource Quest is Changing the World. As the David M. Rubenstein Senior Fellow for the energy and environment at the Council on Foreign Relations, Levi is no stranger to the impact that countries and their decisions have on the rest of the world. In fact, Levi also writes a blog for the CFR, Energy, Security, and Climate, where he discusses the relationship between energy, the world, and its inhabitants. In By All Means Necessary, Levi analyzes the impacts and effects China's resource hunt has on the world and international affairs, specifically looking at the synthesis of economics, security, and politics.

In this interview, Michael Levi explains what catapulted him and his coauthor into the topic of Chinese energy and then Levi dives into the deep and far-reaching waters of this energy crisis. Levi connects the Chinese market with domestic energy companies, like the recent deals with China’s Sinopec (SHI) and the American Devon Energy (DVN 0.19%) and Chesapeake Energy (CHKA.Q) companies. South and Levi continue to discuss a wide range of implications of China’s evolving energy marketplace especially focusing on China’s global relationship in the current conditions. 

South: First off, I just wanted to get your thoughts on, why take on this project at this time? Your last book was The Power Surge, looking at a lot of the energy production and generation in the United States.

What was so exciting about China that you really wanted to tackle this right now?

Levi: My coauthor and I actually started working on the book about China before I started working on the one about American energy. I think there were three big reasons to do it.

The first is that China’s quest for resources has, by many accounts, had a host of important consequences for the world, from impact on the global economy, to international security, to the environment. When people are claiming such big impacts, it’s important to figure out what’s true and what’s not, in order to understand the world.

The second is that, as China rises, we’re all trying to puzzle through what the broad consequences will be. China’s quest for resources is one of the leading edges of its rise.

What distinguishes it from a lot of the other aspects is that there’s already a multi-decade track record that you can go back and study and asses, rather than just coming up with theories about how you think the future will unfold. The resource quest provides a fantastic opportunity to grapple with the way that China’s rise will affect the world, and be affected by the world.

The third reason for doing it is to get a window into how international affairs develop when economics and security and politics all play big roles. During the Cold War, we were used to thinking of the conflict with the Soviet Union as a security conflict, the relationship with Europe and Japan as an economic relationship, but the two didn’t really meet -- and, increasingly, the two are difficult to separate.

China’s resource quest is an important place where economics and security and international politics meet, so it provides a great opportunity to get better at trying to understand what happens at that intersection.

South: Fantastic. I think we’ll cover a couple of those topics in a little more detail.

First off, we’ll just get into the Chinese government and their involvement with Chinese companies that are trying to extract natural resources overseas -- primarily, first off, just looking at the Chinese NOCs. It’s been documented that they received lower interest rates, tried to go out and secure assets. Does this really give the NOCs a leg up on competition?

Levi: First, it’s essential to step back and remember that the biggest aspect of China’s resource quest is its acquisition of resources through trade, rather than through investment. The biggest global consequences have been through more prosaic trade relationships that drive prices up and have consequences, regardless of whether China is directly involved in the country in question.

When you move on to investment, the picture looks different depending on the target, and depending on the industry. Chinese state-owned companies certainly get advantages from cheap capital, that allow them to sometimes underbid their competitors. They also have disadvantages, because they are generally weaker performers. They don’t have the technical and managerial skills that the big international oil companies have.

As you move into sectors other than oil, you have a lot less market concentration. You don’t have just the three big players. In mining, you have a lot of smaller players, private firms. In agriculture, you have provincial players that are important, and they come with their own advantages and their own burdens.

The other thing that’s worth appreciating, when we think about what advantages the Chinese companies might or might not have, is that their lack of experience internationally -- at least early on -- was a significant challenge.

The reality is that you don’t go and read a book in the library to figure out how to operate internationally. You figure it out through experience -- and the international competition has a lot of experience.

At least early on, the Chinese companies only had experience at home, so whatever they were used to doing at home, they took with them internationally. China at home was China abroad. The consequence was that they couldn’t compete on labor standards, environmental standards, dealing with communities -- all of these pieces that are actually essential to surviving and thriving in the resource world.

South: Looking at a couple of deals, with Sinopec signing some joint venture deals with Devon Energy and Chesapeake Energy here domestically, in your book you also talk about a lot of these Chinese companies are out there trying to maximize profit.

With some of these deals, joint ventures, do you think they’re really after going for the maximization of profits, or is it trying to secure more technology that they can bring back home and try to strengthen some of their supply chain issues that they might have?

Levi: You’re looking in the exact right place. I think these companies are trying to do two things. They’re trying to put more reserves on their books, like other big energy companies do, and they’re trying to learn more about the advanced technologies and managerial skills that they need to be able to be effective, not just internationally but with resources at home -- and the way you learn is by working alongside skilled companies.

You see this repeatedly around the world. It’s not just in shale in the United States, but it’s in offshore elsewhere, it’s in oil sands in Canada ... There is a desire to acquire the skills. These companies know that that they are still a rung or two down the ladder from the IOCs, and from the high-end independents in the United States.

Next we’ll want to go into the price of commodities. The big takeaway from By All Means Necessary was China definitely put pressure on pricing, but that’s not it. There’s a lot more to the story. There’s supply and demand issues, which threatened a little bit of that.

Levi: Look. Each resource is different and some, like aluminum ore, have better withstood the impact of rising Chinese demand than others, like crude oil or copper. A lot depends on the particular market structures, and we look at those ... it also depends on the nature of the resource, and other factors like that.

The other critical thing is that resource markets tend to be slow, so you can get big responses over a short time, but after several years you start to see the system adjust. For example, in oil, you’ve seen curves on consumption, increases in production, improvements in technology around the world -- including in China -- that have started to significantly blunt some of the impacts of this rise in Chinese consumption.

You see this in different ways, for different resources. China has pushed up the price of many resources over the last decade. I don’t think we’re going to see a reversal, but I also don’t think that we’re going to see a repeat of that rise. I think we’re going to see something that looks considerably more stable.

When we look at the prices of resources in 2020 or 2024, I suspect they’ll be more similar to today, in contrast with the current situation, where if we look back 10 years, everything’s radically different.

Right before the financial collapse, you saw oil prices upwards of $150 a barrel, and now they’re lower. Do you think that the reason they were so high was more just fear -- the trader’s fear?

Levi: No, I think that most of that rise was driven by fundamentals; strong Chinese and other demand, but not matched by a strong supplier response, particularly in the Middle East.

I think the last leg of that was probably driven in part by fear and by market activity that reflected that. But most of it had pretty reasonable grounding in fundamentals, which helps explain why we’ve given up some of those gains, but nowhere close to all of them.

I heard in a recent interview that you did, when you were researching for this book, the iron ore industry in China was one of the most fascinating parts. What did you find there that was so interesting?

Levi: It’s always a shock. I still can’t believe that I found the iron ore industry interesting!

But we think of China as entering commodities markets and trying to steer them away from flexible, free transactions, and toward opaque, political structures -- and what happened in the iron ore world was the opposite.

The iron ore trade is oligopolistic -- a small set of sellers -- and for a long time they negotiated directly with the biggest buyer, and then everyone else took that price and it stuck for the next year, and then you went back and revised it each year.

An influx of small Chinese mills undermined that entire system. They went off doing their own transactions, and as a result you saw the emergence of a spot market that made the iron ore trade a lot more liberal and flexible than before.

What’s striking there is that the combination of China’s sheer size, with the surprising fact that the Chinese government does not control all of its economic players nearly as tightly as most people in the outside world assume, resulted in an outcome that is completely different from what most casual observers of China would expect.

Another question that I found pretty interesting, that I didn’t really think about too much before reading the book, was thinking of how China is going to have to adapt to the countries that they’re moving into -- specifically looking at the environmental and social issues that they’ll have to adapt -- do you see them moving into other countries and starting to take some of these environmental issues and bringing them back home? Or is it just only meeting the minimums in the countries that they’re in?

Levi: We still don’t see China raising the bar in the countries where it plays, but it’s increasingly able to at least meet the bar that’s established.

That’s partly because countries are making a point of enforcing their rules. It’s partly because the Chinese want to be seen as responsible because they’re trying to invest in advanced markets that care about these things more, like Canada or Australia or the United States.

It’s partly because, over time, an infrastructure of consultants and managers and others who can help them perform better is emerging. So, while the demand for high performance is increasing, the supply of tools with which to perform successfully is also growing, and that matters too.

You can make all the demands you want, but if companies aren’t able to meet them, that doesn’t matter.

South: With Chinese companies and the country itself wanting to be seen as a high performer, are you seeing a lot of these issues being addressed at home? Or is it still quite a ways off before they start ...?

Levi: That’s a good question, and the domestic politics are tricky. One of the joys of writing this book is I collaborated with a colleague who’s an authority on Chinese domestic policies, and their relationship with Chinese foreign policy.

That’s a long way of saying that I don’t have the answer to that particular question.

Next I want to look at some of the sanctions -- a lot of Western sanctions. When we were looking at Iran for a while, China stayed away. They don’t want to burn any bridges in future places that they could possibly put investment, and I was curious on how you might see the relationship with China and Russia, with Western sanctions picking up there.

Levi: That’s a very good question.

The trade relationship with Russia is almost certainly going to be affected by what’s happening between Russia and Ukraine and Europe right now. Just like the Europeans want alternative sources of supply, the Russians want alternative sources of demand.

Their increased desire to get exposure to other markets as a result of what’s happening with Europe -- and China’s likely greater confidence in dealing with Russia because they see Russia as being in a relatively weak spot right now -- probably means that they’ll be more able to do some sort of deal on a natural gas trade.

On direct investment into Russia, what you’ll see is something you see repeatedly around the world. Chinese companies may or may not want to step in and take over where Western (unclear) have been, but either way they typically don’t have the capital capacity to do it.

The reason that Russia brings in BP or Exxon is not because they love giving away their resources and having others invest, or because they’re great enthusiasts for free markets and open investment. It’s typically because they don’t have the technical capacity, themselves -- and sometimes the capital, but particularly the technical capacity -- to exploit these technically challenging resources.

The Chinese companies just aren’t yet capable of matching the Western ones in playing that role.

South: So, you would imagine, looking at past sanctions, that they will probably want to sit this one out and not really get involved too much, and if the technology comes about they ...

Levi: Yes. That’s a long time off.

I wanted to look at some potential problems back in China, in developing their own assets. Obviously, there’s a lot of issues around developing shale assets -- you have to have the infrastructure -- but in your book, you looked a lot into water scarcity and property rights in China.

I was just curious what you think about water scarcity, and that really holding back a widespread use of extracting shale assets.

Levi: I suspect that, for shale gas development to pick up in China, companies will need to find different business models that allow them to drill more successful wells and avoid using a lot of water on unsuccessful ones. By “successful,” I don’t just mean that it produces gas -- these all produce gas -- but that they actually make a profit.

There’s a separate issue, which is China’s pursuit of water, whether it’s for energy or for agriculture, oil or gas extraction. In China, accesses water upstream of a host of other countries in the region.

We took a deep dive into this when we were researching the book, and you find that the security consequences, the political consequences, and the environmental consequences of trying to use the water that flows across borders can be quite acute because, unlike with all these other resources, the countries that might otherwise depend on the water can’t just go to the global market and buy it elsewhere. You’re stuck with the water that flows into the rivers and basins you have.

Wrapping up a little bit, since the book has been published and you did your research, have you seen anything change, that you would want to add to the book?

Levi: That’s a great question. There are two things that you’ve seen happen. The first is an increasing amount of concern about the future prospects of the Chinese economy.

We talk a bit in the book about what might happen if the Chinese economy went south. You would see consequences, not just for aggregate demand, but for the ability of particular companies to function well, for the way the Chinese military conducts itself, and a host of other areas.

The other big thing you see is an extraordinary surge in concern about local air pollution. That has consequences, both for energy because most of the pollution comes from electricity production and industrial energy use, but also for heavy industry more generally, which drives a lot of China’s resource appetite.

China will have a host of different ways that it might address these issues. It might switch from coal to gas. It might try and cut consumption through alternative technologies. It might push people into greater use of scrubbers and boost coal demand slightly as a result.

Each of the different solutions to the environmental problems China is facing will have different consequences for global resource markets, and for Chinese security exposure to those markets. Seeing how China tackles this problem -- which I think is seen as an acute problem among senior Chinese leaders -- will be very important to understanding how this all unfolds.

When you’re looking at the Chinese resource quest, are there some parallels that you could draw on other emerging economies, either now or in the future? Or is this pretty much exclusively just in the Chinese market?

Levi: The most striking parallels are in the past. If you read news accounts and academic analyses and market takes on the rise of Japan in the 1960s and ‘70s, and the demand for resources that went with that, and all the different Japanese ways of securing those resources -- overseas investments, state trading companies, tight links between diplomacy and business -- you see a lot of echoes of the fears that people raise about China.

Now, most of those didn’t turn out to be warranted. I don’t want to suggest that everything will turn out the same; China is not Japan. China is bigger, China aspires to play a different role in the world, so those will all result in different consequences.

But at a minimum, the experience with Japan tells you that you should not jump too quickly to the worst possible conclusions.