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Wisdom of China's Strategic Oil Reserves
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By Niu Li

Starting from early August, the international oil price started plummeting by sharp margins, with the price of crude futures on the New York market dropping by more than 20 per cent from the record-high of US$77.03 a barrel.

Debate has, therefore, heated up in China on lowering the oil price in the domestic market, the introduction of a refined-oil price-setting mechanism, imposition of a fuel tax and, particularly, the establishment of China's own strategic oil reserves.

Petroleum stockpiling is of great significance to the country because a strategic petroleum pool would assure China's energy security.

The experiences of developed nations indicate that strategic oil reserves have a vitally important part to play in case petrol supplies dwindle sharply or are cut off altogether.

Thanks to the fact that all major industrialized nations have their own strategic reserves, the Middle East oil producing countries refrained from wielding the weapon of an oil embargo during the two Gulf wars. The United States' strategic oil reserves also helped it weather the devastating aftermath of Hurricane Katrina last year.

Now that China has begun to pump oil into the reserve centre in Zhenhai, it is bidding farewell to the era when it had no strategic oil reserves and is welcoming a new guarantee of its own energy-supply security.

In addition, the introduction of the strategic petroleum reserve in China is expected to exercise a stabilizing influence on the global petroleum market.

Before the mid-1990s, China was a net oil exporter. The country, therefore, was not motivated to have its own strategic pool. This was multiplied by the fact that the country was not as closely connected to the world oil market as other countries.

Things, however, began to change after the mid-1990s when the Chinese economy kicked into high gear. As a result, the country's demand for oil outstripped the domestic output.

Moreover, the Chinese economy became more and more closely integrated into the world economy as economic globalization picked up speed.

It should be noted that China has benefited from drawing upon the experience and practice of the major developed nations in establishing strategic oil reserves. After a decade or so of studies and promotion the work on its own strategic reserves is finally getting started. This is real progress.

As it begins to build up its own strategic oil reserves, China will acquire a share of the responsibility of helping maintain the world's petrol-supply security.

The timing is good to launch the country's own reserves at this moment, taking into account various domestic and international factors.

For example, the first batch of oil reserve infrastructures have been put in place as a result of a decade of painstaking efforts, which lays down a physical foundation for launching the stockpile. At the same time, rules, regulations and laws relevant to the management of the strategic petrol storage are being formulated and managerial organizations being set up.

In the final analysis, the most important factor for bringing about the strategic petroleum pool is price. And the price works in China's favor at present. First, the oil price has been dropping sharply on the world market, bringing down the cost of oil storage. Second, the trend indicates that the price will continue going downward in the immediate future, which makes it hard for international speculative capital to act on China's introduction of oil reserves. Third, the global demand for oil is set to decrease as the US economy shows signs of slowdown. Finally, that slow-down will elicit macroeconomic co-ordination and regulation efforts to temper Chinese economic growth, and as a further result the growth rate of the world economy as a whole is likely to turn downward.

All this works to slow down the growth in demand for oil and, in turn, relieve the supply strain.

The best time for starting the strategic reserves is when the international petrol price is at the lowest. But nobody or no organization can accurately forecast in which direction the oil price is moving.

In the opinion of this author, both oil producing and consuming countries can accept a price level of US$40 per barrel in the long run. That is because the production cost is much lower than US$40 per barrel, and producers can still reap a fat profit at this price. In addition, the price at this level will not be a drag on the economic growth of the consuming countries.

Also, the tapping of new energy resources that can at least partially replace petroleum enjoys rosy market prospects.

If the oil price is set much higher than US$40 a barrel, investment in the oil producing sector would be galvanized. This would help largely boost the oil output, which, in turn, would force the oil consuming countries to embark on energy saving programs and go in for exploration of new energy resources that can replace oil. Paradoxically, however, this would eventually help reduce the demand for oil.

Finally, the world's oil resources can easily meet the global need in the decades to come. The world's verified oil reserves will not dry up in 40 years, measured by the current extraction pace. In Saudi Arabia, the largest oil producer in the world, petrol reserves can be extracted for more than 100 years. When potential and unverified deposits and deposits in non-typical forms are included, the earth's oil resources could last 130 years.
In view of all this, the petrol price on the international market is likely to move in a downward curve. The price of US$60 a barrel is still much too high.

Starting to pump or ship oil into the Zhenhai strategic pool does not necessarily mean that China has already completed setting up its strategic reserves. Nor does it indicate that the country is going to embark on the massive strategic-reserve undertaking in the immediate future.

The establishment of the strategic reserve system is a herculean task, involving formulation of laws and regulations, setting-up managerial bodies, securing oil sources and capital needed by the storage, choice of the sites and so on.

The strategic petrol stockpiles of the United States, Japan and European countries have been set up and improved step by step over three decades or so. Similarly, establishing and rounding off China's own strategic petroleum pool takes a long time, which means that China's hoarding of oil is unlikely to impact the international oil market. On the contrary, the Chinese storage will help stabilize the global oil supply.

It should be borne in mind that the strategic storage, designed exclusively for coping with energy crises arising from war, natural disasters or other emergencies, has no responsibility or capability to help keep down the international petroleum price. So, the stockpile's effect on price control should never be exaggerated.

The author is an economist with the State Information Centre.

(China Daily November 7, 2006)




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