Saudi Aramco is the state-owned oil company of the Kingdom of Saudi Arabia and a fully integrated, global petroleum and chemicals enterprise.
What is the state of energy relations in Asia in this second decade of the twenty-first century? The simple answer is that they are as robust and thriving as ever. Trade links that are among the oldest still extant have blossomed. By 2013, exports from the countries of the Gulf Cooperation Council (GCC) to North East Asia (NEA) totalled $367 billion; $104 billion went in the other direction. Looking more specifically at oil, just over 50 percent of the GCCâs oil exports flowed to NEA in 2013. In turn, the NEA received almost two-thirds of its oil imports from the GCC. This degree of dependence has only grown in 2014â15.
Yet if the simple answer is ârobust and thrivingâ, the complex answer is a little more nuanced. The ballooning numbers and high dependency mask a fragility, but also an opportunity that this book will explore more thoroughly.
The first element of this fragility is the narrowness of the trade base: virtually every dollar that the GCC earns from its substantial exports to NEA comes from hydrocarbons. In contrast, although NEA exports to the GCC are much more diverse, the GCC represents a tiny market for NEA compared to its worldwide exports. So in one direction, the trade forms a major part of national revenue but is predicated on a very narrow band of commodities; in the other, the seeming strength in the variety of goods flowing from the NEA is undermined by its small scale.
A second element of this fragility is price. Despite OPECâs (and the GCCâs pivotal role within it) reputation as a price-setting cartel, market prices for oil are often beyond the control of any single organization. Prices have climbed and slumped and will do so again. GCC countries can be left with large budget deficits when the price falls, while the importers of NEA can face unsustainable increases in costs when oil prices move in the other direction. Price volatility can stress both economies and relationships.
A third element of this fragility is disruption. Saying that the world is becoming a more complicated place has become a cliché, but it certainly seems true. Global links mean that developments in one area increasingly affect those in another. Dislocation and disruption to the global order may well be the new global order.
Energy Relations Between the GCC and the West
The close relationship between the GCC (and especially Saudi Arabia) and the West (especially the USA) is a staple of the post-War era. Despite the political rhetoric surrounding energy security that bubbled up around election times, American energy security rested on a secure Saudi Arabia. Energy and security relationships reinforced themselves in a virtuous circle, ensuring stable energy supplies for the USA and Western Europe and political stability for the GCCâs governments.
This pactâstable energy for stable politicsâwas central to the GCCâWest relationship. Stagnating to falling energy demand in Europe and plummeting demand for imports in the USA have stressed the traditionally steady relationship. Beyond anything else, the proliferation of US unconventional oil and gas production are another source of friction in the relationship. The oil price fell by 50 percent in less than a year as slowing demand bumped up against rising supply. US unconventional oil glutted the domestic market, and the GCC opted to maintain production in the face of falling prices, to take advantage of its low production cost to keep market share.
While the USA is unlikely to ever become energy independent, its dependence upon Saudi crude has been diminished. Nonetheless, the USA will remain committed to well-ordered and functioning global energy markets, because it will remain connected to them: selling gas and refined products, and trading particular crude qualities to meet particular needs. Further, energy markets are essential to the USAâs allies, and thus for its strategic interests, and for the global economy, upon which the health of its own economy in large part rests.
Given the potential for growth in energy demand, the GCC is more likely to deepen its relationship with NEA. The GCC and NEA and have strong economic ties that have been developed over decades. This next phase in the relationship will entail not just expanding energy trade and commercial ties, but also other areas that may include technology transfer and renewable energy.
GCCâNEA Relations
After acceding to the throne in 2006, King Abdullah chose Beijing to be one of his first official, out-of-region visits. In 2014, then crown-prince, now King, Salman visited both Beijing and Japan. Saudi Arabia was developing a âLook-Eastâ policy.
Since 2000, oil flows to NEA from Saudi Arabia have jumped 50 percent, or roughly one million barrels per day (mmbd). Almost all flowed to China. Indeed, while recent demand has been falling in Korea and Japan, it has merely stagnated in China. This increase in post-2000 production was not limited to eastern consumers. In 2000, Saudi Arabia exported roughly 50 percent of its oil to NEA; in 2013 that percentage was virtually unchanged. If there was a âLook-Eastâ policy before 2013, it was not at the expense of traditional consumers of Gulf oil. GCC countries have also played a significant role in fulfilling NEAâs rapidly growing energy needs for industry, commerce, transportation, and household consumption. In 2013, roughly two-thirds of NEAâs oil imports came from the GCC. Energy supply from the GCC helped NEA countries build their export-oriented economies.
With hydrocarbons as their major revenue source, GCC countries are continuously making huge capital investments to bring new energy projects online. To recover these investments and to sustain economic development, the GCC considers stable access to a growing Asian market a necessity. Many research organizations also view Asia as the natural destination for GCC energy products for the foreseeable future. For example, the Institute of Energy Economics, Japan (IEEJ) in its Asia/World Energy Outlook 2015, estimates that the four NEA economies will import 11.8 mmbd of crude oil from the Middle East by 2030, over 2.8 mmbd more than the total imported in 2014.
The trading relationship goes beyond the GCC supplying energy products. In the other direction, China, Japan, and South Korea rank, respectively, as the first, fourth, and fifth sources of imports into GCC economies. Imports from NEA quadrupled between 2004 and 2014, outpacing GDP growth. GCCâs promising demographics raise numerous business opportunities for NEA. The GCCâs undeveloped resources, young demography, and high-income status provide a multitude of commercial opportunities that can be further developed with policy support from governments.
Governments already play an important role in energy diplomacy, which can be advanced further to stimulate trade and investment. Free Trade Agreements (FTA) are one important policy tool. The GCC has been negotiating bilateral FTAs with China, Japan, and South Korea, but no final agreement has been reached. The GCCâChina FTA has been in discussion since 2004, with petrochemical products as the sticking point of the negotiation: GCC countries see China as a major export market, while China aims to establish a domestic petrochemical complex for self-sufficiency. The argument is not over the need for stable trade links, but over the division of the rents from the value chain. The model for an eventual agreement could be the GCCâs FTA with Singapore, the first the GCC reached with a country outside of the Middle East North Africa region.
Although economic ties across the four NEA economies can be said to knit them together, there has been no coordinated diplomacy with the GCC due to persistent political disagreements within NEA. However, an inter-regional, multilateral trade pact between East and West Asia makes sense from an economic standpoint. Within the current political context, the signing of an FTA between the GCC and China appears increasingly plausible, since it dovetails nicely with President Xi Jinpingâs âOne Belt One Roadâ initiative to expand Chinaâs trade and commercial linkages along the path of the historic Silk Road. A GCCâChina FTA would fulfil many of the aspirations of the One Belt One Road initiative, specifically by boosting Chinese infrastructure investments in the GCC and deepening energy and trade linkages, to achieve what Beijing calls a âwin-winâ objective. It may also lead to further initiatives between the GCC and NEA.
Asymmetric Fears: Energy Security
However developed the economic and social ties may become, energy will likely remain the core of the GCCâNEA relationship, for at least the short- to medium-term. Although both sides benefit from the trade relationship, the significance of energy in shaping the economy leads both sides to believe they carry a heavier energy security burden than the other. NEA countries highly value the GCC countries as responsible and reliable producers, but they also see high dependence on any one countryâs oil as a risk, rather than the practical outcome of comparative advantage. Asian policymakers remain concerned about a disruption of energy supply, based on experiences during the 1970s oil shocks, current regional conflicts in the Middle East, and, for China, past political splits with Russia. This has motivated them to craft risk mitigation measures. For example, South Korea has a freight subsidy programme that finances extra shipping costs if refiners import crude from non-Middle Eastern countries. The Japanese government hopes to reduce Middle East dependency and encourages Japanese companies to expand imports from other countries and regions, such as Russia, Africa, Mexico, and Canada. When these strategies contain subsidies for increased transport costs or target inappropriate crude qualities, they may result in unsustainable economic inefficiencies.
In turn, GCC countries have developed concerns surrounding security of demand as NEA demand growth slows and governments increase support for energy efficiency measures and an expansion of renewable capacity. As discussed above, the consequences of successful exploitation of US unconventional oil and gas have underscored the fragility of even the strongest-seeming trade relationships.
One element of energy security is assured access to energy during an emergency. The International Energy Agency (IEA) defines energy security as the âuninterrupted availability of energy sources at an affordable priceâ. The IEA was established following the first oil crisis, to help countries coordinate a collective response to major oil supply disruptions. Not all NEA countries are IEA members, but all four economies have developed strategic oil stockpiles. Japan, a founding member of the IEA, established an oil stockpiling programme in 1975 and today maintains some 550 million barrels of emergency reserves that are controlled by both the government and private companies. The government maintains a minimum of 90 days of net import equivalent (the level required for IEA member countries) and private sector companies are obliged to maintain a minimum of 70 days of imports. South Korea, another IEA member, completed a 30-year storage enhancement project and now holds 254 million barrels of stocks, far larger than the IEAâs minimum threshold. China, as it increases imports, is building strategic oil reserves, with a target of storing 90 days of oil imports by 2020 (which are expected to be in the order of 550â700 million barrels, depending on the trajectory of Chinese demand growth). All of these measures are costly. China, for example, taxes 0.04 yuan per litre of oil and provides state-backed loans covering 90 percent of the capital for these storage facilities. Despite these costs, NEA countries are willing to bear the burden to minimize the risk of supply disruption, assuming these stockpiles are the most effective countermeasures in the event of a supply disruption.
Japan and South Korea have joint GCC-NEA stockpiling programmes that are an innovative approach to oil reserves. UAEâs ADNOC stores 6 million barrels of crude oil at a storage facility in Korea, held by KNOC. Japan has similar arrangements with ADNOC and Saudi Aramco, which each lease 6 million barrels of storage. Both Japan and Korea offer this storage capacity free-of-charge, and the GCC NOCs ship physical crude oil to the leased storage, providing prompt access to crude oil in case of emergency. Compared to the size of crude oil trade, the stored volume is limited. Nevertheless, these arrangements play an important role as confidence building measures to strengthen relations between the regions.
In addition to oil stockpiling, NEA countries are active in the oil sectors of foreign countries. For example, Chinese national oil companies have established upstream activities in countries including Angola, Azerbaijan, Iraq, Nigeria, Russia, South Sudan, Sudan, Uzbekistan, and Venezuela. Loan-for-oil agreements were a trademark of Chinese NOC international activity prior to 2014; similarly the Korean NOC KNOC followed Seoulâs directive to secure equity barrels. The track record of these deals has been mixed. Despite the expense and government-driven support, these efforts have not significantly reduced NEAâs import dependency on the Middle East, nor have they necessarily improved energy security more generally. Overseas equity barrels are still foreign oil and still must be transported home, although most is sold on the open market.
The recent softening of crude prices and the industryâs perception that prices will be âlower for longerâ due to an oversupplied market, may ameliorate some of NEAâs energy security concerns, at least while the current price environment persists. But NEAâs political mandate to address energy security is not likely to go away. Japan, South Korea, and Taiwan will likely seek to expand their ownership of foreign equity resources. Japan, for example, aims to achieve a minimum âequity production-import ratioâ of 40 percent by 2030 and offers financial support to Japanese upstream companies, irrespective of geographic location. At present, GCC countries present a difficult environment for the joint ventures and investments needed to secure equity barrels. Those countries that do allow foreign equity are clearly investment priorities for NEA, though still not without their challenges.
Investments for the Future
Cross regional investments that yield economic benefits deepen economic interdependency. Significant investments have emergedâthe number of Chinese companies in Dubai has reached around 3,000, up from just 18 in 2005. These numbers are likely to grow even more in the coming years. Kuwait, Qatar, Saudi Arabia, and UAE have or are studying downstream investments in NEA countries. For example, Saudi Aramco has numerous downstream joint ventures in China, Japan, and South Korea, enabling it to expand its reach towards end-user markets. Within Saudi Arabia, Saudi Aramco operates refining and petrochemical joint ventures with Japanese and Chinese companies. Saudi Aramco has expressed interest in further investment in China and sees Chinese companies as well-positioned to grasp investment opportunities in Saudi Arabia and the broader Middle East. Owing to long-standing business relationships, Kuwait Petroleum has partnered up with Japanese companies to build a grassroots refinery in Vietnam. The linkages between West and East Asia are clearly aimed at cementing GCC supplies to the Asian market.
Beyond just the GCC and NEA, the Middle East and Asia are two of the fastest growing energy centres. IEEJ forecasts primary energy consumption in Asia and the Middle East to grow at a compounded annual growth rate of 2.5 and 2.3 percent, respectively, between 2013 and 2020, while the global growth rate is forecast at 1.7 percent. For GCC, greater domestic energy consumption means fewer fossil resources available for export, a critical challenge for GCC countries if they are to remain reliable energy producers, and continue to finance their budgets through export revenues.
These pressures are pushing the relationship between the GCC and NEA to expand beyond conventional hydrocarbons. GCC countries can learn much from NEA, not only on technologies, but also on policy programmes. NEA countriesâ high sensitivity to energy supply and costs led them to prioritize energy efficiency, helping them maximize the benefit of each unit of energy, and minimize global and local environmental impacts. The establishment of the Asian Energy Efficiency Knowledge Sharing Framework, under the International Energy Forum, proposed by Saudi Arabia at the sixth Asian Ministerial Energy Roundtable, is an example of a forum for sharing energy efficiency knowledge. This is an area where both GCC and NEA can enjoy a win-win outcome, and enhance interdependency, by adding another layer to their energy relationship.
In the meantime, GCC countries are exploring renewable energy resources and executing a number of clean energy initiatives and cutting-edge projects. The Asia Pacific region, which saw more than a half of the $318 billion of global new investments in 2014, is leading in the clean energy space. Additionally, NEA is home to many manufacturing companies in the renewable energy value chain, opening another mutually beneficial avenue for energy cooperation and trade.
A Growing Connectivity and a Mutual Interdependence
The connectivity between the GCC and NEA pre-dates todayâs energy trade and will last beyond the oil age. For now, the two regions have an opportunity to cement trade links that have seen explosive growth over the last 10â20 years. They can work together to reduce anxiety over the stability and security of a trade that is essential to both, but can also develop new links that expand the relationship beyond oil and gas, binding the two regions more closely, and opening an era of mutual interdependence.
To do so, both regions need to understand the fundamentals of their current relationship. They need to understand the threats and opportunities facing the current trade links and to realize how domestic decisions can have far-reaching consequences for the relationships between the regions.