The Growing Energy and Oil Alliance Between China and Saudi Arabia

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The oil and energy alliance between China and Saudi Arabia has just been strengthened.

On Saturday – in the wake of Europe’s debt crisis – Saudi state oil company Aramco signed a deal with China’s Sinopec to build an oil refinery in the Red Sea city of Yanbu. The refinery will process 400,000 barrels of oil per day, some of which will presumably end up in China. “Saudi Aramco will hold a 62.5 percent stake with Sinopec holding the balance in the venture that highlights China’s growing role as an infrastructure developer in the oil rich kingdom,” according to AFP.

As an intriguing sidenote, Chinese Premier, Wen Jiabao – who made Saudi Arabia the first stop on his Middle East tour – signed a series of “agreements and cooperation programs” with Saudi King Abdullah. One of those was, “An agreement between the two governments on the peaceful usage of nuclear energy was also signed. Signatories for the two parties were Dr. Hashem Yamani, President of King Abdullah City for Atomic and Renewable Energy, and Chang Peng, President of the National Commission for Development and Reforms of China.”

Hmm. Isn’t that interesting? This confirms our idea that thanks to America’s shale gas revolution – which makes Middle East oil imports a lot less important to the United States – the Saudis are shopping for a new strategic patron in the region and the Chinese are keen to be that patron. Aramco CEO Khalid al-Falih said the deal “Represents a strategic partnership in the refining industry between one of the main energy producers in Saudi Arabia and one of the world’s most important consumers.”

Meanwhile, closer to home, Australia is set to become the world’s largest exporter of liquid natural gas (LNG). Japan’s Inpex and France’s Total gave their final investment sign off to the $34 billion Icthys LNG plant in Darwin. Japan is the world’s largest consumer of LNG, mostly for its domestic power generation. Australia now has $175 billion in LNG developments.

You can’t have growth without energy. Excess credit growth is one way to “boost” growth artificially. But growth driven by credit creation just borrows consumption for the future. You end up with a huge debt overhang, low savings, and a tendency toward overconsumption – all of which makes new growth harder. This is the position Europe and America now find themselves in.

Meanwhile, the strategic race for energy – the natural fuel for growth – is on. More on that below in an excerpt of a report I published last June to subscribers of Australian Wealth Gamelan.

The New “Energy Superhighway”

The Empire and the Kingdom are old friends. One could not exist without the other. But even old friends can fall out, or simply part ways after many years. And when new friendships are made, things change…

Saudi Aramco President and CEO Khalid Al-Falih spoke to a packed room in Washington DC in mid- May. He reminded those in the room that the strategic relationship between the United States and the Kingdom of Saudi Arabia is a long one. Individual, corporate, and government ties between the two have meant a close-knit relationship for the last 78 years.

Al-Falih was understating the case when he said, “Some of these relationships with American firms
and institutions are nearly as old as the modern Kingdom itself.”

This report explores the historic origin of the ties between America and Saudi Arabia and why
these countries may be at an important crossroads. Indeed, the kingdom and the empire are
parting ways. And it’s a major development. No single geopolitical relationship has been more
important to the world’s energy markets since oil was first discovered in commercial quantities in
Saudi Arabia at Dammam #7 on 31 December 1937.

Oil and Empire

The last 100 years of oil history in the Middle East determined the fate of three of the world’s
great empires: the Ottoman Empire, the British Empire, and the American Empire. The strategic
alliance between the Saudis and the Americans – the story of which I’ll tell you in this report –
was only possible because of the collapse of the Ottoman Empire and a crucial miscalculation by
British imperial agents in Mesopotamia.

When Al-Falih announced to the Washington crowd that the Saudis are now engaged in what he
called an Accelerated Transformation Program, he was really telling the Americans that the Saudis
have their eye on a new strategic partner: China.

America’s historic relationship and alliance with Saudi Arabia – the vital relationship between the
world’s largest producer of oil and its largest consumer – may no longer be the most important
energy partnership in the world. And the energy relationship between China and Saudi Arabia
could change history every bit as much as the U.S./Saudi relationship.

But if that’s the case, the speech still hasn’t set off any alarm bells in Washington. After all, the
Saudis have been forced to re-align their strategic energy plans because of an unexpected energy
boom in America. I’m talking about the energy revolution in North America that began on the
plains of East Texas. This development, which could unleash an investment boom and an era of
cheap and clean energy in Australia – has given America enough energy independence that its
long relationship with the Saudis has changed.

What’s more, the whole paradigm of the world’s energy markets is set for a big shift. And here
is the important point for you in this report: Australian companies stand to benefit in a big way
from the building of a new “energy superhighway” between Beijing and Riyadh.

That term “energy superhighway” is not mine, by the way. It was used by Al-Falih in March
2011 at another speech. But this one was in Beijing. And in that speech he said…

“Saudi Aramco’s relationship with China is very much a two-way street, and as we work with our partners to establish more joint ventures here, I look forward to even more traffic and trade – including additional Chinese investments in Saudi Arabia – along the ‘energy superhighway’ connecting our company with this great nation.”

If you take just one thing from this report that could improve your understanding of the energy market and energy investments I hope it’s this: the most important energy alliance of the next 50 years is between China and Saudi Arabia.

This relationship matches up the world’s largest producer of oil with a country that will inevitably
be its largest consumer. It’s also going to trigger some major changes to the world’s energy
markets. And it’s going to lead to some new investment opportunities right here in Australia.
It might not be obvious to everyone else yet, but the Saudis need China.

Why?

The United States has been Saudi Arabia’s best customer and the world’s biggest consumer of oil in the entire Age of Oil. But with the shale gas revolution in the States (more on this shortly), the U.S.
has begun to actually lessen its dependency on Middle East oil. For the U.S., shale gas has made oil
less important.

This is a golden strategic opportunity for China. It does not have neighbours with large oil reserves
like the United States does with Canada and Mexico. China is even more dependent on Middle East
oil exports than America. The shale gas revolution in the States has given the Chinese the perfect
opening to forge a long-lasting relationship with Saudi Arabia.

Energy politics makes for strange bedfellows. This brings up one interesting point about a common
feature of the political elite in China and Saudi Arabia: their complete indifference to popular
opinion and global pressure.

You might think that a kingdom governed by Sharia law and an officially atheist, nominally
communist state would have philosophical reasons for not doing business with one another. But
they’re both pretty practical.

What’s more, both are willing to put strategic economic interests ahead of political or religious
ideology. They would rather make business deals than meddle in each other’s internal affairs. For
the Saudis, this might make the Chinese better long-term business partners than the Americans
have ever been. A history of the relationship shows that the Saudi-Chinese alliance has actually been
growing for years:

  • Saudi Arabia and China establish formal diplomatic ties in 1990, as the Saudis build up
    international support for the coming war against Saddam Hussein’s Iraq.
  • In 1999, then Chinese President Jiang Zemin makes a state visit to the Kingdom of Saudi Arabia and announces a “strategic oil partnership” between the two countries.
  • In 1999, Saudi Arabia’s Aramco Overseas Company provides a $750 million
    investment-25 per cent of the total project-in a petrochemical complex in Fujian capable
    of processing 8 million tonnes of Saudi crude oil per year.
  • In January 2004, the China Petrochemical Corporation (Sinopec) outbids Western oil
    companies for the right to invest in a natural gas project termed Saudi Gas Initiative 2
    (SGI2). The terms of the deal are highly favourable to the Saudis and cause one analyst to
    note that, “the SGI-2 winners seem more interested in establishing long-term strategic relations with Saudi Arabia than they are in reaping any immediate economic benefits from their SGI-2 projects.
  • In 2005, bi-lateral trade volume between China and Saudi Arabia reaches $14.5 billion, with a goal of $60 billion by 2015.
  • Saudi King Abdullah makes the first trip by a Saudi King to China in history in January of
    2006 and signs five bi-lateral agreements, including one on “oil, natural gas, and mineral
    cooperation.” Saudi Foreign Minister Prince Saud al-Faisal, accompanying the King, tells the
    world press that “China is one of the most important markets for oil and Saudi oil is one of the most important sources of energy for China.”
  • In 2009, Saudi oil exports to China reach a million barrels per day (bpd), double from the previous year. U.S. imports of Saudi oil fall to less than million bpd for the first time in 20 years.
  • Bi-lateral trade volume hits a record $43 billion in 2010, up 33% from the year before.
  • In 2011, China becomes the world’s largest energy consumer, according to the International Energy Agency, and ranks second only to the United States in oil imports.

It is impossible to understand where the energy markets will go without understanding where
they’ve been. The story of oil has largely been the story of the decline of one empire and its
replacement by another. The fate of whole nations has risen or fallen depending on their access to
cheap, reliable energy.

Regards,

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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