As the 21 APEC members gathered in Beijing last November to discuss regional trade and investment, China and the U.S. Announced a historic climate deal. This is an important symbolic commitment on the road to substantive climate re- form. However, there are roadblocks to overcome. First, in order to make progress, other countries will have to join in—especially throughout Asia. Another is the need for sound oil policy. Without it, China and the rest of Asia face serious environmental and geo- political security risks.
Oil is at an inflection point. New resources in ex- panding geographies are surfacing amid changing consumption patterns and fluid industry investments, creating renewed volatility in the market. Perhaps this oil paradigm shift is why, at least in part, the U.S. and China were able to make the climate deal given rising perception that America is more secure about its energy future, whereas China is not.
Significant increases in China’s oil consumption began in 2008 and this trend expected to continue in India and elsewhere in Asia (except in Japan and South Korea, where consumption remains flat). But as oil consumption will continue to rise, the region’s oil supply opportunities are severely lacking.
Diverging demand and supply
Collectively, 28 million barrels a day of petroleum and liquids are consumed in Asia, more than any other global region (Figure 1). By 2040, the lion’s share—40 percent—of global oil demand is projected to flow to Asia. As such, it is anticipated that total pe- troleum and other liquids consumption will be fueled by a phenomenal 65 percent growth rate in Asia, far faster than anywhere else.
But where will this oil come from? While de- mand soars, production capacity across Asia pales incomparison to other major global regions (Figure 2). China today ranks as the world’s seventh largest oil producer, but this represents only 5 percent of global oil production. When the rest of South, East and Southeast Asia are taken into consideration, the region’s overall oil production stands at one in ten barrels of current global output.
Over the next two decades, oil production in this region is projected to increase by a scant 1 million barrels a day, losing 2 percentage points of its current global share. In fact, only in China is oil production expected to rise, although not nearly enough to close the gap with the nation’s increasing consumption. The wedge being driven between oil supply and demand across Asia could have repercussions. As such, managing the oil situation today is a top priority.
Asia’s oil dilemma cannot be assessed in isolation.It is vital to understand the oil paradigm shift—whereby changing oil economics fueled largely by Asian growth has pushed technological breakthroughs throughout the sector. Renewed resource availability is reversing long-held peak oil assumptions and rebalancing economic, geopolitical and environmental objectives.
Economic oil issues
No nation, no corporation, no energy expert can accurately predict the future price of oil. In fact, this market fundamental is so uncertain, the U.S. Energy Information Administration plots wide-ranging forecasts—from $70 and $200 per barrel (Figure 3). In reality, oil is likely to exhibit some degree of price volatility between unknowable extremes. This is occurring now. Crude costs have fallen nearly 30 percent between July and November 2014. While immediate price reprieves are good news for Asian oil consumers, such a dynamic oil price scenario will make it hard to plan. Furthermore, the jury is out whether oil will remain traded in U.S. Dollars, Chinese Yuan or multiple denominations.
Unpredictable market forces will likely be the new normal in imperfect oil markets that lack informa-tion transparency, have significant barriers to entry and exit, and impose unwanted externalities. These market failures underscore why Asian nations cannot afford to proceed with business-as-usual. Instead, they must think and act strategically when it comes to investing, trading and subsidizing oil.
Geopolitical oil issues
The changing geopolitical map for crude and petroleum product trade will influence long-term oil security, but it is uncertain how flows might be redrawn (Figure 4). Oil partnerships are expected to grow with neighboring nations: Russia, Middle East and North Africa. But who else might play a major role filling the void in trans-Pacific oil trade? Canada is difficult to access, the U.S. may maintain its ban on exporting light-tight oil, South America must contend with numerous challenges, Mexico is expressing interest and Australia’s coal and gas take a new hydrocarbonpathway altogether.
There are certainly more questions than answers.Will the rest of Asia turn to China for oil resources, that is, if China can adequately and soundly develop them? If energy-intensive industrial development patterns—large refineries and petrochemical complexes—continue across Asia, how will the region prevent becoming more tightly bound to the very oil feedstock they lack? One thing is certain. If the Asia-Pacific economic engines are fueled largely by petroleum—and without vast efficiency gains, oil alternatives, and backstop policies—new geopolitical risks will materialize. If this increases military assertiveness for global oil resources, decision-makers will have learned nothing from the past.
Environmental oil issues
Environmental security is an intensifying factor in China and throughout the region. As air pollution worsens, petroleum-driven motorization is being closely scrutinized. The large and growing urban populations across Asia are exposed to a photochemical concoction of noxious emissions that are created when oil is combusted. These pollutants—ozone, carbon monoxide, particulates, nitrogen oxides, and more—are transported eastward over the Pacific to North America (Figure 5.) Oil use also intensifies climate change risks by loading the atmosphere with greater concentrations of carbon dioxide and other greenhouse gas emissions from oil extraction, refin- ing, transport and combustion.
A major question facing the Asian nations is how much and what types of new oil and petroleum products might they each import. The recent boom in unconventional oil production in North America is unearthing certain oils that are difficult to manage. Extra-heavy, gassy, watery and depleted oils, if mis- handled, can have up to two-times the greenhouse gas footprint as conventional crudes. And if oil invest- ments turns on oil shale (kerogen), coal-to-liquids, gas-to-liquids, methane hydrates and other untested techniques that transform hydrocarbons into petroleum products, there’s no telling how much environmental damage may result in petroleum’s path.
Creating a new balance
The oil sector—its unpredictability, lack of ready substitutes and massive global investment—will pose vexing trade-offs for many Asian policymakers. But there are opportunities amid the challenges.
Fortunately, oil markets abhor a vacuum. The more informed and transparent they are, the more efficiently they function. As such, institutional collaborations will be key, as will the governance rules that guide them. A few examples follow.
A new membership category in the International Energy Agency (IEA) could be established for China, India and other non-OECD Asian nations. (Japan and South Korea are already IEA members; and ASEAN nations are in discussions.) The question of voting rights will have to be resolved. But including fast-growing oil consumers is instrumental to this autonomous agency. While IEA was created by western nations, its mission—to promote energy security and conduct analysis on reliable, affordable, clean energy —is shared by many Asian nations.
Existing Pacific partnerships could improve regional coordination on growing energy interdependence. Harmonizing standards, cutting petroleum fuel subsidies, factoring security into trade deals and cementing ties to one another are important steps. Economic growth strategies that depend less on oil will be critical if the region is to remain the “engine room of world trade.”
A new tripartite dialogue between China (world’s largest oil consumer), Saudi Arabia (a major China supplier selling two-thirds of its oil to Asia) and the U.S. (a major consumer and producer) could increase transparency to address market uncertainty. Such intelligence could offer new understanding on the tentative oil equilibrium, market volatility, climate mitigation and political risks.
Many past proposals have considered enhancing regional cooperation. While it won’t be easy given social, cultural and institutional differences across the region, experimentation with new arrangements has merit given changing oil circumstances.
Revised investment strategies offer another opportunity (Figure 6.) If even a portion of the $7 trillion in planned investments for the power (electricity) sector are used to advance electric transport through smart grids, renewable generation and mobile backup power, that would be a boon for hedging oil bets. Moreover, the relatively small oil investments forthcoming merit rethinking to eliminate inefficiencies.
Many economies across Asia are slowing, some after a long period of growth. As such, this is an opportune moment to think strategically about physical resource limitations, associated environmental concerns and evolving geopolitical realities. Given the large capital outlays, long lifetimes and enduring impacts associated with the oil sector, the decisions made and policy adopted throughout Asia will influence oil markets, climate outcomes and security for generations to come.