Cato Institute
1000 Massachusetts Ave, NW
Washington, DC 20001-5403
 Phone (202) 842 0200
Fax (202) 842 3490
 Contact Us
Support Cato

TESTIMONY OF

Jerry Taylor
Director, Natural Resource Studies
Cato Institute

before the

Armed Services Committee,
U.S. House of Representatives

July 13, 2005

National Security Implications of the Possible Merger of the China National Offshore Oil Corporation with Unocal Corporation

Mr. Chairman, I thank you for the opportunity to testify this morning on the subject of the national security implications of the possible merger between the China National Offshore Oil Corporation and Unocal Corporation.

My comments will be confined to the fear that such a transaction would harm national security by making the United States more dependent upon foreign oil or, relatedly, that the proposed transaction threatens to provide China with an "oil weapon." I believe those fears are ill founded. In short:

Dependence on Foreign Oil is Not an Economic Problem

It's doubtful that American oil imports would increase as consequence of a CNOOC-Unocal merger. That's because Unocal's domestic oil assets are small (58,000 barrels of oil production a day, which translates into 0.8 percent of U.S. production from petroleum liquids and 0.3 percent of to U.S. petroleum consumption1) and are most profitably sold to the U.S. market.

Even if Unocal's U.S. oil assets diverted elsewhere, it would have no effect on America's vulnerability to oil supply disruptions abroad. That's because it makes no difference from an economic standpoint whether the oil we consume is produced domestically or from foreign sources.2 Moving oil around the globe is so cheap and easy that a shortage of oil anywhere in the world increases the price of oil everywhere in the world. That is why the oil price shock set off in by the Iranian Revolution in November, 1978, increased the price of oil in Great Britain just as much as it increased the price of oil in Japan. It didn't matter that Great Britain was energy independent at the time and that Japan was 100 percent reliant upon imports. The only way to render America invulnerable to oil supply disruptions abroad would be to stop using petroleum products altogether or, alternatively, ban all imports and exports of oil, gasoline, and the like.

Moreover, removing our economy from international energy markets in a quest for independence would make America more vulnerable to supply disruptions for two reasons. First, it would be easier for terrorists to disrupt energy production if the sources of supply are geographically concentrated rather than dispersed. Second, if a domestic disruption were to occur and a trading infrastructure were not in place, we would not be able to avail ourselves easily of supplies elsewhere.

Finally, oil imports do not increase the pressure on oil prices. Rather, they relieve the pressure on oil prices. America imports oil because it's cheaper than producing that oil here at home. Trade reduces domestic prices for all services and commodities.

Physical Access is Not a Problem

The pre-OPEC oil market was characterized by long-term contracts between producers and consumers with little oil available in secondary markets. Accordingly, physical access might once have been a reasonable concern.3 The modern oil market, however, has been radically transformed. Robust spot and future markets exist for oil and refined petroleum products. Long-term contracts are rarer and contract prices are relatively transparent. Accordingly, physical access is no longer a legitimate concern for consuming nations.4 As Prof. Richard Gordon, professor emeritus of mineral economics and former director of Pennsylvania State University's Center for Energy and Mineral Policy Research, puts it, "Basic economics indicates that no shortages will arise as long as prices are uncontrolled. The question is the price needed to eliminate the shortage."5

That explains why any diversion of Unocal production toward Chinese domestic markets is irrelevant from an economic standpoint. Unocal production redirected towards China would simply displace imports from other suppliers. Those displaced imports would reenter the world market with no net effect on global supply.

That also explains why an oil embargo against the United States is incapable of preventing oil imports from reaching U.S. ports. Once oil leaves the territory of a producer, market agents dictate where the oil goes, not agents of the producer. The globalization of oil markets ensures that the United States will always have access to Persian Gulf oil whether oil producers like it or not.6

The 1973 oil embargo proves the point.7 As MIT's Thomas Lee, Ben Ball, Jr., and Richard Tabors observe regarding that experience, "it was no more possible for OPEC to keep its oil out of U.S. supply lines than it was for the United States to keep its embargoed grain out of Soviet silos several years later. Simple rerouting through the international system circumvented the embargo. The significance of the embargo lay in its symbolism."8 Granted, "there were short term supply disruptions," but "the only tangible effect of the embargo was to increase some transportation costs slightly, because of the diversions, reroutings, and transshipments necessitated."9 MIT oil economist M.A. Adelman agrees:

The "embargo" of 1973-4 was a sham. Diversion was not even necessary, it was simply a swap of customers and suppliers between Arab and non-Arab sources … the good news is that the United States cannot be embargoed, leaving other countries undisturbed.10

Unocal Provides Little Ammunition for an "Oil Weapon"

Unocal is a relatively minor player in world crude markets. Its worldwide operations produced a total of 169,000 barrels of petroleum liquids in the 1st quarter of 2005,11 or 0.23 percent of global oil production.12 Accordingly, CNOOC would not gain any real market power in world oil markets were it to acquire Unocal.

Some have expressed concern that China hopes to gain such market power through the incremental acquisition of reserves and through concessions for development rights from producer states. While we cannot discern with certainty what Chinese intentions might be, we should recognize that there are simply not enough non-OPEC reserves available to CNOOC to challenge OPEC's market power. Moreover, concessions from producers do not translate into control over oil assets, as both the United States and Great Britain discovered to their chagrin between 1960-1980.13

Regardless, the United States is not in a position to interfere with a Chinese drive for market power in oil markets were such a campaign to take place. The oil assets China would need to acquire such market power are outside the control of the United States government. Unocal's reserves are for all practical purposes immaterial.

Chinese & American Energy Interests Coincide

The fact that China is a net importer of petroleum means that the Chinese economy is best served by low oil prices. Because embargoes are empty gestures, the only sense in which an "oil weapon" can be said to exist is in the economic damage that can be done to consuming nations by a supply reduction engineered by producers. Accordingly, were the Chinese government - through CNOOC or whomever - to deploy an "oil weapon," its use would harm the Chinese economy as much if not more than it would harm the United States economy. That's because it requires more oil to produce a unit of GDP in China than in the United States and because the Chinese economy is less able to efficiently adjust to price shocks than the United States economy.14

Conclusion

There is no reason to worry about the impact that a merger between CNOOC and Unocal might have on domestic energy prices or America's access to oil. Unocal would not provide China with an "oil weapon." Thank you Mr. Chairman for the opportunity to testify this morning and I look forward to answering any questions you or the committee might have on these or other related issues.

1Bernard Gelb, "Unocal Corporation's Oil and Gas," Congressional Research Service, RS22182, July 1, 2005, p. 2.
2Energy analysts on both the political Left and Right agree on this point. For instance, see Pietro Nivola, "Energy Independence or Interdependence?" The Brookings Review 20:2, Spring 2002, pp. 24-27, and Michael Toman, "International Oil Security: Problems and Policies," Issue Brief 02-04, Resources for the Future, January 2002. The contention that energy independence doesn't matter is also the orthodox view among academic energy economists. See for instance M.A. Adelman, The Genie out of the Bottle: World Oil Since 1970 (Cambridge, MA: MIT Press, 1995).
3Analogies have been made between the Japanese drive for oil in the 1930s and 1940s and the present Chinese interest in international oil assets. The analogy is poor. The only reason that the Japanese government had to worry about access to oil was because that government went to war with every country that operated major oil production facilities.
4Chantale LaCasse and Andre Plourde "On the Renewal of Concern for the Security of Oil Supply," Energy Journal 16:2, 1995, pp. 13-14; Hossein Razavi and Fereidun Fesharaki, Fundamentals of Petroleum Trading (Westport, CT: Preager, 1991); and Philip Verleger, Adjusting to Volatile Energy Prices (Washington: Institute for International Economics, 1993).
5Richard Gordon, "Energy Intervention after Desert Storm: Some Unfinished Tasks," Energy Journal 13:4, October 1992.
6M.A. Adelman represents the overwhelming consensus among economists on this point; "Rarely has a word [access] been so compact of error and confusion. Nobody has ever been denied access to oil: anyone willing to pay the current price could have more than he wanted. One may assume what he likes about future demand, supply, and market control, and conclude that the future price will be high or low, but that price will clear the market in the future as in the past. The worry about 'access' assumes something queer indeed: that all of the producing countries will join in refusing to sell to some particular buyer - for what strange motive is never discussed … it takes only one other country, with a desire for gain, to cure this irrationality." M.A. Adelman, The World Petroleum Market (Baltimore: Johns Hopkins University Press, 1972), p. 260.
7There have actually been three attempts by Arab states to target embargoes against certain western states; 1956 (targeted at Britain and France), 1967 (targeted against the United States, Britain, and West Germany), and 1973 (targeted against the United States and the Netherlands). All failed to reduce imports into the targeted countries. For a political and economic history of those embargo episodes, see A.F. Alhajii, "Three Decades After the Oil Embargo: Was 1973 Unique?" Journal of Energy and Development 30:2, 2005, pp. 1-16.
8Thomas Lee, Ben Ball, Jr., and Richard Tabors, Energy Aftermath (Boston: Harvard Business School, 1990), p. 17.
9Ibid., p. 30. See also Edward Fried, "Oil Security: An Economic Phenomenon," in Oil and America's Security, Edward Fried and Nanette Blandin, eds. (Washington: Brookings Institution, 1988), pp. 56-59. Although many think the gasoline lines, high prices, and shortages were due to the embargo, they were not. For a brief review of the real causes of the above, see Jerry Taylor & Peter VanDoren, "An Oil Embargo Won't Work," Wall Street Journal, April 24, 2002. For a more extensive discussion, see Alhajii and Adeleman, Genie out of the Bottle.
10M.A. Adelman, "Limiting Oil Imports," Hearing before the Subcommittee on Energy Regulation, U.S. Senate, 96th Congress, 1st Session (Washington: Government Printing Office, 1980), p. 86, cited in Robert L. Bradley, Jr., The Mirage of Oil Protection (Lanham, MD: University Press of America, 1989), p. 140.
11Petroleum liquids include crude oil, condensate, and natural gas liquids. Production data from Robert Wright and Nancy Murachanian, 2005 Net Production Outlook, Unocal Corporation, April 28, 2005, cited in Bernard Gelb, "Unocal Corporation's Oil and Gas," Congressional Research Service, RS22182, July 1, 2005, p. 2.
12Global oil production was 73,301,000 barrels a day in the 1st quarter of 2005.
13M.A. Adelman, The Genie out of the Bottle: World Oil Since 1970 (Cambridge, MA: MIT Press, 1995), and The World Petroleum Market (Baltimore: Johns Hopkins University Press, 1972).
14For a review of the nature of the impact that oil supply shocks have on the economy, see Donald Jones, Paul Leiby, and Inja Paik, "Oil Shocks and the Macroeconomy: What Has Been Learned Since 1996," Energy Journal 25:2, 2004, pp. 1-32; Robert Barsky & Lutz Kilian, "Oil and the Macroeconomy Since the 1970s," National Bureau of Economic Research, Working Paper 10855, October 2004; and James Hamilton, "What is an Oil Shock?" Journal of Econometrics 113, 2003, pp. 363-398.