An $18.5 billion bid by a Chinese energy company to acquire theAmerican gas and oil firm Unocal has sparked a strong but misguidedreaction on Capitol Hill. On June 30, the House passed a resolutionby 398 to 15 expressing national security concerns about theacquisition of Unocal by the China National Offshore OilCorporation (CNOOC), an energy company 70 percent of which is ownedby the Communist government of China. On July 13, the House ArmedServices Committee held a hearing that raised the decibel levelseveral notches, with members especially vocal about the impact ofthe proposed deal on America's "energy security."
But fears that such a transaction would harm national securityby making the United States more dependent on foreign oil or thatthe proposed transaction threatens to somehow provide China with an"oil weapon" are ill-founded. In short:
Energy independence provides no economic protection againstsupply disruptions abroad and no guarantee that supplies will besecure in the future. America's vulnerability to oil supplydisruptions is primarily related to how much oil we consume, notwhere the oil we consume happens to originate.
America need not worry about access to international oilsupplies. Embargoes or supply diversions cannot keep oil out ofU.S. ports, and there are plenty of sellers in world oil markets.Only a naval blockade could prevent America from buying all the oilit needs from international oil markets.
Unocal's reserves are not large enough to provide CNOOC withsignificant market power in the global oil economy.
Because China is a net oil importer, it has every incentive tomaximize production and none to curtail production. Accordingly,American and Chinese interests in the oil market coincide.
Dependence on Foreign Oil Is Not an EconomicProblem
It's doubtful that American oil imports would increase as aconsequence of a CNOOC-Unocal merger. That's because Unocal'sdomestic oil assets are small (58,000 barrels of oil production aday, which translates into 0.8 percent of U.S.production frompetroleum liquids and 0.3 percent of to U.S.petroleumconsumption)1 andare most profitably sold to the U.S. market.
Even were Unocal's U.S. oil assets diverted elsewhere, it wouldhave no effect on America's vulnerability to oil supply disruptionsabroad. That's because it makes no difference from an economicstandpoint whether the oil we consume is produced domestically orfrom foreign sources.2 Moving oil around the globe is so cheap and easythat a shortage of oil anywhere in the world increases the price ofoil everywhere in the world. That's why the oil price shock set offby the Iranian Revolution in November 1978, increased the price ofoil in Great Britain just as much as it increased the price of oilin Japan. It didn't matter that Great Britain was energyindependent at the time and that Japan was 100-percent reliant onimports. The only way to render America invulnerable to oil supplydisruptions abroad would be to stop using petroleum productsaltogether or, alternatively, ban all imports and exports of oil,gasoline, and the like.
Moreover, removing our economy from international energy marketsin a quest for independence would make America more vulnerable tosupply disruptions for two reasons. First, it would be easier forterrorists to disrupt energy production if the sources of supplyare geographically concentrated rather than dispersed. Second, if adomestic disruption were to occur and a trading infrastructure werenot in place, we would not be able to avail ourselves easily ofsupplies elsewhere.
Finally, oil imports do not increase the pressure on oil prices.Rather, they relieve the pressure. America imports oil because it'scheaper than producing that oil here at home. Trade reducesdomestic prices for all services and commodities.
Physical Access Is Not a Problem
The pre-OPEC oil market was characterized by longterm contractsbetween producers and consumers with little oil available insecondary markets. Accordingly, physical access might once havebeen a reasonable concern.3 The modern oil market, however, has been radicallytransformed. Robust spot and future markets exist for oil andrefined petroleum products. Long-term contracts are rarer, andcontract prices are relatively transparent. Accordingly, physicalaccess is no longer a legitimate concern for consumingnations.4 AsRichard Gordon, professor emeritus of mineral economics and formerdirector of Pennsylvania State University's Center for Energy andMineral Policy Research, puts it: "Basic economics indicates thatno shortages will arise as long as prices are uncontrolled. Thequestion is the price needed to eliminate theshortage."5
That explains why any diversion of Unocal production towardChinese domestic markets is irrelevant from an economic standpoint.Unocal production redirected towards China would simply displaceimports from other suppliers. Those displaced imports wouldre-enter the world market with no net effect on global supply.
That also explains why an oil embargo against the United Statesis incapable of preventing oil imports from reaching U.S. ports.Once oil leaves the territory of a producer, market agents dictatewhere the oil goes, not agents of the producer. The globalizationof oil markets ensures that the United States will always haveaccess to 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., andRichard Tabors observe regarding that experience, "It was no morepossible for OPEC to keep its oil out of U.S. supply lines than itwas for the United States to keep its embargoed grain out of Sovietsilos several years later. Simple rerouting through theinternational system circumvented the embargo. The significance ofthe embargo lay in its symbolism."8 Granted, "there wereshort-term supplydisruptions," but "the only tangible effect of the embargo was toincrease some transportation costs slightly, because of thediversions, reroutings, and transshipmentsnecessitated."9
MIT oil economist M. A. Adelman agrees: "The 'embargo'of1973ÃƒÂ¢Ã¢â€šÂ¬Ã¢â'¬Å"4was a sham. Diversion was not even necessary, it was simply a swapof customers and suppliers between Arab and non-Arab sources... thegood news is that the United States cannot be embargoed, leavingother countries undisturbed."10
Unocal Provides Little Ammunition for an"OilWeapon"
Unocal is a relatively minor player in world crude markets. Itsworldwide operations produced a total of 169,000 barrels ofpetroleum liquids in the first quarter of 2005,11 or 0.23 percent of global oilproduction.12Accordingly, CNOOC would not gain any real market power in worldoil markets were it to acquire Unocal.
Some have expressed concern that China hopes to gain such marketpower through the incremental acquisition of reserves and throughconcessions for development rights from producer states. Althoughwe cannot discern with certainty what Chinese intentions might be,we should recognize that there are simply not enough non-OPECreserves available to CNOOC to challenge OPEC's position as themarginal producer in world oil markets--the position that bringswith it market power. Concessions from producers do not translateinto control over oil assets, as both the United States and GreatBritain discovered to their chagrin between 1960 and1980.13
The fact that China is a net importer of petroleum means thatthe Chinese economy is best served by low oil prices. If we positthat the Chinese government is interested in a stronger and not aweaker Chinese economy, we can safely assume that Chinese controlof oil assets will result in maximum production.
This is important because the only sense in which an "oilweapon" can be said to exist is in the economic damage that can bedone to consuming nations by a supply reduction engineered byproducers. Accordingly, were the Chinese government--through CNOOCor whomever--to deploy an"oil weapon," its use would harm theChinese economy as much if not more than it would harm the UnitedStates economy. That's because it requires more oil to produce aunit of GDP in China than in the United States and because theChinese economy is less able to efficiently adjust to price shocksthan is the United States economy.14
Relatedly, if the Chinese tried to hoard oil to keep it out ofAmerican hands (either by stockpiling inventory or shutting downproduction), it would drive up oil prices for consumerseverywhere--Chinese and American alike--and do more harm to theChinese economy than to the American economy. Simply put,deployment of a Chinese "oil weapon" would backfire on theChinese.
A reasonable understanding of how international oil marketsactually work in practice is sufficient to dismiss the worries ofthose who fear Chinese control of oil-producing assets or long-termcontracts with producer states.15Although national security analysts havehistorically worried about "access," those fears are no longerreasonable.
1. Bernard Gelb, "UnocalCorporation's Oil and Gas,"Congressional Research Service, RS22182,July 1, 2005, p. 2.
2. Energy analysts on boththe political Left and Right agree on this point. For instance, seePietro Nivola, "Energy Independence or Interdependence?" TheBrookings Review 20, no. 2 (Spring 2002): 24-27, and Michael Toman,"International Oil Security: Problems and Policies," Issue Brief02-04,2 Resources for the Future, January 2002. The contention thatenergy independence doesn't matter is also the orthodox view amongacademic energy economists. See for instance M. A. Adelman, TheGenie out of the Bottle: World Oil Since 1970 (Cambridge, MA: MITPress, 1995).
3. Analogies have beenmade between the Japanese drive for oil in the 1930s and 1940s andthe present Chinese interest in international oil assets. Thatanalogy is a poor one. The only reason that the Japanese governmenthad to worry about access to oil was because that government wentto war with every country that operated major oil productionfacilities.
4. Chantale LaCasse andAndre Plourde, "On the Renewal of Concern for the Security of OilSupply," Energy Journal 16, no.2 (1995): 13-14; Hossein Razavi andFereidun Fesharaki, Fundamentals of Petroleum Trading (Westport,CT: Preager,1991); and Philip Verleger, Adjusting to VolatileEnergy Prices (Washington: Institute for International Economics,1993).
5. Richard Gordon, "EnergyIntervention after Desert Storm: Some Unfinished Tasks," EnergyJournal 13, no. 4, (October 1992).
6. M. A. Adelmanrepresents the overwhelming consensus among economists on thispoint: "Rarely has a word [access] been so compact of error andconfusion. Nobody has ever been denied access to oil: anyonewilling to pay the current price could have more than he wanted.One may assume what he likes about future demand, supply, andmarket control, and conclude that the future price will be high orlow, but that price will clear the market in the future as in thepast. The worry about 'access' assumes something queer indeed: thatall of the producing countries will join in refusing to sell tosome particular buyer--for what strange motive is never discussed... it takes only one other country, with a desire for gain, tocure this irrationality." M. A. Adelman, The World Petroleum Market(Baltimore: JohnsHopkins University Press, 1972), p. 260.
7. There have actuallybeen three attempts by Arab states to target embargoes againstcertain 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 apolitical and economic history of those embargo episodes, see A. F.Alhajii, "Three Decades After the Oil Embargo: Was 1973 Unique?"Journal of Energyand Development 30, no. 2 (2005): 1-16.
8. Thomas Lee, Ben BallJr., and Richard Tabors, Energy Aftermath (Boston: Harvard BusinessSchool, 1990), p. 17.
9. Ibid., p. 30. See alsoEdward Fried, "Oil Security: An Economic Phenomenon," in Oil andAmerica's Security, Edward Fried and Nanette Blandin, eds.(Washington: BrookingsInstitution, 1988), pp. 56-59. Although manythink the gasoline lines, high prices, and shortages were due tothe embargo, they were not. For a brief review of the real causesof the above, see Jerry Taylor and Peter VanDoren, "An Oil EmbargoWon't Work," Wall Street Journal, April 24, 2002. For a moreextensive discussion, see Alhajii and Adeleman, Genie out of theBottle...."
10. M. A. Adelman,"Limiting Oil Imports," Hearing before theSubcommittee on EnergyRegulation, U.S. Senate, 96th Congress,1st Session (Washington:Government Printing Office, 1980), p.86, cited in Robert L. BradleyJr., The Mirage of Oil Protection (Lanham, MD: University Press ofAmerica, 1989), p. 140.
11. Petroleum liquidsinclude crude oil, condensate, and naturalgas liquids. Productiondata from Robert Wright and Nancy Murachanian, 2005 Net ProductionOutlook, UnocalCorporation, April 28, 2005, cited in Bernard Gelb,"Unocal Corporation's Oil and Gas," Congressional Research Service,RS22182, July 1, 2005, p. 2.
12. Global oilproduction was 73,301,000 barrels a day in the first quarter of2005.
13. M. A. Adelman, TheGenie out of the Bottle: World Oil Since 1970 (Cambridge, MA: MITPress, 1995), and The World Petroleum Market (Baltimore: JohnsHopkins University Press,1972).
14. Charles Wolf, K. C.Yeh, Benjamin Zycher, Nicholas Eberstadt, and Sung-Ho Lee, FaultLines in China's Economic Terrain (Santa Monica, CA: RandCorporation, 2003), pp.105-116. For a review of the nature of theimpact that oil supply shocks have on the economy, see DonaldJones, Paul Leiby, and Inja Paik, "Oil Shocks and the Macroeconomy:What Has Been Learned Since 1996," Energy Journal 25, no. 2 (2004):1-32,Robert Barsky & Lutz Kilian, "Oil and the MacroeconomySince the 1970s," National Bureau of Economic Research, WorkingPaper no. 10855, October 2004; and James Hamilton, "What is an OilShock?" Journal of Econometrics 113 (2003): 363-98.
15. For good treatiseson the matter, see Adelman, Genie out of the Bottle, and FranciscoParra, Oil Politics: A Modern History of Petroleum (New York: I.B.Tauris, 2004). For a somewhat brieferand more accessiblediscussion, see U.S. General Accounting Office, "Energy Securityand Policy: Analysis of the Pricing of Crude Oil and PetroleumProducts," GAO/RCED-93-17, March 1993. This author is unaware ofany alternative perspective regarding the operation of world oilmarkets in the academic literature that is at odds with theperspective offered in this paper.