North America and China in the New Energy Age

North America and China in the New Energy Age

Remarks at the Opening of the 2014 Conference of the Canada-United States Law Institute

Ambassador Chas W. Freeman, Jr.
Cleveland, Ohio  4 April 2014

Good morning, ladies and gentlemen.

It’s a pleasure to join you at Case Western University.  We’re here to explore the connections between energy, the environment, markets, technology, legislation, and regulation  in North America and the world.  We Americans have, of course, figured out how to stage a world series by redefining the “world” to exclude everyone other than ourselves and a few Canadians.  But we can’t get away with doing this when it comes to energy, the environment, markets, and technology.  These are global systems affecting life throughout our planet.

Energy was one of the first commodities to be globalized and trade in it is a constantly shifting picture.  When I served as U.S. ambassador to Saudi Arabia twenty-odd years ago, someone told me that around 1880 American businessmen petitioned the U.S. Department of State to establish a consulate on the Red Sea at Jeddah.  They claimed they needed a U.S. government presence there to support burgeoning sales of Pennsylvania rock oil (what we now call “petroleum”) to the Arabs, who were becoming addicted to imported American kerosene.   Less than seven decades later, those very same Arabs began to export huge quantities of crude oil to the world, including the United States.

Another seven decades have passed, and the release of tight oil and shale gas in North America is making the United States — at least for a time — once again a major exporter of various forms of energy, including not just coal but natural gas.  Tight oil has boosted U.S. oil production by nearly three-fifths since 2008 and cut our annual import bill by about $100 billion. But oil prices are still set by global, not regional markets, and they will continue to be set in this way.  By contrast, gas prices — and therefore the costs of petrochemicals — now differ greatly from continent to continent.  Gas in North America costs one-third what it does in Europe and one-fifth what it does in Asia.  Trade is the exchange of what one has in relative abundance for what one does not.  The U.S. no longer imports liquefied natural gas (LNG).  That’s cut another $100 billion off our trade imbalance. More than twenty applications to export LNG from the U.S. are now pending at the Department of Energy in Washington.

We still import a lot of crude oil, in part because our refineries are designed to handle heavier oils than we are now producing domestically.  We have been selling a rapidly growing amount of petcoke — the highly polluting residue of such refining — to China.  At the same time, we are exporting rising quantities of diesel and other refined petroleum products.  In sum, we are exporting some types of energy and products that incorporate fossil fuel feedstocks even as we continue to import many others.

As this suggests, the ultimate result of what’s happening will not be “energy independence” — as some claim — so much as strategic self-sufficiency in some, but not all, categories of energy.  Our geopolitical autonomy will continue to be tempered by our participation in an increasingly complex pattern of international energy interdependence.

I’ve  been asked to speak to you this morning about how North America’s interactions with China will affect some of these emerging complexities.  Why China in particular?  Well, China is now the world’s largest energy user and its greatest polluter.   Five years ago it became the world’s largest automobile market.  For two years it has been the world’s largest annual investor in renewable energy.  Economists predict that it is about to become the world’s biggest economy, a status it enjoyed for millennia until it was surpassed by Britain around 1850.  A few years after China overtakes the American economy in size, if its growth continues, it will have a GDP larger than the U.S. and Canada combined.  Trade in energy promises to be a major element in North America’s evolving relationship with China.

This year’s Canada-U.S. conference is focused on prospects for the development of environmentally responsible energy sources, for North American participation in the global energy trade, for increased efficiency in the use of energy, for carbon trading and tax schemes, and for the future of the automobile.  I have only a very few minutes to say something about all these issues.  I’m afraid I’ll be pretty superficial.  But that has never bothered me at all.  Years ago, a wise man from the East assured me that, if something is worth doing, it is worth doing superficially.  (He was, of course, from the East Coast of the United States.)  I console myself that the excellent panels at this conference will provide the depth and detail I cannot.

Thinking about the current state of Sino-North American energy relations caused me to recall a famous piece in the Toronto Globe and Mail over three decades ago  In it, Ross Munro, the Globe and Mail’s Beijing correspondent, wrote about his participation in the Beijing marathon.  This was, of course, before that marathon became the slog through the smog that it is now.  As Mr. Munro, who is Canadian, ran the course, he heard the crowd yelling 加油, 加油 (jiāyóu, jiāyóu!).  He was greatly encouraged by this.  He took it to be short for 加拿大朋友 (jiānádà péngyŏu) or “Canadian friend” and reported that China had been seized with s mysterious wave of affection for Canadians.  Perhaps.  But jiāyóu literally means “add oil” — that is, “step on the gas” or “pick up the pace.”  And in our energy relations with China, that’s exactly what we’re now doing.

The boom in shale gas is creating new opportunities for North American energy companies to market fuels to China and for Chinese oil and gas companies to buy into their production here.  Chinese imports of petcoke — the sludge from U.S. refineries — have been growing at 50 percent per year.  China imported U.S. propane for the first time last May.  The U.S. shipped 111,000 metric tons of it to China last year, according to Chinese customs data.  China imported 74,000 tons of propane from the U.S. this January alone.

In the last few years, Chinese energy companies have invested huge amounts of money abroad.  Despite the severe political obstacles we Americans (and, to a lesser extent, Canadians) have put in the way, they have also invested more than $25 billion in oil and gas production in North America.  They are now actively exploring buying positions in the services sector here as well as elsewhere.  In addition to securing resources, they want to master hydraulic fracturing, horizontal-drilling, and oil sand extraction technology as well as other techniques for application both back home in China and in their foreign operations.

Investment in increased energy production, especially environmentally responsible investment, is good for the global economy as well as for Canada, China, and the United States.  Its implications go well beyond the bilateral context in which we usually consider it.  Let me give you a pertinent example that involves Canada, China, and the U.K.  When CNOOC’s newly acquired Nexen unit shuts down the Buzzard oil field in the North Sea for maintenance this July, Britain’s exports will drop enough to have a marked effect on its GDP and job market.  (A shutdown by Nexen in 2012 helped push the British economy back into recession.)   As ownership of the means of production is globalized, we are seeing economic interdependence develop new dimensions.

The sudden abundance of natural gas in the United States has brought about more than opportunities for exports.  It has reduced domestic demand for other fuels, especially coal.  Coal now accounts for less than 40 percent of U.S. electric power generation, down from over 50 percent a decade ago.  For a while, exports to China and Europe  kept U.S. production up and prices high.  China is the world’s largest producer and consumer of coal.  It burns half the coal burned in the world and it depends on coal for around 78 percent of its power.  The result in the great cities of China, as in London from the 1880 through the 1950s, is increasingly unbreathable air and polluted water.  Coal is the source of a lot of China’s environmental problems.  Could  tight oil and shale gas be the answer to these problems?

Most estimates are that China has only half the tight oil but about the same amount of shale gas reserves as Canada and the U.S. combined.  Unfortunately, however, much of China’s unconventional energy is located in relatively remote areas with little or no infrastructure, limited water, and convoluted geology.  You can drill a shale gas well in North America for between $3 and $4 million. It costs nearly $15 million to do that in China.  Given geological and other differences, it won’t be enough for Chinese companies to copy North American practices.  They will need to develop innovative technologies of their own to exploit their country’s reserves.  These include injecting substances other than water to raise reservoir pressure and perfecting new drilling techniques.  All this will take time.

But the Chinese public is quite understandably unwilling to continue to put up with unbreathable air.  Some of the eight-and-a-half million Chinese who have emigrated in recent years are environmental refugees.  They left to spare their children the experience of growing up in a badly degraded environment.  The political salience of the environmental catastrophe in Chinese cities is why Premier Li Keqiang’s state-of-the-nation speech at the recent National People’s Congress came down so heavily on the need to combat pollution.

China  is shutting down steel, cement, and glass-manufacturing facilities that are heavy polluters.  Air pollution in China is the result of multiple factors, including car engine exhaust and construction dust, but there is no question that coal-burning power plants are the largest cause of the sooty air in China’s cities.  The Chinese government is finally forcing power plants to stop shutting down their scrubbers when the inspectors aren’t looking and cracking down on the corruption that facilitates this.  Coal consumption in China continues to rise but emissions of sulphur dioxide — a health hazard in its own right and a major contributor to acid rain and visibility problems — fell by 3.5 percent last year and should drop by another 2 percent this year in what Western scholars have called “one of the most swiftly effective air-pollution policies implemented anywhere.”

In his speech, Premier Li claimed that the amount of energy consumed per unit of GDP growth would be cut this year by 3.9 percent, following a 3.7 percent drop last year.  China already has some of the toughest efficiency standards in the world for buildings and transport.  But for these standards to be effective, China needs to make further progress toward enforcement under the rule of law.  Accomplishing this is a stated objective of the new Chinese government, though environmental enforcement is not helped by the escalating persecution of non-governmental activists.  All in all, however, China is attempting to move away from a focus on rapid economic growth to address a widening range of quality-of-life issues.

As it restructures key elements of its socio-economic system, Beijing is trying to shift energy production toward renewable sources.  It has just banned new coal-fired power plants in some of its major cities.  It is also building 32 nuclear power plants and hopes to raise the nuclear component of its national energy diet from its current 2 percent to 6 percent by 2020.  (By comparison, the U.S. is about 19 percent nuclear and Canada is a bit more than 15 percent.)

Nuclear power aside, renewable energy sources made up 57 percent of newly installed Chinese generating capacity last year.  China put in 22 gigawatts of hydropower capacity and about 14 gigawatts of wind power.  It is looking to install another 18 gigawatts of wind power this year and to generate 200 gigawatts from wind by 2020.  In 2013, China installed a record 12 gigawatts of photovoltaic panels, more than the total amount of solar power now in operation in the U.S. and Canada together.  This year, another 14 gigawatts of solar power should come on line in China.

In the aggregate, these trends amount to the fastest shift in the structure of a national energy market that history has ever seen.  Shifts in energy supply and demand in China have global consequences.  Their impact is not limited to China and its major trading partners.  For example, China’s subsidies for photovoltaic projects have caused solar-panel prices to tumble worldwide.  This has made solar power competitive with other sources of power in a widening range of environments.  The same sort of efficiency gains and cost reductions are now taking place in wind power. China’s current experiments with carbon-trading regimes in seven cities and provinces and its plans to develop a national carbon-trading system next year are being carefully watched around the world.

Nor is China isolated from policy and legislative trends in other countries.  The Australian government’s declared intention to abandon its carbon tax system is leading to second thoughts about imposing one in China.  In Beijing, there’s now a lot more talk about raising taxes on air pollution, waste water, and solid waste than about a carbon tax.

Meanwhile, with another 90 million people — about 43,000 people per day — expected to move into China’s cities by the end of the decade, the Chinese government continues to emphasize investment in urban transportation, including roads as well as mass transit.  At least 26 Chinese cities are now building or expanding subway systems, while another eleven have begun to plan them.  But the growth in mass transit will moderate but not solve the traffic gridlock on city streets.  The Chinese love affair with the private automobile is new but shows few signs of abating.

Last year more than 20 million new cars and trucks were sold in China, while sales in North America topped 17 million.  Between them, North American, European, Korean, and Japanese companies have 60 percent of the Chinese vehicle market.  So far this year, sales in China are up 18 percent, outpacing expectations of a 10 percent gain.  But, despite subsidies for electric vehicles, most Chinese consumers have so far been as unenthusiastic about them as North Americans.  Perhaps Tesla’s arrival in China, where it hopes to find its largest market, will change this.  Let’s hope so.  1.4 billion Chinese driving cars with internal combustion engines is more than the planet could bear.  The fact that the U.S. is helping China to develop higher emissions standards may help, but it won’t be enough.  Whatever the answer to environmentally sustainable urban transportation systems may be, China is where we will find it, if we ever do.  We all have an interest in China succeeding at this task.

I want to close with a few thoughts about geography and the balance of resources between China and North America as it affects comparative advantage and the prospects for our relations.  No thoughtful Canadian or American would exchange our physical circumstances for those of China.  North Americans use 14.5 percent of the world’s arable land and about 19 percent of its water to feed and clothe a mere 4.9 percent of its population before exporting a huge food surplus.  China must sustain 19.5 percent of the world’s people on about 7.5 percent of its arable land, with less than 7 percent of its water.  It is the world’s largest importer of oil seeds and other food crops.  As the acquisition of Smithfield Foods by Shuanghui shows, Chinese agribusiness is beginning to figure out that it is more efficient to feed animals here than to transport the feed for them to China.  In food as in energy and petrochemical production, North America has the advantage.

Finally, to paraphrase Otto von Bismarck, from a strategic perspective, compared to just about everybody else, but especially the Chinese, we Americans and Canadians are two very lucky peoples.  We are bordered to the south by friendly Mexicans and to the east and west only by fish.  China has the Russians and Mongols to its north, the Vietnamese to its south, the Afghans,  Indians, and Pakistanis to its West, and the Koreans and Japanese to its east.  Those are the kind  of neighbors that make one cautious.

The military-industrial-congressional complex in this country has been doing its best to cure our enemy deprivation syndrome by depicting China as a military peer competitor.  But China is unlikely to live up to the image.  There’s really not much for us to fight with it about.  In the end, we’ll have to look elsewhere to justify military Keynesianism.

Meanwhile, there are multiple energy and environmental partnerships to be struck with the Chinese.  There is cooperative science and technology development to be done with their universities, companies, and scholars.  There are experiences and conclusions from regulatory experiments to be shared.  There is a lot of profitable business to be done.  And there is a conference to get on with.

Thank you very much and best wishes for a successful set of meetings.