With Li Keqiang’s recent business and investment blitz through Latin America, many in the region are hopeful these increased commitments will result in expanding business and trade links between the two.
The energy sector represents one of the largest opportunities for expanding trade between China and Latin America. China has made a concerted effort to expand energy links in the region and to assiduously build up dependencies, especially in form of oil-backed loans. This has resulted in oil exports from the region realizing near double-digit growth to China over the past decade, a relationship that will continue to expand for several reasons.
First, the U.S. shale oil and gas revolution is forcing major changes on Latin American producers. Not only do these exporters have to adjust to lower sustained prices, but they must also adapt to continual reductions in energy exports to the United States due to the shale boom.
With the U.S. rapidly slashing its dependence on imported oil, the market for Latin American oil producers has shrunk considerably.
According to EIA data for the five years leading up to 2014, Argentina, Brazil, Venezuela, and Mexico have all seen their exports to the U.S. fall.
The reduction in oil exports to the United States will force Latin American suppliers to look elsewhere with vigor, in a bid to diversify away from the U.S. market, and China seems the logical destination.
Second, due to reduced exports to the U.S. market and the small Latin American share of Chinese oil imports, there’s room to grow on both sides of the ocean. This trend has been underway for several years already, but shale growth has accelerated the growing energy relationship between China and Latin America, as China picks up the extra barrels that the U.S. is no longer interested in. Related: Why Buffett Bet A Billion On Solar
In fact, nearly all of the Latin American oil exporters have boosted exports to China over the same period, and this includes countries like Venezuela, where despite declining production, exports to China have grown three-fold. The dependency in this relationship is severely lopsided, with Venezuela depending on China for 16% of its oil exports and Brazil for a whopping 30% of its oil exports, while China receives only about 10% of its total oil imports from all of Latin America.
Any production increases or exports that are shifted from North America to Asia will be handled by the growing Chinese tanker fleet, where leading companies like China Merchants Energy Shipping and China Ocean Shipping Company have tripled tanker capacity over the past decade. Additionally, new refining facilities are being constructed in Latin America and the Caribbean with Chinese joint ventures, in addition to a new refining facility being constructed in mainland China, built specifically to process Venezuelan crude.
This shift benefits Chinese national security as well. Energy import diversification remains one of the most effective methods to ensure security of supply to a consuming country. Although diversification measures show that China has greatly improved its import diversity, there is still much left to be desired.
In particular, if China could establish routes for seaborne imports across the Pacific, this would give them a new, relatively more secure trade route to transport crude, bypassing the one or two chokepoints their supplies typically must travel through along their traditional energy import routes. The Strait of Hormuz and the Strait of Malacca pose perennial difficulties to Chinese security, since large portions of their imports must pass through the former, and over 80% of crude oil imports to China pass through the latter.
This has become such a major issue for China that China National Petroleum Corporation resorted to commissioning the Myanmar-China oil and gas pipelines, which is capable of carrying 440,000 bbls per day, or 6 to 7 percent of China’s daily import volume. But importing from Latin America will open up chokepoint-free routes of trade.
Finally, China leverages many of these dependencies and unbalanced relationships to reap annual discounts in the area of 10 to 15 percent, below the discounted costs expected for varying crude grades. For instance, in 2013, China’s average cost per barrel globally was $106, whereas their average cost per barrel from Venezuela was $89, a 16 percent discount from the average. Related: What Oil Export Ban Means for Investors
And, these arrangements have been quite profitable to the China Development Bank (CDB) and China’s top three national oil companies, CNPC, Sinopec, and CNOOC. The CDB has been repaid at least two-thirds of the nearly $50 billion lent to Venezuela over the past decade, and lower costs per barrel have helped boost the returns on capital employed by the oil companies themselves as they sell the discounted oil on the open market. Contrast these discounts with China’s current overreliance on Middle East crude, where they typically pay above the world average. The economic problems in places like Venezuela work to China’s benefit – it can extend a financial lifeline to an economically embattled regime in exchange for cheap oil.
For these key reasons, Chinese energy investments in Latin America should be expected to grow further, continuing to eclipse other sectors, except for select agricultural items. This combination of geopolitical imperatives, profitability, diversification, and the slow evaporation of a key Latin American export market, all point to increased Chinese energy investments to the region, resulting in potential outsized gains to companies positioned there. The region’s oil producers have little alternative other than to continue to shift to Asia.
*Unless otherwise noted, the calculations in this article were completed by the author using data sourced from the Energy Information Administration and United Nations databases.
By Ryan Opsal for Oilprice.com
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