[EAI Commentary] The Future of US-China Competition - Resource Edition: US-China Competition in the Global Energy Market

Editor's Note

Since 2018, the East Asia Institute (EAI) has been planning and operating a mid-to-long-term research project titled "China's Future Growth and the Construction of a New Asia-Pacific Civilization" with the aim of designing a desirable order for the Asia-Pacific region that can lead to humanity's coexistence and sustainable development, and to present Korea's role in this endeavor. As the first phase of this project has been completed, EAI published its research findings as an English working paper series over April and May. As a follow-up series, EAI has planned the "Future of US-China Competition: 4-Stage Competition Dynamics" special issue briefing series, consisting of four reports that provide an outlook on the future of US-China relations.

As the third report in this series, we are publishing an issue brief on the US-China competition for energy resources, authored by Professor Lee Wang-hui of Ajou University. China is expected to experience the largest increase in energy demand over the next 20 years, while the United States is projected to become a net energy exporter starting in 2020. From an economic perspective of energy supply and demand, the US and China were seen as having a complementary relationship, leading to high expectations for energy cooperation between the two countries. However, as the trade war between the US and China has intensified, the author points out that the relationship in the energy sector has shifted from a "win-win game" to a "zero-sum game." Particularly, considering the security implications of energy resources, the author assesses that even if the trade war ends through negotiation, China will seek to reduce its dependence on US energy, making it difficult to maintain the expectation that expanded energy trade will lead to improved security relations.

Introduction

This paper forecasts the impact on the global energy market in 2040 from the perspectives of market and policy. From a market perspective, it is necessary to examine how the supply and demand of energy resources will change in the long term. The supply and demand of resources that generate energy are influenced not only by price but also by technological advancements. From a policy perspective, since the supply and demand of major resources do not align within a single country or even a continent, it is necessary to examine the geopolitical aspects surrounding resource security. In the short to medium term, events such as armed conflict, economic sanctions, and terrorism can have a profound impact on the energy market. Global efforts to combat climate change since the 21st century have strengthened international cooperation. As the slogan "more energy, less carbon" suggests, reducing carbon emissions on a global scale can lead to a restructuring of the energy mix through increased use of alternative energy, as well as an absolute reduction in energy consumption through improved energy efficiency. Therefore, to forecast the global energy market, it is necessary to consider long-term trends in energy supply and demand along with international political variables.

In the long term, the most significant factor expected to influence demand is China's economic growth. Historically, energy consumption has tended to increase concurrently with economic growth in most countries. China is no exception. The International Energy Agency (IEA), the U.S. Energy Information Administration (EIA), ExxonMobil, and BP, all of which provide long-term forecasts, predict that China's energy demand will increase by an average of more than 1.5% annually until 2040. On the supply side, the U.S. shale revolution, which began in the mid-2000s, warrants attention. Following the lifting of the crude oil export ban, which was implemented in 1975 due to the oil crisis, in December 2015, exports surged, and the U.S., which had been a net oil importer since 1948, became a net oil exporter in December 2018.

In the short to medium term, the most likely event to cause significant disruption to the global energy market is the trade war between the United States and China. Before the trade war began in March 2018, the prevailing expectation was that a virtuous cycle of energy trade would form between the U.S. and China. Specifically, the U.S. was increasing exports to China, which had emerged as the world's largest oil consumer. Simultaneously, China sought to increase imports from the U.S. to achieve two goals: diversifying its import sources (reducing reliance on Russia and the Middle East) and reducing its trade deficit with the U.S. However, with the escalation of the trade war in 2019, trade between the two countries has rapidly declined, eroding expectations of a virtuous cycle. Even if the trade war ends through a compromise, it is highly unlikely that China, having experienced the aggressive intentions of the U.S., will maintain its import dependence on U.S. energy resources beyond a certain level.

The structure of this paper is as follows. The next section examines the forecast for the global energy market up to 2040 from the perspectives of supply and demand. It analyzes the short-to-medium-term impact of cooperation and conflict between the U.S. and China. Finally, it briefly discusses the implications of US-China conflict for South Korea.

Long-Term Trends in the Global Energy Market

The main variables used in estimating energy consumption are population growth, energy intensity (defined as primary energy consumption divided by GDP, representing the amount of energy required to produce $1,000 of GDP), per capita GDP, and net change. Among these, per capita GDP is the most crucial variable.

<Table 1> Contributions to Primary Energy Demand Growth

Source: Contributions to Primary Energy Demand Growth, Energy Outlook Downloads and Archive (BP 2019)

Historically, energy consumption has tended to increase until income reaches a certain level due to economic growth. As economies mature, per capita energy consumption stabilizes or decreases due to lower potential growth rates, population growth rates, and energy intensity. Based on these past experiences, energy consumption is expected to continue increasing in emerging economies while decreasing in developed economies until 2040.

<Figure 1> Per Capita Energy Consumption and Per Capita GDP (2000, 2015, 2040)

Source: Annual International Outlook 2018: Summary (EIA 2018, 4)

Among emerging economies, China and India are predicted to have the largest increases in energy consumption. This is because their contributions to economic growth are the largest. Approximately 80% of global economic growth until 2040 will come from emerging economies, with China accounting for about one-third and India for one-fifth.

<Table 2> Contributions to Global Economic Growth

Source: Global GDP Growth and Regional Contributions, Energy Outlook Downloads and Archive (BP 2019)

Energy consumption is projected to increase more rapidly in India than in China. China's growth rate is expected to sharply decline from an average of 5.1% between 1995-2017 to an average of 1.1% between 2017-40, while India's is expected to decrease slightly from 5.1% to 4.2% over the same period. The slowdown in China's growth rate is attributed to a decrease in potential economic growth rate, as well as improvements in energy efficiency and a decline in the share of energy-intensive manufacturing. Although India's growth rate will surpass China's after 2020, energy consumption is projected to increase more rapidly in India than in China. China's growth rate is expected to sharply decline from an average of 5.1% between 1995-2017 to an average of 1.1% between 2017-40, while India's is expected to decrease slightly from 5.1% to 4.2% over the same period. The slowdown in China's growth rate is attributed to a slowdown in potential economic growth rate, as well as improvements in energy efficiency and the development of alternative energy sources. Although India's growth rate will surpass China's after 2020, China's absolute consumption will account for about 20% of the net increase, and by 2040, it is predicted to be more than double that of India.

<Table 3> Primary Energy Consumption

Source: Primary Energy Consumption, Energy Outlook Downloads and Archive (BP 2019)

On the supply side, it is necessary to examine the production of oil and natural gas, which hold the largest share in the energy mix. Although clean energy sources that can replace fossil fuels are being actively developed to manage and prevent climate change, the share of oil and natural gas is not expected to decrease, as most countries are prioritizing the reduction of coal usage.

<Table 4> Primary Energy Demand: Fuel

Source: Primary Energy Demand: Fuel, Energy Outlook Downloads and Archive (BP 2019)

From 2017 to 2040, oil and natural gas production are expected to increase by approximately 0.3%. Oil production is projected to increase by more than 1% in the United States and Brazil. Since the U.S. production volume is at least three times larger than Brazil's, the increase in U.S. production will be the largest in absolute terms.

<Table 5> Oil Production

Source: Oil Production, Energy Outlook Downloads and Archive (BP 2019)

Natural gas production, which emits relatively fewer pollutants, is expected to increase in all regions except Europe. In terms of production volume increase, the share of the United States and Russia is expected to be significantly larger than that of other regions.

<Table 6> Gas Production

Source: Gas Production, Energy Outlook Downloads and Archive (BP 2019)

The Relationship Between the U.S. and China in the Global Energy Market

Examining the trends in global energy supply and demand reveals significant disparities between continents. Asia and Europe have supply deficits, while Eurasia, Africa, and the Americas have surpluses. Between 2017 and 2040, the largest fluctuations are observed in Asia's deficit and the Americas' surplus. Therefore, conditions are emerging for Asia and the Americas to pursue mutual benefits through energy trade over the next 20 years.

<Figure 2> Fossil Fuel (Oil, Gas, Coal) Trade Balance

Source: Energy Outlook 2019 (BP 2019, 71)

Within Asia, China is the country with the largest projected increase in energy demand over the next 20 years. Urbanization can be considered the most critical factor influencing energy demand. Urbanization leads to an increase in per capita GDP, thereby increasing energy consumption. Over the next 20-30 years, it is estimated that 300 to 500 million people, more than the entire population of the United States but less than the entire population of the European Union (EU), will migrate from rural to urban areas. Based on empirical evidence, considering that the urbanization rate in countries with income levels similar to China's current level was 70%, China's urbanization is expected to progress by at least another 20-30%. If it develops similarly to the U.S., it could reach 80%, and if it follows the path of South Korea and Japan, it could reach 90%.

Conversely, the rate of increase in energy demand will continue to decline. The emphasis on the service sector over manufacturing in the "supply-side reforms" will reduce China's energy consumption in the long term. Energy intensity is expected to decrease by approximately 54% between 2017 and 2040. Concurrently, to reduce carbon dioxide and fine dust emissions, the Chinese government is pursuing plans to shift its energy mix towards greater use of natural gas and nuclear power over oil and coal. This is reflected in the "Opinions on Establishing a Mechanism for Ensuring the Stable Supply of Natural Gas" (關與建立保障天然氣穩定供應長效機制的若干意見) issued by the National Development and Reform Commission (NDRC) in April 2014. Currently, the share of natural gas in China's primary energy consumption is less than 5%, which is very low compared to 30% in the U.S., 24% in the EU, 26% in OECD countries, and the global average of 24%. Although China produces oil and natural gas as an oil-producing country, its import dependence is bound to increase as consumption grows faster than production. Between 2017 and 2040, oil import dependence is expected to increase from 67% to 76%, and natural gas dependence from 38% to 43%.

Despite these policies, the share of natural gas in China is unlikely to surge in the short term. Firstly, the price of natural gas is relatively high compared to coal and even oil, making it affordable only in large cities with high income levels. Furthermore, the infrastructure for transporting natural gas (pipelines, city gas networks, natural gas refueling stations, etc.) is also unevenly distributed regionally. It is important to note that conventional natural gas, rather than unconventional gas such as shale gas and CBM, overwhelmingly dominates natural gas production in China. According to China's National Bureau of Statistics, in 2013, 240 million people used natural gas, and the gas penetration rate in cities was 32%. Considering this, the share of natural gas is projected to grow from 6% in 2016 to approximately 13% by 2040.

In the United States, the share of manufacturing, which is energy-intensive, is decreasing, while the adoption of new technologies that significantly improve energy efficiency is expected to prevent an increase in energy consumption. Between 2017 and 2040, energy intensity is expected to decrease by approximately 36%. Concurrently, in line with policies aimed at preventing climate change, the share of fossil fuels in the energy mix is expected to decrease, and the share of alternative energy sources will increase. In particular, with the shale gas revolution leading to increased production and lower prices, the share of natural gas is projected to rise from 28% in 2018 to 37% by 2040.

Furthermore, the U.S. is expected to achieve self-sufficiency in primary energy sources by 2020. As the rate of production increase exceeds the rate of consumption increase, the surplus must be exported. For this reason, the Obama administration lifted the crude oil export ban in December 2015. The U.S., which had been a net energy importer since 1953, is projected to become a net exporter in 2020.

<Figure 3> U.S. Total Energy Trade Balance (Projected)

Source: Annual Energy Outlook 2019: with projections to 2050 (U.S. Energy Information Administration 2019, 13)

In the future, U.S. primary energy exports are expected to be led by natural gas rather than oil. While oil exports will peak in the mid-2030s and then decline, natural gas exports are projected to continue increasing even after 2050. U.S. LNG exports surged by 61% year-on-year in 2018, making it the world's fourth-largest exporter, and with the completion of facilities currently under construction, it is expected to become the largest exporter by 2020.

<Figure 4> Net Energy Balance by Resource (Based on Projections)

Source: Annual Energy Outlook 2019: with projections to 2050 (U.S. Energy Information Administration 2019, 13)

Currently, the United States exports natural gas to its neighbors, Canada and Mexico. From the mid-2020s onwards, as production surges, the U.S. will need to develop new export markets. Very few countries can purchase more than half of its production. According to the International Gas Union (IGU), the top LNG importers in the global market in 2018, in million tons (MT), were Japan (25.4%), China (16.7%), South Korea (13.6%), and India (7.1%). China, which increased its imports by 39% year-on-year in 2018, is expected to surpass Japan as the largest importer as early as 2025. The export outlook for the European market is not bright, as Germany is proceeding with the "Nord Stream 2" project to import Russian natural gas via pipeline, despite U.S. opposition. Therefore, the U.S. gas industry has no choice but to stake its survival on exports to China.

<Figure 5> U.S. Natural Gas Trade (Based on Projections)

Source: Annual Energy Outlook 2019: with projections to 2050 (U.S. Energy Information Administration 2019, 19)

Impact of the Trade War on U.S.-China Energy Relations

Before the trade war erupted, LNG was considered a prime example of U.S.-China economic cooperation. China's imports of U.S. LNG were based on shared interests: resolving the U.S. supply glut, reducing China's trade surplus, and diversifying its imports (limiting reliance on Qatar, Australia, and Russia). Before the trade war, it was estimated that the U.S. could reduce its trade deficit with China by approximately $17 billion through LNG trade, while China could reduce its energy import costs by about $1.8 billion. This mutual benefit created conditions for rapid trade growth even before the conclusion of large-scale long-term contracts.

<Figure 6> Liquefied Natural Gas (LNG) Trade Outlook (by Country and Continent)

Source: Energy Outlook 2019 (BP 2019, 98)

President Trump agreed to the "100-day action plan" (百日计划) proposed by President Xi Jinping to reduce the U.S. trade deficit with China during their first summit meeting on April 7, 2017. Among the ten agreements released on the websites of the commerce ministries of both countries on May 11, the fourth item was China's import of U.S. LNG.

The United States welcomes imports of LNG from China and our trading partners. The U.S. will provide the same benefits for LNG import authorization as for other non-FTA countries. Chinese companies can negotiate any type of contract, including long-term contracts, at any time, based on the commercial considerations of each party. As of April 25, 2017, the U.S. Department of Energy authorized the export of 19.2 billion cubic feet of natural gas per day to non-FTA countries.

China's imports of U.S. LNG, which began in 2016, surged after this agreement. Looking at trade volumes in 2017-18, the U.S. accounted for about 4% of China's total LNG imports, and China accounted for slightly over 10% of the U.S.'s total LNG exports. Discussions on joint development investments between U.S. and Chinese companies also progressed rapidly. Concurrently, in November 2017, when President Trump visited Beijing, after agreeing to jointly invest $43 billion in the Alaska LNG project with China, U.S. energy companies began expanding their LNG export facilities. In February 2018, U.S. company Cheniere Energy signed its first large-scale long-term supply contract with China National Petroleum Corporation (CNPC), the world's third-largest and China's largest oil company.

However, the trade war transformed a win-win game into a zero-sum game. On September 18, 2018, China imposed additional retaliatory tariffs of 5% to 10% on 5,207 items worth $60 billion from the United States. A 10% tariff was imposed on U.S. LNG. Subsequently, LNG trade volumes rapidly declined. In particular, trade sharply decreased after the imposition of the 10% tariff by China on U.S. LNG took effect. In March 2019, amidst repeated interruptions and restarts of trade negotiations, there were no exports to China.

<Figure 7> U.S. LNG Exports (Amount: US $)

Source: https://usatrade.census.gov (Accessed: June 19, 2019)

Shipment performance shows a similar pattern to export values. U.S. LNG exports to China plummeted from 30 vessels in 2017 and 27 vessels in 2018 to just 2 vessels by April 2019. In terms of 2018 export performance, 18 vessels were shipped in the first half of the year, before the discussion of China's 10% retaliatory tariff on U.S. LNG, while only 9 vessels were shipped in the second half, including the period after the tariff measure was announced. In 2019, only one vessel was shipped in January and February, respectively, when high-level negotiations resumed. After the U.S. announced an increase in retaliatory tariffs from 10% to 25% in early May, China raised its tariff rate on U.S. LNG from 10% to 25%.

<Figure 8> U.S.-China LNG Trade

Source: U.S. Department of Energy; Refinitiv Eikon shipping data (reproduced from Reuters, “Trade War Cuts U.S. Liquefied Natural Gas Exports to China,” May 10, 2019)

To make matters worse, the signing of a 20-year supply contract worth $16-18 billion between Cheniere and Sinopec, China's third-largest oil company, which was agreed upon at the end of 2018, is being delayed. As exports to China plummeted, the American Petroleum Institute, representing the oil and gas industry, urged the U.S. government to end the trade war on May 13, 2019.

If the trade war continues, China's imports of U.S. LNG are expected to further decrease. First, if China raises its tariff rate from 10% to 25% in response to additional U.S. retaliatory tariffs, the price competitiveness of U.S. LNG in the Chinese market will inevitably decline. Furthermore, as the global natural gas market is a buyer's market, not a seller's market, the U.S. position will be further weakened. China can increase imports from Qatar (24.9%) and Australia (21.7%), the world's largest producers as of 2018 – Malaysia (7.7%) and the U.S. (6.7%) are third and fourth, respectively. Simultaneously, China has two alternatives for importing LNG via the Arctic route and natural gas via pipeline from Russia. In April 2019, China National Petroleum Corporation and China National Offshore Oil Corporation (CNOOC) agreed to each purchase a 10% stake in Novatek's "Arctic LNG 2" project. A research report by the Asian Development Bank Institute (ADBI) projected that an expanded role for Russia could lead China to build an East Asian LNG trading hub together with Japan and South Korea. In this scenario, U.S. influence would be further limited.

Conclusion

Until the trade war intensified, expectations for U.S.-China energy cooperation were very high due to their complementary relationship of U.S. surplus and China's deficit. In particular, trade between the two countries was expected to flourish as demand for LNG in China surged, with production in the U.S. projected to increase significantly over the next two decades. However, since the trade war, as China began imposing tariffs on U.S. LNG, the possibility of energy cooperation has been diminishing. Even if the trade war ends through negotiations, the expectation that China would become the largest importer of U.S. LNG is now much less likely to be realized. Due to the security implications of energy resources, China will seek to minimize its dependence on U.S. LNG. Therefore, the expectation that expanded energy trade will improve security relations is unlikely to be sustained.

■ Author: Lee, Wang-Hui_ Professor of Political Science and International Relations at Ajou University. He holds a Ph.D. in International Politics from the London School of Economics. His main research areas are international political economy and corporate-state relations. His co-authored works include "The Belt and Road Initiative: China and Asia" (2016), "East Asian Regional Governance and Transnational Cooperation" (2019), and "A Study on Cooperation Measures for South-North-China Economy" (forthcoming). His major papers include "Geopolitics of the Belt and Road Initiative: Sino-Russian Cooperation vs. Linking Russia to Strike China" (National Security and Strategy 2017), "International Political Economy of Fintech: Competition between the U.S. and China" (National Strategy 2018), and "U.S.-China Trade War: Resistance to Protectionism within the U.S. and China's Lobbying Efforts in the U.S." (National Security and Strategy 2018).

■ Editor: Choi, Soo-yi, Senior Research Fellow at EAI

Inquiries: 02 2277 1683 (ext. 206) I schoi@eai.or.kr

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