China should prepare for the risks of declining oil reserves for the sake of future energy security

In recent years, Chinese scholars have been embracing “peak oil” theory in increasing numbers. The idea – first put forward by American geophysicist MK Hubbert in 1949 – is that individual oil fields, oil-producing regions and world oil production will display a “bell curve”: a steep rise in available supplies, narrow peak and subsequent rapid fall.

Proponents argue that world oil supplies will peak in the mid 2020s at an annual output of 40.3 billion tonnes, while China will see domestic oil production peak at 190 million tonnes per year by around 2015.

At first glance, their view that finite subsoil resources like oil will be harder to find and harder to tap appears very reasonable. But the peak oil model itself shows an inadequate empirical representation of historical patterns. World oil discoveries have peaked at least four times since 1950. Take the United States: here, there has been a major deviation between Hubbert’s projections and real figures of oil production. As economist Daniel Yergin has pointed out, at the end of 2010, US oil production was 3.5 times higher than Hubbert forecast.

Peak oil theory holds a static view of the world, and its models ignore price effects: lots of oil discoveries and high production mean that prices and profits wane, and incentives for further exploration decline. But ensuing oil shortages then restore these incentives. When incentives exist, the industry will continue to produce and is likely to produce even more.

Peak oil theorists also neglect the role of technological advances in oil production as a great multiplier. The history of the oil industry reflects an endless struggle between nature and our knowledge. Progress in technology allows both new discoveries and the increase in recovery rate needed to turn non-recoverable or hypothetical resources into recoverable reserves.

Worse yet, peak oil theorists do not take into account the assessment of unconventional oil resources, such as oil shale, oil sands, biomass-based liquids, coal-based liquids and liquids arising from chemical processing of natural gas. These could substitute for conventional oil when new technologies, such as steam injection for oil sands deposits, mature. Unconventional oil will very likely contribute to future production. By 2009, unconventional liquids had already contributed approximately 14% of total global production capacity, and this share was expected to grow to 23% by the end of 2030.

It’s true that China’s largest oil fields, in its north-eastern and coastal regions, are already mature and that production has peaked, with an annual output of 189 million tonnes. To date, China has already extracted 5 billion tonnes of oil out of 7.84 billion tonnes of discoveries, numbers that seem to leave little room for China to leverage output volume. But on balance, China’s overall oil production is still trending upward, at an average annual rate of 2.1%.

In addition, scientists and energy experts estimate that China’s untapped oil reserves in the western interior provinces and offshore fields could be as high as 12.2 billion tonnes (Figure 1). China will likely have an annual discovery rate of 900 million tonnes by 2020 and this rate will remain at 600 to 700 million tonnes leading up to 2030. As such, oil production is expected to continue to rise.

Figure 1. China’s untapped oil sites with significant oil reserves (circled in red)

Source: US EIA, USGS, Chinese Academy of Engineering, 2011

None of this means that China should disregard the peak oil conversation. In the popular debate, it may be easy for peak oil sceptics to argue that economic forces and advanced technologies will stave off the feared peak. But in the policy world, things are different. China’s leadership would be wise to approach the peak oil issue cautiously and strategically. China should consider what consequences it would face in a post-peak oil era.

Declines in oil production in certain regions of China have raised a red flag, compounded by the widening gap between oil consumption and oil production. The annual growth rate of China’s oil consumption was 2.8% from 1980 to 1990. With rapid industrialisation and urbanisation, the number jumped to 7% between 1990 and 2010.

The elasticity of oil consumption with respect to GDP (a way of measuring growth of oil consumption compared to growth of the economy) also increased from 0.3 in the 1980s to 0.7 in 2000s to more than 1 in early 2011. This means that the speed at which oil consumption is rising in China has now outstripped GDP growth.

In contrast to surging consumption, China’s oil production growth rate is only 2%. China already depends more on oil imports from unstable sources than either the United States or Europe: nearly 60% of its oil is imported from regions such as the Middle East and North Africa.

China’s oil demand is expected to increase in the foreseeable future, driven by industrial and agricultural use as well as phenomenal growth in car ownership. Turmoil in oil-producing nations raises the prospect of serious energy security concerns. During the unrest in Libya, more than 35,000 Chinese evacuated and all the oil-related investments in the country came to a halt. Rising world oil prices – the price had topped more than US$100 (631 yuan) a barrel as of 2011 – also raise economic concerns about elevated inflation and affordability of life for Chinese households.

Over the long term, China’s best bet is to scale up research, development and deployment of clean energies, particularly biofuels, as a substitute for oil. The Chinese government aims to increase non-fossil fuel energy to 11.4% of China’s total energy mix by 2015 and to 15% by 2020. These objectives are plausible, but they are not enough to decrease overall oil demand and consumption in the next two decades.

China cannot control or reduce the oil required to fuel its economic growth without accelerated structural reforms. Nevertheless, due in part to its current phase of industrialisation and urbanisation, China’s sluggish shift from heavy industry to service industry will take longer than expected.

A strategy for stabilising foreign supply is thus a short-term option. But China still needs to diversify its oil import markets in comparatively stable states such as Nigeria, Russia and the United Arab Emirates. Another good near-term strategy against future oil crises is to enhance oil extraction knowledge and technologies.

If China’s policymakers can rethink peak oil theory and prepare properly for the risks – rather than simply engaging in faith-based energy debates – then the country will find itself in a significantly more secure position.

Lin Shi is a teaching assistant at Columbia University and consultant to the World Bank; Yuhan Zhang is a Randle International Fellow at Columbia University and former researcher at the Carnegie Endowment for International Peace.

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