Oil, other resource prices surge on China's demand

The question is how high prices will go before Chinese buyers decide to cut back.

China Oil reserve 88 248 (photo credit: )
China Oil reserve 88 248
(photo credit: )
One reason behind the rebound in world oil prices lies here on China's eastern seaboard, where tidy rows of immense, squat oil tanks tucked away on an island south of Shanghai have been filled to guard China's energy security. Patrolled by military personnel, these tanks in Zhoushan are one of four locations where China keeps its national strategic reserves. Since crude oil and other commodity prices plunged last year - oil tumbled from $147 last July to nearly $33 in December - China has been rushing to build up stockpiles at bargain prices, economists say. That motive, more than a revival in actual industrial demand, has driven its recent import boom of oil, copper and other metals. The surge in Chinese demand, along with rising hopes for a global economic recovery, has helped lift the price of oil, which is now trading at close to $70 a barrel, and other commodities. The question is how high prices will go before Chinese buyers - and other investors who have flooded into commodities from other markets - decide to cut back, according to Simon Wardell, an oil analyst at London-based IHS Global Insight. "This market is persisting, and it may well persist for a few more months yet, simply on the basis of increased optimism," he said. China is obsessed with making sure it has enough energy and materials to feed its economy. Authorities plan to build more oil reserve tanks while lining up diverse supply sources, including Brazil, Nigeria and Siberia. Earlier this month, energy chief Zhang Guobao announced government approval of a second phase of strategic oil reserves that will hold 26.8 million cubic meters of crude oil - bigger than the current reserves of 16.4 m.cu.m. Ultimately, China aims to have about three months of supply in national reserves. It now has about a month's worth, or about 38.6 million tons of crude oil in both commercial and state reserves, according to state media reports. The United States also has taken advantage of the drop in oil prices to buy crude for its Strategic Petroleum Reserve, which is far bigger than China's. In January, the US Energy Department said it would seek contracts and other arrangements for the delivery of nearly 20 million barrels of oil for the reserve to raise its total to 727 million barrels by the end of the 2009 - equal to about 70 days of oil imports. The world's second-largest oil consumer after the US, China imported 178.9 million tons of crude oil last year, up nearly 10 percent from 2007, to meet about half of its total demand. In May, imports surged to 17.09 million tons, nearly matching the monthly peak hit in March 2008, when the economy was still booming. China also is the world's biggest consumer of many other commodities, including iron ore, coal, soybeans and cotton. In volume terms, May copper imports skyrocketed 325.8%, iron ore soared by 37.4% and steel products by 23.1% from the same period in 2008, according to Merrill Lynch. Oil imports rose 5.5%. During the boom years before the global financial crisis hit, shortages of many key commodities prompted Chinese planners to begin building the strategic reserves in Zhoushan, in nearby Zhenhai and in the northeastern ports of Dalian and Huangdao. China's State Reserves Bureau has also been buying up aluminum, copper, zinc and other metals in a move partly aimed at diversifying the country's heavy holdings of US Treasuries into nondollar-denominated holdings of other assets. Beijing's sensitivity over the strategic value of its reserves was evident during a recent tour of Zhoushan and Zhenhai, a first for both domestic and foreign media. At Zhenhai, 52 tanks, each able to hold 100,000 cu.m. of crude oil, are zealously protected by military personnel and equipped with the latest in fire-fighting and security equipment. The meticulously landscaped facility is flanked by a Sinopec commercial reserve of 138 tanks, all linked by pipeline to a nearby oil terminal. Zhoushan's 50 tanks, holding some 5 m.cu.m. of crude oil, were built and are managed by Sinochem, a state-owned oil and chemicals trading company. "Oil is a very important national strategic resource. It is crucial for our national energy security," said Tang Zhibin, deputy general manager of the Zhoushan reserve. Zhoushan could be expanded during the second phase of the program, he said. But some of the new reserves, unlike the first 100 billion yuan ($14.6 billion) first phase, likely will be located in inland regions. "Certainly, they're very eager to have much bigger strategic reserves," Wardell said. But he said imports in June and July could fall "because they simply have nowhere left to put oil." Earlier this year, an official with the China General Chamber of Commerce, Zhou Youshan, proposed that the government start using private oil company reserve tanks, many of which lie empty, to bolster national reserves, the state-run newspaper China Daily reported. Others have reportedly suggested keeping some reserves offshore in tankers. With oil at less than half its peak reached last year, China appears to be undaunted by worries that higher costs could crimp its recovery. Given the government's willingness in the past to help out oil refiners with huge subsidies, the higher prices may not be much of a threat, said Christoffer Moltke-Leth, head of sales trading at Saxo Capital Markets in Singapore. "It would probably take crude above $100 to start to severely threaten the economic scenario in China," he said.