National Commentary

The Peak Oil Crisis: Revolt Of The Teapots

In China, small privately or locally owned oil refineries are called “teapots.” Unlike the giant ones that refine hundreds of thousands of barrels each day, these little fellows typically process about 10,000, but taken together, they produce some 10-15 percent of China’s refined products. Reduce the teapots’ production and you have a problem.

In the last 25 years, China has come a long ways from its old soviet-style command economy to a rather bizarre mixture of traditional Communist centralism and free-wheeling capitalism. This bifurcated system has brought China undreamed of economic success in recent decades, but from time to time, problems turn up. Someday, the unprecedented environmental mess they are busily creating will do them in, but currently Beijing’s major concern is a nationwide fuel shortage. In other times, Chinese waiting in gas lines would be of minimal concern to most Americans so long as enough stuff was still getting through to the WalMart.

These are not “other times,” however, and shortages in China may be only weeks or months away from becoming shortages in other places— perhaps even at your favorite gas station. Thus it may be more important than you realize to keep track of gas lines in China for we are living in a globalized world.

The problem starts with China’s soaring economic growth, recently on the order of 11 percent a year. This, of course, leads to a large increase in the demand for petroleum and since China’s oilfields will no longer provide large increases in output, steadily increasing imports.

In recent months China’s impressive economic growth has been accompanied by some impressive inflation which reached an 11-year high of 6.5 percent in August and again in October. Beijing, which apparently has not yet discovered “core inflation,” allowing it to remove food and fuel from the index, is becoming worried. Not worried enough to clamp down on growth, which most in China seem to agree is the overriding national priority, but worried enough to put a ceiling on gasoline prices. That is where the current trouble started. As the world price of crude oil rose and rose, independent Chinese refiners, the teapots, lost more and more money.

For the teapots, the solution was to switch their production mix away from price-capped gasoline and diesel to non-regulated products such as petroleum coke or simply to suspend refining until the situation changed. They didn’t have to wait long to bring the mighty Chinese economy to its knees.

Prior to the shortages, it seems to have been Beijing’s policy to deny crude to the small refiners in order to force them out of business. To keep going, the teapots were importing crude oil from as far away as Venezuela and were using heavy fuel oil as the feedstock for their refineries in place of crude.

As world crude prices went higher and higher, production started to slip so that by October the situation was critical. Spot shortages broke out along the coast and imports of fuel oil for the teapot refiners dropped 29 percent. Total Chinese oil demand in October was only 2.4 percent higher than a year earlier – not much of an increase by Chinese standards. Of most concern to Beijing was the inability of all those trucks hauling exports to the coast to keep rolling.

The government sprang into action and, throwing inflationary concerns to the wind, authorized a 10 percent increase in diesel and gasoline prices. As some 80 to 85 percent of China’s oil industry is controlled by two giant state-owned oil companies, they were ordered to fix the problem.

Maintenance was cancelled and the large refineries were ordered to all-out production. Diesel imports which had been averaging 370,000 barrels a month for the first nine months of 2007 were increased to 750,000 barrels a month. The political heat must be unusually intense for the state-owned oil companies are posting reports on the progress they are making and spokesmen are making frequent announcements that all will be well soon.

By spring we should know how all this works out. As we in America should know by now, delaying refinery maintenance will come back to bite. Whether a 10 percent increase in retail prices will be enough to slow consumption and encourage increased production remains to be seen.

What should be troublesome to Americans is that during September and October, when Chinese imports were at their lowest, world prices took a rather spectacular jump. Now that China seems to be back in the world market with a vengeance, supply and demand can only get tighter still. But maybe OPEC will come to our aid. The Saudis say their production is back up to 9 million b/d. The Iraqis seem to have found the right people to bribe so that their northern export pipeline has remained operational for several months without being blown up. This alone has added 250,000 barrels a day to world supplies.

Unless a major recession that seriously slows Chinese economic growth starts soon, Chinese demand is going to keep growing and Beijing certainly has the money to pay any price. The last few months suggests that Beijing is running into an available oil ceiling that is not going away. Efforts to increase efficiency may be a great idea, but in practice, they take years to make a difference.

Even if the Chinese succeed in eliminating the current shortages, the success is likely to be temporary. A few months ago, China started importing refined gasoline for the first time. Although they have started to build new refineries, these take many years to complete and if current trends continue, in a few years, the Chinese will be selling themselves 10 million new cars a year.

Someday soon we in America will be facing shortages, gas lines, and rationing.

The chances are the revolt of the teapots is a harbinger of things to come.