Enverus Blog

Insights across the energy value chain

China’s decision to devalue the Renminbi after filling its crude oil reserves earlier this year has effectively provided it a hedge against any short-term supply disruption. Because China depends heavily upon oil imported from the Middle East, Angola and Venezuela, it has taken advantage of its past currency strength to purchase crude priced in US Dollars. China can now temporarily reduce imports for a few months while meeting domestic demand by drawing down its stockpiles. This allows China to hedge today without needing to pay a political risk premium in the near future if a supply disruption were to occur due to political instability in any of its suppliers.

China has also used its Renminbi strength in the last several years to negotiate favorable contracts with the Russian government and private entities, in some case agreeing to pay for imports of Russian crude oil and gas in Yuan which effectively gives China a discount post devaluation. China allowed its private, teapot refiners to import more crude beginning in July, in effect locking in lower prices.

Unlike most industrialized net oil importing nation states, China has come to view strategic petroleum reserve management relatively recently.

The importance of maintaining a strategic petroleum reserve has been understood by industrialized nation states since at least the end of World War II. Many historians believe that without Texas oil the Allied war effort may not have easily won the war. Created by President Roosevelt in 1941, the US Petroleum Administration for WAR (PAW) established the geography of Petroleum Administration Defense Districts (PADDs) which figure prominently today in global analysis of the hydrocarbon flow from rock to gas tank.

The 1973/1974 oil crisis caused major oil consuming nation states to create the International Energy Agency (IEA), an international governmental organization that continues to promote policies designed to limit the effects future oil supply disruptions and to gather and analyze public energy data. Signatories to the treaty creating the IEA agreed to create strategic resources as an on-going program to shield the global economy against adverse effects from oil supply disruptions. Twenty-nine European, North American, and Pacific Rim countries currently comprise the IEA. As of May 2015 all IEA member countries collectively held crude oil stock equal to 269 days of net imports calculated on historic use. The treaty calls for each member country to have oil stock levels that equate to no less than 90 days of net imports.

The US Strategic Petroleum Reserve (SPR) has been somewhat of a political football in the last several decades. For example, the US Congress recently considered selling SPR crude to help pay for bills to subside drug development and highway maintenance. SPR crude has been sold to bring down oil prices after Operation Desert Storm in 1990, Hurricane Katrina in 2005, and to encourage economic growth in 2011. Some have argued that the SPR has outlived its usefulness and should be discontinued.

China is not a signatory to the IEA treaty and thus is not bound by international law to store crude for release in the event of a supply disruption. As Chinese hydrocarbon consumption increases, the importance of maintaining and managing its own strategic resources will only grow.

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Tom Morgan

Tom Morgan is an Analyst for Drillinginfo. He has 20 years of experience practicing law with a focus on advocating for public policy to advance energy security and private property rights. Tom received his law degrees from Georgetown University and American University law schools. He hosts the weekly Drillinginfo Energy Minute, and you can find and connect with him on LinkedIn as Tom Morgan.