Will China Supercede Saudi Arabia as the Key to U.S. Oil Prices?

January 15, 2010
By Keith Fitz-Gerald, Chief Investment Strategist, Money Morning

I bought a Toyota Prius last Saturday.
The signs are everywhere that oil is headed for stratospheric highs - $200, $250 or even $300 a barrel. Some of these signs are just plain obvious. But even the subtle indicators are telling us that some very expensive energy costs headed our way.
Let me tell you about one such indicator that I came across over the New Year holiday. A tiny news item said that Saudi Arabian oil concern Aramco is abandoning a lease on Caribbean oil storage, and further reported that PetroChina Co. Ltd. is moving in to take Aramco's place.
Most investors here in the West - if they even read the item - would've dismissed it as just another minor business transaction, one among the thousands that take place each day. But this particular deal was much more than that. It's another indication of China's continued global emergence. And it also underscores this country's relegation to the growing legion of "former" world powers that have been eviscerated by the financial crisis that they created.
In case you missed the story, let me share the details, and then explain what I believe those details actually mean.
On the last day of the year, the state-owned Saudi Aramco walked away from a 5 million barrel storage capacity lease at the Statia Terminals Group NV facility on St. Eustatius Island in the Caribbean. Ordinarily that wouldn't be significant. After all, oil leases come and go - change is a normal part of doing business.
But two facts make this transaction different:
First, Aramco had renewed this lease - which accounts for 38% of the total storage capacity on the island - since 1995 as a means of staging oil near its primary market: The United States.
And, second, with Aramco's departure, PetroChina, China's state-run oil company, has opted to move in.
From a strict numbers standpoint, I grant you that a 5-million-barrel facility doesn't appear significant. That much oil will meet U.S. energy needs for all of about five hours. And it equates to less than 1% of the U.S. Strategic Petroleum Reserve, which holds about 726.6 million barrels of oil. So it's not like China will suddenly have a lock on the U.S. oil market.
So what gives?
The Saudis know that U.S. has peaked. The Prius - and hybrid vehicles in general - are no longer a novelty on U.S. highways. And though still inadequate, alternative-energy policies are finally gaining traction in Washington. Finally, U.S. consumers are getting smart: They aren't just going to stand passively by and just "take it" when oil reaches the $150-a-barrel level. They'll find additional ways to conserve, pushing demand down even more.
So Aramco is shifting its focus elsewhere.
In fact, the company is targeting China and India, the first and second-fastest-growing oil markets in the world, as measured by petroleum consumption. Aramco is actually using free-storage capacity that it recently acquired from Japan.
Now I grant you that the high growth rates from China and India are partly due to the fact that they are both starting from a small base. Even so, if you take the time to do a little bit of simple forecasting, a dramatic picture emerges. China's oil consumption is growing 12% a year. At that rate, China's annual oil use will equal or surpass that of its U.S. counterpart by 2018.
We're talking less than a decade from now.
U.S. energy demand peaked in 2005, according to Department of Energy statistics, and most recent forecasts say it's unlikely to ever return to those levels.
Saudi Arabia's oil shipments to the United States hit 22-year lows in 2009. And that situation is unlikely to reverse itself even if the U.S. economy bounces back this year and beyond. It seems as if a financial-crisis-induced recession and all rhetoric about reducing our dependence on foreign oil combined to do just that.
What this deal really signals is a global changing of the guard.
For its part, Aramco is making a calculated decision to "follow the money" (the same mantra we follow here at Money Morning, and at our monthly advisory service, The Money Map Report). In that company's view, the money trail leads to China. The facilities it snapped up in Japan are a mere three days sailing distance from Shanghai's busy ports.
Charles K. Ebinger, director of the Energy Security Initiative at the Brookings Institute, said the move is "purely a reflection that the world market is changing... [and the] Saudis want to make sure they don't lose those markets."
PetroChina, on the other hand, isn't buying a pig in a poke. The Beijing-based player is taking over what seems to be a somewhat insignificant storage lease in the Caribbean as part of a strategy that includes more than just serving the U.S. market. Indeed, China intends to increase its presence in South America, and is building a base for more oil deals south of the equator.
Mark my words: We will see additional Chinese oil firms headed for South America, and can expect some headline-making deals.
Not that China is planning to ignore, or even forget, the U.S. market. Just the opposite, in fact.
With this deal, PetroChina - and, by extension, China - will actually enjoy a bigger, and more direct, influence on the U.S. oil markets because of the trading leverage that stems from having physical delivery capacity located so close to our borders.
Factor in the futures exchanges in Shanghai, Shenzhen and Dubai that are growing in volume every day, and you can easily see what the next step will be in this evolution of the world energy markets. U.S. exchanges will see a decrease in their influence on oil prices; that influence will shift to exchanges that exist far from our shores - a point that I made repeatedly in my new book, "Fiscal Hangover."
For U.S. lawmakers and the rest of the inside-the-beltway crowd, this changing of the guard - and the fallout that's certain to result - will lead to some challenging times. With China now in the game, there's even a very real chance Washington will discover that it's been maneuvered at least to the sidelines, and perhaps even out of the game.
The bottom line here is that oil prices are headed higher. Much higher. The oil industry itself is likely to be very volatile in the next few years, so the escalation will be in fits and starts, and there will even be some periods of retrenchment.
But don't worry. Investors who accept this new reality will find plenty of opportunities to profit.