Almaty. August 5. Information Center - How China's disputes with its regional rivals and the US pan out will dictate the future of global energy trade, writes Kevin Foster, Argus media reports.

A crude cargo shipped from the Mideast Gulf to northeast Asia passes through the most dynamic — and potentially unstable — part of the globe. Tankers leaving the Gulf head south of Gwadar port in Pakistan's unstable Balochistan province, the terminus of the troubled China-Pakistan Economic Corridor, before passing by major importer India and Myanmar (Burma), where civil unrest is threatening China's oil pipeline links to the Indian Ocean. Transiting the narrow, pirate-ridden strait of Malacca, cargoes then move north through the contested waters of the South China Sea and the Taiwan strait to discharge at ports in China, Japan or South Korea, in the shadow of North Korea's nuclear weapons.

Around 9mn b/d of crude is shipped every day from the world's biggest oil producing region to the top importer, passing by countries that account for almost half of global crude import demand, but which are also home to rising nationalism, festering territorial conflicts and intensifying superpower competition between the US and China for primacy in Asia. What is the risk of one of these flashpoints igniting a wider conflict — and what would it mean for energy trade and demand if it did?

China rising

Local conflicts notwithstanding, the common theme driving regional instability is China's attempt to carve out a place in the world commensurate with its economic heft. The world's second-largest economy and top energy importer is operating within global economic and political structures shaped by the US after World War 2, when China was mired in civil war. And as China moves towards regaining the top spot in the global economy that it occupied for much of the past 1,000 years, it is increasingly attempting to shape those structures to its own benefit.

"China has gone through the stages of standing up and getting rich and is now advancing to the stage of becoming strong," says Yan Xuetong, dean of the institute of international relations at the country's Tsinghua University. Beijing's efforts to shift the regional balance of power in its favour are seen nowhere more clearly than in the South China Sea, where the risks of a conflict over energy resources or control of sea lanes have intensified sharply in recent years (see map).

China claims sovereignty over large parts of the sea, including in areas also claimed by a total of six other littoral nations. Naval clashes over disputed oil and gas reserves, tensions over US "freedom of navigation" operations to challenge what Washington calls "unlawful" maritime claims, and rival claimants' construction of military bases on contested islands together led US secretary of state Tony Blinken to say in July that "nowhere is the rules-based order under greater threat than in the South China Sea".

Beijing denies that freedom of navigation is threatened and claims to have recently driven off a US warship that was "violating its sovereignty" by passing near disputed territory. Any military clash between US and Chinese vessels could have major repercussions for energy flows — about 10mn b/d of crude and 100mn t/yr of LNG pass through the South China Sea, along with 30pc of global seaborne trade. Meanwhile, the sea's estimated energy resources of up to 11bn bl of oil and 190 trillion ft³ (5.4 trillion m³) of gas lie largely undeveloped as a result.

Dire straits

A potentially bigger flashpoint lies to the north, in Taiwan. On any given day, around 7mn bl of crude passes along Taiwan's east and west coasts, while Chinese and Taiwanese naval and air forces face off across the Taiwan strait. Beijing, which sees Taiwan as an "inalienable part of China", has stepped up its military activity in the strait since the 2016 election of Taiwanese president Tsai Ing-wen, who opposes unification with the mainland. In July, Chinese president Xi Jinping promised a "complete reunification" with Taiwan during a major speech marking the centenary of the Chinese Communist Party, adding to Beijing's increasingly aggressive rhetoric. Foreign forces bullying China will "smash their heads bloody" against a great wall of steel built by the Chinese people, Xi says.

China could invade Taiwan within the next six years, the US' top military commander in Asia-Pacific, admiral Philip Davidson, warned a US Senate committee this year. Other observers play down the risks of armed conflict, arguing that the likely international condemnation — and potential for economic sanctions against Beijing — could derail China's carefully managed economic rise and lead to upheaval in oil imports.

The US could respond to any Chinese blockade of Taiwan with a counter-blockade of its own, including by "interfering… in the Indo-Pacific region and the [Mideast Gulf] with a lot of Chinese access to oil and other raw materials", US research group Brookings senior fellow Michael O'Hanlon told think-tank the Centre for Strategic and International Studies in July.

A new defence bill moving through the US Congress commits the country's armed forces to maintaining the ability to deny a "fait accompli" against Taiwan, in an attempt to deter China from using military force — suggesting tensions will only rise further in the short term. And should China decide to take Taiwan by force, the risks of a wider conflict appear to be increasing. Japan's deputy prime minister, Taro Aso, recently hinted that Tokyo might come to Taiwan's aid in the event of an attack — remarks that Beijing described as "extremely wrong and dangerous".

Energy vulnerability

Energy importers in the region are trying to manage the rising risks by diversifying their supply sources, although with limited success. China is increasingly sensitive to the risks that stem from its heavy oil and gas import dependence. Its latest five-year plan includes a section on energy security for the first time, and refers to the importance of securing "critical chokepoints" along import routes.

Beijing has sought to reduce its reliance on seaborne imports through a huge programme to build or expand its overland oil and gas pipeline links with Russia, central Asia and Myanmar. Cross-border pipelines supplied only about 7pc of China's crude imports last year. And the pipelines bring their own security risks.

Beijing has strengthened its ties with Moscow and many of its central Asian neighbours in recent years, helped in part by its booming energy trade, as well as by investments under its huge Belt and Road Initiative. But turmoil in Myanmar following this year's military coup threatens the security of China's Burma Road pipelines, which carried 200,000 b/d of Mideast Gulf crude to China last year. And Beijing's ambitions to further bypass the strait of Malacca by securing access to Pakistan's Indian Ocean port of Gwadar have been plagued by problems, including a militant attack in July that killed nine Chinese workers.

Other regional importers have even fewer alternatives to seaborne imports. South Korea — where imports cover more than 90pc of energy and natural resource needs — has focused on strengthening energy ties with exporters such as the US and countries in the Middle East, its foreign ministry says. India is scrambling to diversify oil imports and boost domestic supplies, with minimal success. The increased tension in the Taiwan strait, along with US-China rivalry in the South China Sea, has also highlighted the risks to energy security in Japan, which relied on Middle East suppliers for 92pc of its 2.5mn b/d of crude imports last year (see table). Policy advisers to Japanese premier Yoshihide Suga are urging the government to look for alternatives to the main import routes through the strait of Malacca and the South and East China seas.

Pivot points

Big energy importers have another option to reduce risk — cutting oil and gas imports altogether through a transition to cleaner energy sources. Japan's total fuel demand could fall by 50pc by 2040, according to the country's biggest refiner, Eneos, while oil's share of China's energy mix could drop to as low as 3pc by 2050, from 18pc now, as part of the government's commitment to achieve carbon neutrality by 2060, according to Tsinghua University estimates.

The energy transition will not eliminate security risks entirely, with the emergence of an international market for hydrogen hinting at one potential future for global commodity trade. But China's dominant position in global rare earth supplies provides a sharp contrast to its dependence on imported crude and gas, while the localised nature of renewables such as solar and wind could also reshape supply dynamics.

Looming over Asia-Pacific is the US, in the role of guarantor of stability and freedom of sea lanes that it has played since 1945. But Washington has overstretched its military power after two decades of conflict in Iraq and Afghanistan, and its commitment to safeguarding its faraway allies looks shakier after four years of "America First" policies under former president Donald Trump.

"We have historically a strong position in Asia [but] that position has slipped and we are at risk," White House Indo-Pacific co-ordinator Kurt Campbell says. "China wants to reshape the operating system of Asia." Trump's successor Joe Biden is acting to repair damaged bilateral relationships with Asian allies such as Japan and South Korea to promote a multilateral front against China, as his administration embraces as tough a line towards Beijing as Trump's did.

Despite the change in rhetoric under Biden, questions remain about US engagement in Asia. Former president Barack Obama's "pivot to Asia" was stalled by a competing US security focus on Russia and the Middle East, creating the perception of a growing security vacuum. Biden is keen to avoid the same trap by seeking an equilibrium in relations with Russia and ending the US' combat role in Iraq and Afghanistan.

The growth in trade between the US and China — notwithstanding periods of turmoil under Trump — as well as within Asia-Pacific itself, still holds out hope that economic integration will outweigh political rivalries. The shale boom resulted in the US strengthening its energy trade with east Asia over the past decade — even as political relations grew increasingly uncertain — and US oil and gas exports through the Panama Canal bypass many of the flashpoints that threaten Asia-Pacific trade with the Mideast Gulf. China has imported more than 500,000 b/d of US crude in the past 12 months. And US-China trade totalled almost $560bn in 2020, up by more than 20pc from 10 years earlier.

Conscious decoupling

But history has another warning. While the rise of China could herald the end of the post-1945 global political system, some observers see a more worrying analogy for modern-day Asia-Pacific in the build-up to World War 1. China's challenge to US primacy echoes the dynamics between Germany and Great Britain that sparked that conflict, and trade between those countries was also on the rise ahead of the start of hostilities.

Whether a similar disaster can be avoided a century later in east Asia could become the most important question for global energy trade. And Washington's policies to decouple its economy from that of China — accelerating as US actions to limit investment flows to China find a counterpart in Beijing's move to cut off access to western finance for its own technology sector — may already be eroding the stabilising effect of financial and economic interdependence.