The Chinese don't think oil is fungible

Ah, me!  I see that the Guardian has a column by Mark Tran that could equally well have been written by Econbrowser.  In essence he is saying that oil remains fungible and that profit is the driver.

But concerns about China's energy deals are overblown. It is immaterial who owns oil reserves as sooner or later the oil ends up on the world market. If China decides to hoard oil from one of its foreign reserves, say in Kazakhstan or Sudan, it frees up a barrel of Saudi oil for the world market.
Owning reserves does not change the price either. If the price of oil goes to $100 a barrel, and China owns a field in Sudan, the price for that barrel from Sudan is still $100. If China hoards that oil from Sudan for its own use, it would miss the chance to sell it at the higher price. That oil from Sudan would effectively cost the Chinese the same as if they bought oil on the open market.

This only works when there is more oil available than there is a need for.  And until we see more demand destruction than we have so far one must conclude that this historical situation is coming to an end.  As depletion continues to carve away at the oil available from existing fields, and as new development fails to match both this depletion and the growth in demand, then oil will stop being fungible.

At that point China may well get what it needs, only if it has the rights to the oil through the companies that it controls.  And that may become an issue.  Countries such as Indonesia are already having problems because "their" oil is leaving, and they can't afford to buy it back.   This may lead to different national policies.  After all, in the past, a number of countries took over the oil from foreign operators, and there is nothing to say that existing arrangements cannot be changed, by state fiat in many cases.

The article goes on to state:

There are other reasons why China may be on to a hiding for nothing. First, China's oil concessions abroad will not yield anything like enough for its energy needs in the next two decades. Second, most of the oil produced in China's foreign concessions will not physically enter China because of transport and logistical costs.
The oil will most likely be sold on the international market or swapped for oil that will enter China
I wonder how they reach that conclusion? China seems bent on a very determined program of oil acquisition around the world - the purchase of the PetroKazakhstan reserves are only a step in that process.  Unocal was obviously another such attempt, and though that failed, remember that Unocal has large Asian reserves.  In looking at China's five year plans (from Asia Times
The tenth plan, which runs from 2001 from 2005, continued the previous efficiency goals but also called on enterprises to seek international sources of oil and gas. CNPC responded to this goal energetically, and now has projects in over 11 countries, including Indonesia, Sudan, Azerbaijan, Syria, Algeria, Ecuador, Peru, Niger, Chad, Russia, and Kazakhstan. The latter two have been the main focus of China's international oil hunt in recent years.

The Guardian would suggest that China does not see its demand growing, which is obvious nonsense.  Likely what China sees is that if it does not tie up reserves, then down the road as the pie gets smaller it may lose its share.  As the Asia Times notes:

For China, this deal is about resources. It's material. But it's not a solution to China's growing oil demand. PetroKazakhstan represents maybe 30% of one year's demand growth in China if it keeps growing [at its current rate]. So the Chinese would need one PetroKazakhstan every four months to satisfy demand [growth]. Still, it's a good and a fairly large purchase for them."

Magee specifies, "They have a very good refinery - it's pretty modern - as well as production and reserves. They produce high quality oil, too. It's light sweet crude. So taken as a whole - the reserves, the production facilities, the refinery, and pipelines - it's a nice package. And it's strategically located near the Chinese border, close to its ultimate markets."

The bid, however, is not yet a done deal. And Business Week  would seem to agree.
With its economy booming, China is striving to meet its enormous energy needs by intensifying its ties to major energy producing countries and seeking to buy a wide array of foreign oil and natural gas assets.?
Though that article goes on to note that their purchases will not be enough to keep up with demand, and that, like the rest of us, Chinese needs can only be met by Saudi Arabia.
It is an unarguable fact that China's dependence on Middle East oil is increasing," said a recent report from the government-sponsored Chinese Academy of Social Sciences. "And this reliance will continue. Henceforth the Middle East will be the most important supply source of international oil for China."
Out of China's total oil consumption last year of 6.7 million barrels a day, almost half came from imports, according to BP PLC statistics. Chinese customs figures show Saudi Arabia provided 16 percent of China's import needs, with Oman and Iran contributing another 24 percent between them.
Less than 10 percent of its imports -- about 300,000 barrels a day -- came from foreign oil properties controlled by Chinese firms, said Wu Kang, a fellow at the University of Hawaii's East-West Center in Honolulu, citing Chinese statistics. And as China's economy expands, Wu estimates that its import demands will swell to 5 million barrels a day by 2010.
Saudi Arabia is probably the only country that can meet those demands, Wu says -- at least for the next several years. "But in the long term, there is a big problem," he said
Adrian Loh, an analyst with Merrill Lynch in Singapore, believes the situation will deteriorate even sooner. He predicts China's oil import needs in 2010 will grow to at least 10 million barrels a day -- twice Wu's projection and an amount that would leave it struggling to find Persian Gulf suppliers.

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I think the issue that Mark Tran misses is not so much fungibility as the nature of contracts.  Let's assume that oil from Sudan is the same quality as WTI.  If China's contract with Sudan says that China will pay Sudan the prevailing spot price then Mark Tran is correct.  But I bet that the contract with Sudan will call for a fixed price (maybe with some escalation clause) over a period of time, say 10 years.  

So, if the contract is signed for $50/barrel and the price of oil rises to $100/b or falls to $25/b in 5 years Sudan will still get $50.  

Note that China could have a similar financial hedge by buying an option on Nymex but Nymex only goes out to 5 years, may not list the volume of contracts that China wants, and probably offers terms worse than China could negotiste bilaterally with Sudan.

Surprising to most people when I point this out but, worldwide "free" markets are an extremely recent event in world economics and coincide with the rise of the oil boom and the relative peace of the post WWII era. Cheap oil made transportation less of a barrier and the successive rounds of tarrif reductions gained under US economic/military hegemony after WWII have temporarily created a working global economic system for the first time in history. Remove either of those pillars and the global economic system may start to devolve into regional blocs that will strive toward maximum self sufficiency AND try to deny their competitors from strategic resources - top on the list is oil.
The idea that petroleum is always going to be 'fungible' is an economist's fantasy, an article of faith that is not grounded in reality or history or human nature.  On the contrary, when Peak Oil is finally recognized as having already occurred, the people who own (possess,control) petroleum reserves are going to think that they can benefit by taking those reserves off the free market and instead using them to benefit themselves, the owners. We are practically guaranteed to see the phenomenon of nationalization of petroleum reserves.  Everybody will ask themselves 'just what is the true value of petroleum?', and they will rapidly conclude that the true value to their people, their nations, is a lot greater than 68 USD per barrel.  As the previous poster said, the existence of a free market in petroleum is a relatively recent phenomenon.  Up through WW-II, petroleum was thought of by everybody as a special asset that nations either possessed (controlled) or didn't possess (control).  The story of WW-II can be written as the struggle to control petroleum assets.  There was no free market in those days!  Instead of believing in 'fungibility', it would be more prudent to suppose that after Peak Oil the situation will more resemble that of 1939-41, when Germany desperately wanted Caspian petroleum and Japan desperately wanted Indonesian petroleum.
I hope this analogy does not incur any more sandwich shop references, but imagine you are a baker. Normally flour is purchased cheaply, you process it into bread, feed your family and sell as much of the surplus to all your customers who are happy they can buy bread and not make it themselves. What if one day there was a disruption that caused flour to stop coming, or at an extraordinarily high price. No matter what you are still going to feed your family. Maybe you sell one extra loaf (at a very high price) to pay for other essentials. But until the disruption ends, you may just sit on your stockpile of flour as long as possible and deny access to your customers to continue to baking for your family. The same is true of oil producers - they will not sell the oil if their citizens need it. They will sell just enough to afford the other items they need and not more.
This is true for food and families, but not true for food and nations. African nations are frequently exporting food while their people are starving. I imagine oil will work similarly. Most oil reserves are already nationalized - the question is whether the government and national oil companies will want to sell oil cheaper on the internal market than they can get on the external market. Indonesia and China are becoming case studies with what happens under that approach. Black markets and smuggling will limit the ability to do so (as in Iraq).
Obviously if you have an asset which is increasing in price, like oil during a shortage, it's better to own it. Then you will profit (or at least not be hurt) by the increase.

At the same time, economics doesn't go away. If your oil increases from $65/bbl to $200/bbl, people still face the same choice: holding $200 or holding a barrel of oil. This choice applies to equally to people who hold the oil and to people who don't. Owning the oil doesn't make this choice go away.

Generally, absent price controls, the price will rise to the point where (marginal) producers are ambivalent between holding the oil and holding the money. This means that even if you own oil, you're still going to be faced with a hard choice between whether to sell it (i.e. go without the oil but have the money) or keep it (go without the money but have the oil). Exactly the same choice is faced by a buyer: go without the money and have oil, or go without oil and have money.

This is the point of the "oil is fungible" argument, and it applies even if the price rises. Again, of course being an owner is better during the price rise; it's always good to own an appreciating asset. But that doesn't change the fact that you will always be faced with the hard choice: oil or money. Both owners and consumers are in that same situation.

Oil is or is not fungible depending on acquisition terms. If the Chinese are allowed to "own" the oil reservoirs they purchase, and need only lay out the money for extraction, transportation, and refining, the dollar outlay for them would likely be far less than if they were to purchase the oil at world prices.

I am aware that if the oil was then shipped to China from the foreign concession and priced lower inside China based on production cost, China would be taking an opportunity cost hit. Nonetheless no one in China would have to write a check for the penalty. IOW, if they obtained Kazakh oil on the cheap, swapped it for other oil at world prices, the accounting costs (as opposed to economic costs) would be essentially the same to China.

If however the foreign concession nationalized its fields and compelled China to buy back oil... or taxed away China's "economic rent" then China would be taking an accounting hit as well if they sold their oil to domestic users at below market rates.

From what I know China will try to get the oil it needs in order to fund its plans for economic development as a strategic goal. It can be expected to pay up for reserves because it will not hold itself to the high hurdle rates than Exxon-Mobil or Chevron-Texaco would.

Furthermore the recent press coverage says that China is building a number of greefield refineries and that its recent cutbacks in consumption growth are seen as temporary, despite what the Guardian seems to think. So I think I pretty much agree with HO here.

My curiosity is whether or not authors like "Dr. Oil Fungible" are ever countered in print in their own newspapers by letter writers.  The counter published at this site right below the fungible excerpt, for example, would make a great letter to the editor.  ZAP!  And it would counter the article right where most of its readers would see it.  Does this happen?          
I think the Chinese are perhaps just consolidating the supply line.  Cutting out the middle man, so to speak.  Am I being way to simplistic in this view?

For example:
Let's say I buy water from the city, and suddenly the price tripled.  If I were able to sink a well (either on my property or with a neighbor who agreed to terms), I could pump my own water and not have to pay the city for it anymore.  I could also (if I wanted) sell some of my water to other folks and compete with the city, to help pay expenses (pumps don't last forever!), or not sell and just keep a stock tank, it would be my choice.  That's one way I look at it.

Or, let's say our govt. has decided it is in the interest of National Security that we no longer export oil to China.  They would then either restrict exports or place such a premium on them (tarriff or whatnot) that Exxon and pals either would not or could not export to China. (I'm picking on China but it could easily be any other country, and I know we don't export domestic oil but our oil cos are working midle eastern oil fields and they are exporting).  I know that the US govt. can't tell a foreign based oil company what to do, but pretend for a moment that they can.

Now, if that scenario makes sense, from a national security standpoint, why wouldn't the chinese do exactly the same thing with their oil companies?  

Am I wrong totally?  (this is simplistic, I'm lacking sleep, etc. etc.)