China cannot escape the energy shock

THE COASTAL Chinese city of Zhuhai is linked to Hong Kong by a showy piece of infrastructure: a 55km (34-mile) bridge and tunnel, the largest sea crossing of its kind. Some Hong Kongers use it to visit Chimelong Ocean Kingdom, a theme park featuring a whale shark, rollercoasters and a hotel shaped like a spaceship. Others are motorists with a more mundane purpose. They travel to Zhuhai to fill up their tanks with petrol, available at a big-enough discount to make the drive worthwhile.

The mainland’s petrol-price formula smooths out the international market’s ups and downs. As such, it is one of the ways China’s government is shielding citizens from the effects of the war in Iran, which has trapped oil tankers on either side of the Strait of Hormuz and damaged energy infrastructure in the Gulf.

There are plenty more. As an emergency measure, China’s planning agency has banned exports of refined products including petrol, diesel and jet fuel. The country’s small, independent “teapot” refiners, clustered in Shandong province, are busy processing Iranian crude, which is still allowed to pass through the strait.

And if the war drags on, China may also dip into its vast strategic reserve of oil, which it diligently topped up when oil prices were low last year. “This is China’s nightmare,” said Lindsey Graham, an American senator, earlier this month. But precisely because China’s vulnerability to an energy shock haunts its leaders, they have taken steps to mitigate it.

China’s exposure is a result of its gargantuan appetite. The country produces more oil than Kuwait or the United Arab Emirates (UAE); including petrol and other refined liquids, it also outproduces Iraq. The problem is that China also consumes more energy than America, Russia and India combined—an amount that dwarfs its domestic output.

Coal, which runs in thick seams across the northern provinces of Shanxi, Shaanxi and Inner Mongolia, provides most of that energy. Renewables like wind and solar power represent a fast-growing share. But oil still produces more than 18% of the total (see chart). Despite China’s own respectable crude production, it relies on oil imports for about 13-14% of its energy needs. More than half of these come from the Middle East.

Much of this is now stuck. The war has snarled up Hormuz, the narrow waterway separating Iran from the UAE and Oman, through which about 15m barrels of crude per day used to travel. Shipments from Iran’s neighbours have slowed to a trickle.

Meanwhile, much of the oil Saudi Arabia is frantically piping to its west coast, in order to avoid the strait, does not suit China’s refiners. And Russian crude was promptly bought by India after America gave its blessing, suspending the tariff threat it previously brandished to discourage such purchases.

China does, however, have some advantages, including a handy source of supply that is off limits to many others: Iran itself. An average of about 1.3m-1.4m barrels per day of Iranian oil have been able to pass through the strait this month, according to Kpler, a data firm. That is roughly 90% of the pre-war amount. Most of this is destined for China.

The country’s national oil companies do not dare touch the stuff for fear of Western sanctions which would cut them off from the dollar-centric global financial system. But the tiny teapots, which collectively account for about a quarter of China’s output, are happy to take Iranian oil, often paying in yuan, according to Muyu Xu of Kpler.

Some of the teapots seem surprisingly sanguine about the next few weeks. The turmoil has tempted them to raise prices for their refined products, even as they work through cheap crude inputs bought before the war. “We’re…aiming to reap profits in the month of March for the whole of 2026,” a teapot official recently told Reuters, a news agency. But that assumes buyers will be willing to pay the higher prices they are now charging.

As well as Iranian crude, China can tap its own vast stockpiles. They are thought to cover about 120 days of import demand, once inventories held by state-owned enterprises and refiners are added to the government’s strategic reserve. In the meantime, the authorities have banned exports of refined fuel products.

It has also stuck to a formula established in 2016, which adjusts retail prices only gradually and freezes them altogether if the global benchmark exceeds $130 per barrel. When the cost of crude surged from April 2020 to June 2022, the formula passed only about three-quarters of the increase, according to researchers at the World Bank. On March 9th China raised the price caps on petrol by 695 yuan ($100) per tonne. This translated into a 7.8% rise in Guangdong province, where Zhuhai is located. Prices in Hong Kong are almost 50% higher.

Still, China cannot shield its economy entirely. Higher prices will raise freight charges and ripple through supply chains, increasing the cost of many chemicals, plastics and synthetic rubber. If the oil price averages even $85 a barrel this year (and it is currently above $110), it could shave 0.3 percentage points from growth in China’s industrial production, according to Shenwan Hongyuan, a securities firm. Goldman Sachs has already cut its GDP growth forecast for this year by 0.1 percentage points to 4.7%, although the bank made more substantial cuts to its forecasts for India (0.5 points), South-East Asia (0.4) and Japan (0.3).

In the long run, chaos in the Middle East might hasten worldwide adoption of electric vehicles, as welcome as solar and wind power, all of which China supplies in abundance. Countries may choose to turn away from fossil fuels not because these are dirty but because so much of the supply comes from such a dangerous region. In the past countries have worried about the “China squeeze”, fearing that China might bully or manipulate countries that depend on its suppliers. After recent events in the Gulf, however, energy-insecure places may see dependence on China as the lesser evil. Better to be squeezed than straitened. ■