Sure Is a Sweet Setup for China and Europe

 | Nov 12, 2013 | 10:30 AM EST
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China would like to extend a hearty "thank you" to American taxpayers and voters. Thanks to the U.S., China has clear access to secure sources of crude oil at below-market prices -- but, as it does not want to wake a sleeping giant, China will keep its gratitude to itself.

In order to understand what this means, three important facts about oil need consideration.

The first is the commodity itself. Crude oil has different varieties, blends and geographic locations. It is also financially liquid and enjoys price transparency. Even with several benchmarks operating around the globe, a world-pricing benchmark is established.

There are approximately 200 major crude streams around the globe. They include West Texas Intermediate (WTI), Western Canada Select (WCS), Brent Blend, Dubai, OPEC Basket, Tapis, Bonny Light and about 175 other major crudes. Wellhead prices vary, but most crudes are generally correlated to a single world price. Consequently, as a commodity, crude oil is financially fungible -- and, given this, it should respond to supply-and-demand economics. All other things being equal, additional supplies should put downward pressure on prices.

Well, additional supplies are entering the market. North America raised production, and Canada, the U.S. and Mexico plan additional increases. With more crude oil entering the supply side, the world's benchmark prices are lower than they might otherwise be.

In short, China's economy is benefitting from North America's oil boom. As more North American oil is produced, prices are kept low and world economies benefit.

The second important fact is the world's balances of oil supplies and demand. The Energy Information Administration (EIA) compiled country profiles, which lists suppliers and consumers.

Notice the regions with the largest supply imbalances. The European Union has the largest with a deficit of 11.7 million barrels a day. China is the second-largest with a shortfall of almost 6 million barrels a day. North America has a 5-million-barrel shortfall, then comes Japan with 4.6 million barrels. Altogether, the top four regions need to import almost 30 million barrels a day.

China's need for foreign oil leapfrogged that of North America. Going forward, it appears China's needs will grow as North American needs decline. For those who believe these trends are good for the U.S., TransCanada's (TRP) proposed Keystone XL Pipeline might take on new meaning.

This leads to the third important fact. Compared with the U.S., China pays almost nothing for energy security. They are getting a free ride at U.S. taxpayers' expense.

Saudi Arabia and its Persian Gulf neighbors need to export approximately 20 million barrels a day of surplus oil to China, Japan, India and Europe. Most of that oil must transit through The Strait of Hormuz -- which can be easily disrupted by hostile interests.

Oil suppliers and importers have an economic interest in making sure Middle Eastern oil tankers can pass freely through the Gulf and the Strait of Hormuz. To assure free and safe passage (and lower crude oil prices), the oil industry needs to have the region militarized.

Years ago, the U.S. government came to the rescue. It deployed tens of thousands of Army, Air Force, Navy, Marine and Coast Guard personnel on dozens of bases and ships all around the Persian Gulf. To a lesser degree, EU countries have supplemented US troops. However, the bulk of the military costs are borne by the U.S. taxpayer. Those costs are not included in the market price of crude oil.

The issue has not been lost on China. It appears the country has concerns about North America becoming energy independent, as this means the U.S, will consider withdrawing from of the Middle East. This, in turn, could force China to take America's place and take on energy security responsibilities.

In the U.S., the issue is beginning to attract attention within the Obama Administration. As North America steps up oil production, the question of paying to protect other nations' energy security attracts more attention. As political leaders look for opportunities to cut budgets, energy security in the Middle East could become an interesting target.

In the meantime, China is benefitting from North American energy boom. It is benefiting from U.S. financial commitment in Middle East military. It is also benefitting from the fact that Europe also needs U.S. support to assure their energy security. As long as America is tied up in the Middle East, China and Europe benefit.

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