2004 May 08 Saturday
Increased Chinese Demand For Oil Is A Net Loss For The USA

For reasons that make no sense to me Tyler Cowen thinks China's demand for oil is not a net cost to the United States. (correct me if I'm wrong in my interpretation Tyler)

Oil just hit $40 a barrel. Many analysts, such as Paul Krugman have noted the Chinese role in pushing up commodity and natural resource prices:

Lately we've been hearing a lot about competition from Chinese manufacturing and Indian call centers. But a different kind of competition — the scramble for oil and other resources — poses a much bigger threat to our prosperity.

I am surprised to see Krugman so qualifying his former belief in the virtues of free trade. Keep in mind that the core theory of international theory is a barter theory. "The Chinese buying oil" and "the Chinese selling bicycles" are just two sides of the same coin. If you don't think one can harm the U.S., you shouldn't, in general, think the other will harm the U.S. either. (Of course if your vision of free trade is we get the bicycles but give up nothing in return, we are worse off relative to that state of affairs!)

Here is another way to think of the logic. If the Chinese are bidding up the price of oil, they have found good uses for that resource. If they have a comparative advantage in buying oil, that benefits the rest of the world. Comparative advantage in production also will mean comparative advantage in buying certain inputs. The U.S. still has access to its previous production possibilities frontier. It must now decide whether it would rather spend its money on oil, or on something else, perhaps the outputs of the Chinese.

Tyler is surprised by Paul Krugman? Well, I'm surprised by Tyler. Or wait, no, I take that back. This is the sort of argument I expect Tyler to make. I also disagree with it.

Okay, what is wrong with Tyler's argument? The higher price for oil reduces the amount of oil the US will buy. The oil that the US will buy will cost more. The rising Chinese demand for oil makes us worse off. The Saudis and other oil producing nations will get more money for producing the same stuff and therefore can buy more stuff with the same amount of oil sold. The Saudis will not need to work harder or more efficiently. They didn't even have to do anything to get the oil in the first place. They just got lucky to have oil under their deserts. They didn't even have to develop the technology to extract, process, and ship it. Yet they make the bulk of the money from its sale.

Rising demand for natural resources as a result of the industrialization of more of the world is going to shift more wealth from manufacturers to the possessors of natural resources. The United States will have to lower the prices at which it sells goods in order to generate more sales to get the revenue to pay for the higher price for oil imports. It is hard to see how this is a gain for the USA. The same holds for other existing big buyers of natural resources. They will pay more for inputs and at the same time will have to sell a larger fraction of their outputs abroad to earn the revenue to pay for the inputs.

Tyler mentions the environmental cost to the US and other countries from the increased energy consumption of China. Yes, Chinese air pollution does cross the Pacific to reach the United States.

The contributions to Western US air pollution are sometimes substantial.

Based on air quality measurements at Cheeka Peak at the westernmost tip of Washington state and later airplane-based measurements, Jaffe's research group has shown that a steady trickle of air pollution comes across the Pacific from Asia -- at least in the spring -- punctuated by a surge of pollutants once or twice a month. 

These surges are presumably due to the wholesale movement of air from Asian urban areas across the Pacific. This prevents the pollutants from being diluted by mixing with cleaner air. During these surges, the air entering the West Coast can have pollution concentrations as high as 75 percent of federal air quality standards, Jaffe said. 

China is going to surpass the United States in carbon dioxide emissions.

China will surpass the United States in annual emissions of CO2 within a decade and, in a few decades, in total cumulative emissions of CO2 since the beginning of the Industrial Revolution.

Chinese sulfur dioxide emissions have skyrocketed.

Between 1990 and 2000, annual releases of sulfur dioxide into the atmosphere in the United States dropped from about 20 million tons to 13 million tons, but in China they have climbed to about 45 million tons.

But pollution is not the biggest cost to the rest of the world coming from increased Chinese oil purchases and increased Chinese coal burning. Nor is the biggest cost the higher price the US has to pay for oil (though, contra Tyler, that really is a net loss for the United States). The biggest cost for the United States from Chinese economic growth is in the realm of national security. The rising demand for oil from China and other industrializing countries is going to make the Middle East even more problematic.

To the extent that China becomes a military rival they will of course also cost us a lot more in increased military spending. How that plays out remains to be seen. But we certainly are faced with both higher energy prices and a more intractable Middle East as a result of China's economic growth.

Update As Nobel Laureate Richard Smalley argues, the US government ought to spend an additional $10 billion per year on energy research. Energy research is a much cheaper way to avoid with the potential costs (assuming there really are net costs) of climate warming too.

Share |      By Randall Parker at 2004 May 08 09:59 PM  Economics Political

Brock said at May 9, 2004 2:37 AM:

Good catch. Your natural pessimism caught what my tired, Finals-induced dementia missed. ;-)

Endorsing your p.o.v., I take back and qualify what I said in the previous post. We, America, won't pick a fight with China directly, but if we come to deadlock over differences in Middle Eastern policy (say, on what to do about Saudi Arabia in the event of another 9-11) it might come to blows.

And I wouldn't want to be Chen Shui-bian on that day. Or my relatives in Taipai.

Funny, isn't it that Saudi Arabia & the Middle East in general only has the wealth it has because WE, the West, gave them the benefit of our legal system and law. Any of the last three (true) rulers of the Middle East (Turkey, Britain, the US) could have (and can to this day) easily wipe out the Arabs to a man and nationalize the oil fields.

And they know it too, deep down. One of the "roor causes" for 9-11 I think. To quote my favorite author "Never shame a small man. He'll kill you to preserve his pride."

M said at May 9, 2004 3:55 AM:

"only has the wealth it has because WE, the West, gave them the benefit of our legal system and law."

Our system of law has nothing to do with it,where Sharia isn't the norm simple kleptocracy is.
The ME is wealthy because of Western technolgy and technical knowledge and skill.
One would think that after more than 5 decades of the oil culture there,they would have scads of people experienced and educated in the petroleum busness,but they are still dependent on western engineers and technical workers and cheap labor from Pakistan and the Phillipines.They are complete parasites and deep down know this,that's the "root cause" of 9/11 and most of the problems of the ME.

Luke Lea said at May 9, 2004 7:57 AM:

This is reality. Get used to it. Free trade doesn't mean free or even cheap oil. The notion that we have any choice in the matter is an illusion -- unless, by choice, you mean the choice to go to war with China over access to oil in the Middle East. But that way madness lies: another world war would cost the United States and the free world far, far more than any prospective rise in world oil prices due to rising world demand. On the other hand, if the US wants to recapture some of that added value of oil, a good place to start might be to tack on a two or three dollar a gallon tax on gasoline at the pump. At least we keep the money instead of shipping it off to the Saudis. But, then, for that approach to work it would be necessary for our European and even Asian trading partners (including China) to adopt similar policies. Maybe this would be grounds for some real international cooperation: OPIC vs. OPEC?

Steffen Hentrich said at May 9, 2004 8:01 AM:

I wonder why rising oil prices are only seen as costs. One's costs are others revenues and possessors of natural resources buy a lot of things from revenues.

Brock said at May 9, 2004 8:27 AM:

M - my point was we don't have to pay them bup-kiss. They obviously don't provide anything of value. We only pay them for the oil because we have a tradition of paying landowners for their natural resources. It doesn't have to be that way. WE could import cheaper labor from Pakistan & the Phillipines, run the fields like we do anyway and not pay them anything.

Steffen - Same answer. Sure they buy stuff from the West - but they buy it with OUR money, and they spend it on crap like Madrassas in Afghanistan and "Muslim Research" here in the US, Madrassas by another name. They don't actually give us anything we didn't already have. The Japanese & Germans make good cars and electronics. Australia grows a butt-load of sheep. China makes a buttload of everything. What exactly does Saudi Arabia make? Oh, right - nothing. It stands on its desert and charges us for the privilege of making them multi-billionaires. They are the ultimate parasites.

Luke - We wouldn't have to go to war with China. Assuming we ran the oil fields we could sell it to them as well. We could even sell it to the Saudis. The point is (1) We stop paying the Saudis for their luck of being born in the world's oil bin. They did nothing to deserve it. (2) We keep the oil profifs for ourselves (or for whoever runs the drills keeps it - Britain, France, Russia, etc.) and (3) We stop funding terrorism.

That was the point of Randall's post after all. Currently $40/ barrel is fine, ceteris paribus. Competing with China for the oil is fine, ceteris paribus. It only when (1) that $40 buys an Iraqi insurgent an AK-47 to kill our troops with, and (2) that Competition causes China to sabotage our efforts in the ME to keep the supply strong, that it becomes a problem.

TM Lutas said at May 9, 2004 10:13 AM:

The country with the 2nd largest reserves of oil in the world is no longer Iraq as of last year. Instead, it's Canada which knocked Iraq down to number 3. Why did Canada (which had no major oil discoveries in 2003) suddenly shoot up the charts? It is because reserves are judged by deposits of oil (oil endowment) that can be economically extracted at current market prices and using current technology. Canada has huge oil sand deposits that recently have come down in production price to about $12 per barrel. If Saudi Arabia still maintained a high reserve of production capacity, the Canadian endowments wouldn't much matter because SA could knock down the price to $10 a barrel by temporarily running at full capacity and bankrupting marginal Canadian producers at SA's convenience. Nobody would invest in a scheme like Canadian oil tar sands as long as SA maintains reserve production capabilities like that.

Saudi Arabia has formally announced that it's now no longer maintaining such reserves of production capacity and is running full out thus making it safe for all sorts of large, high expense, oil sources to come on line.

The truth is that the US will again become a huge oil power with massive increases in reserves whenever oil starts rising above a certain ceiling price. We've got lots of oil shale that isn't counted in our reserves because it is uneconomic to extract at current prices and current technology. If you want oil independence for the US, you can have it instantly at $80 a barrel today. As oil shale extraction technology gets better, the price that we become an oil exporting nation again will drop and eventually we're likely to hit crossover.

In other words, there are huge oil endowments in all sorts of places you wouldn't think (non-OPEC nations in the majority) that will start to come on line as the PRC and the rest of the developing world comes online. This increased demand does not impoverish us, it merely is one more in a series of continual economic challenges that we will overcome and use them as opportunities for our own growth.

It is highly likely that we will exit the age of oil before we run out of our physical petroleum endowment.

Randall Parker said at May 9, 2004 10:56 AM:

Bicycles versus oil: Some goods can have their production increased. But there is a finite amount of oil With increased world demand we get less of it and pay more for it. We have less money to buy other stuff. We have to sell more stuff to get what oil we do buy. Meanwhile, much of the oil that the Chinese buy gets used in China for domestic living. It does not go to run bicycle factories to make goods for export. It gets used to generate electricity for air conditioning or to pay for weekend drives into the mountains.

Some are arguing in essence that as China gets richer and more able to offer Saudi Arabia goods in exchange for oil that we are better off or equally well off. But why? We are the third party standing off to the side being told by the Saudis they have less to sell to us because they can get more goods from the Chinese in exchange for oil than they have in the past from us.

If China's industrialization increases the rate of advance of science and technology (because they employ more scientists and engineers to do original innovative R&D work) then that could provide a net benefit to us. But that is the only way the net benefit would flow to us. I don't see Ricardo's theory of comparative advantage providing a net benefit to all manufacturing nations when they are competing for natural resources.

Randall Parker said at May 9, 2004 11:37 AM:

TM Lutas, Oil prices that are high enough to bring marginal US fields into production are a net loss for the United States even if we start making more of our own oil. We still will be buying foreign oil at high prices plus we will be spending a lot to operate costly production facilities of our own. The oil industry will become a larger percentage of the total US industry and therefore other industries will produce less. We will just have higher overall production costs.

What we need to is fund a huge research effort to obsolesce oil.

Steffen Hentrich said at May 9, 2004 2:28 PM:

Wait a minute, Brock. We don't pay oil owners for having oil but for extracting oil now and tomorrow. They have costs to do it, it means they forgive other opportunities to use resources. What is the difference between a oil producer and a producer of widgets? They use a technology to transform resources to commodities. Thats all.
If Chinese buy a lot of oil and it gets more expensive it means they produce a lot of things with a ever higher value. If not, they would not demand mutch oil and oil prices (value) were not so high. So we sell more stuff for oil because products from oil have more value than before.

Dave L. said at May 9, 2004 3:29 PM:

I wouldn't overstate the value of the tar sands in Canada. Although total reserves in those deposits are considered to be 1.5-2.5 trillion barrels, recoverable crude is likely to be more like 300 billion barrels or somewhere around 10-15% of the total world's crude reserves depending on what estimate you place faith in. 300 billion barrels is nothing to sniff at to be sure, but most of the deposits are heavy and somewhat sour consequently cracking and use costs increase as well. The tar sand production costs publicized in various trade journals and press releases vary from $8-13 per barrel but it should be said that for the most part these figures do not include the $8-10 billion dollars in sunk costs for discovery and capital expenditure. There is also some doubt as to whether or not production can be ramped up to the same degree as lighter crude production has been. Moreover, back-end costs such as reclamation (we are talking about mining here) are frequently discounted.

The bottom line is as we proceed down the Hubbert curve, energy costs will increase in real terms. If the supply of crude flattens out or declines while demand increases, the effect on the price of everything from plastics to plywood will be obvious to all, not to mention the magnitude of our foreign balance of payments problem. I agree with Randall that considering the potential risks to our economy and our strategic position, substantial investment in the development of other energy technologies is warranted as mitigatory.

Brock said at May 9, 2004 8:15 PM:

Randall - I get your question now. We're "better off" in a sense because China would be the low cost producer. It would put the oil to a more efficient use, make bicycles out of it at a lower cost than we could make bicycles, and sell us the bicyles cheaper than we could make it ourselves. We'd be "better off".

Of course we'd be better off only under the condition that oil is fixed at $XX/ barrel. For commodities, lower prices are always better than higher prices, of course.

But in the long run a prosperous China really is better for us. They will be able to shoulder their weight, and together we will be able to move the human race further and faster than we alone could do. You think that scientific research is advancing quickly now? Wait until China goes from 200 Million ubran/800M rural to the other way around. Tens of millions of engineers, scientists and businessman all innovating in the pursuit of profit.

Plus, then the Chinese could pitch in on "Researching Oil into Obsolescence." They could help with Engineered Negligible Senescence too, if we haven't figured it out by then.

Steffen - No, I'm sorry, but you're just wrong. We pay Exxon and Royal Dutch-Shell for extraction and refining. We pay Hong Kong supertankers for shipment. Those are both valuable services, and they are welcome to their profits. We pay the Saudis because our own Property Law tells us to. They don't actually do anything, just collect rent.

TM Lutas's point should help you. Oil sells for $40/ barrel. It costs $10/ barrel to extract it from the ground in Saudi Arabia (by Exxon). Where do you think that other $30/ barrel is going? They're like a Land Lord that never fixes your pipes, actively throws rocks through your windows, and threatens your wife & children, all while continuing to charge rent. Nice, huh?

Steffen Hentrich said at May 10, 2004 12:47 AM:

Ok, Brock, we pay Saudis for allowing Exxon extract oil and they abstain from building golf courses instead. What is the alternative option for property rights for Saudis in your opinion?

Brock said at May 10, 2004 6:25 AM:

Nothing civilized, unfortunately.

I wasn't really advancing an alternative, because I don't really have one. I just thought it ironic that 1/3 to 1/2 of their respective economies is from selling a commodity that (1) they didn't know was there, (2) could never dig up on their own, (3) would have no use for if they could. Without the oil wealth they would still be riding around (exclusively) on camels. Golf Courses v. Oil rigs are questions both Texas and California can meaningfully choose between. Not so the Middle East.

Steffen Hentrich said at May 10, 2004 3:45 PM:

...except you use a lot of water, another scarce resource in the desert. ;-)

Engineer-Poet said at May 10, 2004 7:05 PM:

China is already selling "alternative energy" hardware to the USA; one of the companies plugging evacuated-tube collectors in Home Power is Chinese.  One wonders if they use their own products widely.

Little petroleum is used to provide hot water in the USA, but this sort of thing shows that China may be taking the issue more seriously than we are.

Brock said at May 12, 2004 7:07 AM:

What are evacuated-tube collectors?

Mark Harm said at June 21, 2004 9:50 AM:

There are a few new energy technologies. For example, newly developed Thermo-Depolymerization Technology (which converts carbon-rich garbage into crude oil). The conversion process doesn't create any harmful pollutants and use of the new form of oil actually releases less greenhouse gases than would be released by the natural decay process if the material had been stored in a landfill - in the case of naturally decaying material. The process can also be used to convert plastics and other non-decaying material.

'Turkey waste turned into oil' - New York Newsday - New TDP plant generating a positive cash flow while selling crude oil converted from garbage at a price 10% less than equivalent oil produced at a conventional refinery.

'Missouri plant begins making oil from farm waste’ – Waste News - Crude oil No. 4, produced from agricultural waste products, put on the market.

'Turkey Fuel? Factory to Turn Guts into Crude Oil' - National Geographic - Details how a Carthage plant is converting turkey waste into crude oil and its potential to solve many of America's waste disposal problems while making us less dependant on foreign oil.

'Researchers turn manure into crude oil' - MSNBC News - Researcher Yanhui Zhang of the University of Illinois has successfully converted pig manure into oil in small batches. He uses a similar process to the one already being used by a plant in Carthage, Mo., that converts tons of waste material, such as feathers and entrails, from a nearby Butterball Turkey plant into light crude oil.

Successful Result of a California Pilot Thermo-Depolymerization Plant in the Philadelphia Navy Yard on the California Energy Commission's government website

And on the hydrogen frontier, there was a recent breakthrough in an ethanol-to-hydrogen reactor that will make hydrogen much more competitive as an energy source. The new reactor eliminates the need for large expensive facilities to produce hydrogen - being small and cheap enough for home and car use.

Mark Harm
Candidate for State Representative - Michigan

Randall Parker said at June 21, 2004 10:03 AM:


I can not find any confirumation for Changing World Technology's claim that the amount of available biomass that could be processed would produce millions of barrels per day. I'm aware of CWT and the pilot plant and know it just started operating recently. But I've yet to find any evidence that they are correct in arguing that their process can make a substantial contribution to our energy needs.

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