JAPAN AND CHINA'S ‘ENERGY SUPPLY SECURITY' POLICY VIS-A-VIS IRAN

Number 06 ● 07 December 2006

The high energy demand in Japan and the rapid surge for energy imports in China, as well as the high dependence these countries have on Persian Gulf oil supplies, bring to light two main questions: under which circumstances will Japan and China tend to engage in energy cooperation, and under which conditions will they be dragged into fierce competition over oil supply? How will the evolving energy circumstances impact the triangular relationship between Japan and China vis-à-vis Iran?

Japan is completely dependent upon foreign sources for its oil needs, importing 99.6% of its oil. Since the mid-1980s, oil from the Middle East has accounted for some 80 to nearly 90% of the oil Japan imports annually. In 2005, Japan's oil imports from the Middle East as percentage of its total oil imports reached 89.1%, of which 29.2% came from Saudi Arabia, 24.5% from the United Arab Emirates (UAE) and 13% from Iran.

The importance of Iranian-Japanese energy relations is highlighted by the countries' "special relationship" developed over the years, resulting from the extensive experience of Japanese oil projects in Iran. Moreover, since Japan's Arabian Oil Co. lost its concession to operate the two offshore oilfields Khafji and Hout in the Saudi Arabian Neutral Zone in February 2000, the country sought enhancement of its energy relations with Iran. New oil agreements with Iran became essential for Japan in order to secure its energy needs.

Japanese policy makers regard Iran as a pivotal regional geopolitical player for two main reasons: Iran’s huge proven oil reserves, and its central position in both the Persian Gulf and the Caspian region, which provides Iran with political influence in two major oil territories. Moreover, Iran's geo-strategic position in the Persian Gulf is emphasized by its control over the Strait of Hormuz. Control of the strait enables Iran to disrupt not only Iranian oil supply, if desired, but also oil coming from Saudi Arabia, Kuwait, Iraq, and the UAE.

Considering the strategic significance of Iran, Japan has been bringing about numerous energy and economic developments designed to enhance the security of its oil supply and expand bilateral trade relations. In 2005, the bilateral trade volume reached $11.7 billion dollars. Among most recent and important oil deals involving Japan and Iran is the Azadegan oil field concession signed in February 2004 between a government-backed Japanese consortium led by Inpex and the government of Iran.

Countering resultant US disapproval, Japan argued that the deal will empower moderates in Iran. However, since the election of the Iranian President Mahmoud Ahmadinejad in 2005, this argument has become increasingly controversial. Nevertheless, the Japanese government proceeded to implement the Azadegan project, despite difficulties the project faced. The recent breakup of the Azadegan agreement, by which Inpex was downgraded to a ten percent stakeholder in the project and Inpex’s status as operation manager was canceled, reflects mainly Iranian considerations rather than Japanese.

In the meanwhile, China's remarkable economic development is causing a corresponding rise in energy consumption. China has become a net importer of oil since 1993. In 2004, China became the world’s second largest oil consumer after the US. Thus far, China's strategy to diversify oil suppliers has attained relatively positive results; nevertheless, the fact that two-thirds of the world’s proven oil reserves are located in the Persian Gulf will impose Chinese dependency on Persian Gulf oil in the long run. Thus, achieving a secure oil supply from the Persian Gulf becomes an imperative for China.

China's oil imports from the Middle East have increased dramatically from 1.1536 million tons in 1990 to about 45 million tons in 2004, a forty-fold increase in fourteen years. In 2005, 58%, of China’s oil imports originated in the Middle East, with 13.6% coming from Iran. As a result, China has made great efforts to secure its energy supply from the region and, critically, from Iran.

In 1995, China negotiated a deal tripling its annual oil imports from Iran. In October 2004, China's Sinopec signed an oil and Liquefied Natural Gas (LNG) agreement with Iran which will provide 150,000 b/d of crude oil and 250 million tons of LNG over the next 30 years from Iran’s Yadavaran oilfield. In the long term, China hopes to participate in the so-called ‘Nekka pipeline’, an Iranian pipeline project that would connect Tehran to the Caspian Sea and continentally link China to the Middle East. Japan's policy to secure energy supply from Iran has to do largely with China's growing demand for imported oil. Japan’s decision to follow through with the Azadegan deal, despite nuclear proliferation concerns and American opposition, can be seen therefore as a possible response to China’s growing acquisition of oil concessions in Iran as its demand for oil increases. If Japan would have decided to drop out from the Azadegan project, China’s Sinopec would have taken advantage of this and conducted the deal. Iran seized the opportunity to play off Japan against China. In July 2003, Iranian Foreign Minister Kamal Kharrazi released a statement saying: “if Japan doesn’t get its act together, Iran will begin negotiating with other countries such as China on the Azadegan deal”. The triangular relationship between Japan and China vis-à-vis Iran emphasizes several common energy interests that may lead these countries to seek, at a preliminary stage, the coordination of measures that would improve their oil bargaining position:

1. Promoting regional stability: It is in both Japan and China's advantage to promote regional stability in order to maintain an uninterrupted flow of oil. Regional stability would also eventually enable greater access to local markets. 2. Canceling the Asian Premium: It is also in both countries' interest to promote the cancellation of the so-called ‘Asian Premium’. This oil pricing formula, which has been applied by Saudi Arabia since 1987 and determines oil prices under the basis of a long-term contract in accordance with regional benchmarks, damages Asian countries' economic interests. Recently, the growing Asian demand for imported oil has been forestalling the Asian Premium. However, Japanese and Chinese oil companies are still at a disadvantage when competing with the traditional international 'Majors'. Thus, Japanese-Chinese cooperation is imperative in successfully terminating the Asian Premium. 3. Establishing secure oil shipping routes: Collective oil strategy could meet common interests in security of oil shipping routes. Despite the huge distance and vulnerability of seaborne oil supply, shipping oil from the Middle East to Asia remains the most economical and convenient method, compared to alternative sea-lane routes or oil pipelines. Sharing the burden on oil sea lanes will lower transportation costs and enhance security of oil supply. 4. Geo-political balance: Japan's coordination with China regarding polemic energy issues such as Iran might counterbalance American demands in this respect. Moreover, a unified position and cooperation between China and Japan will signal to Iran that promoting understating between consumer and supplier based on all parties’ understanding of their mutual interdependency is worthwhile.

Nevertheless, Japan and China's positions within this triangular relationship are not symmetrical. Two key advantages China has over Japan grant it leverage to enhance bilateral energy agreements with Iran, making prospects for energy cooperation not necessarily imminent: 1. China enhances its energy interests through provision or finance of military goods. Although the transfer of military technology could destabilize the region, China is likely to continue with this practice due to its potential revenues for the Chinese economy. Military revenues become especially important in light of the economic burden posed by heavy oil imports from the Middle East. 2. China's potential use of its right of veto as a permanent membership of the UNSC blurs political, strategic and energy issues. China's position to veto any US economic sanctions on Iran within the framework of the 'nuclear Iran’ debate is an effective mechanism to cause Iran to favor Chinese energy interests.

In conclusion, analysis of the triangular energy relationship between Japan, China and Iran reveals that focal points of cooperation, based on the interests shared by the Japan and China, are numerous. Nevertheless, further friction between Japan and China over security of oil supply from Iran might arise, as a result of the following occurrences: 1. Japan's New National Energy Strategy, which calls for increasing the ratio of Hinomaru oil, or oil developed and imported through domestic producers, from the current 15% to 40% by 2030, will lead to further political involvement in Iran and hence restrain rational economic considerations when concluding oil deals. 2. Japanese policy makers realized that oil-supply diversification has become an unachievable goal. Energy conservation strategies have also proven unable to provide an absolute alternative to Middle Eastern oil supplies. As a result, ensuring the security of energy supply from countries such as Iran is imperative for Japan. Consequently, Japan will make all efforts to gain priority within oil projects vis-à-vis Chinese competitors. 3. The growing demand for oil and gas worldwide – and in China in particular – is posing a critical challenge for China-Japan relations: will governments be able to address security of energy supply as a transnational aim rather than one of national unilateral character? At the moment, it seems that governments have not reached such awareness■

*Raquel Shaoul is a lecturer at the Department of East Asian Studies of Tel-Aviv University and a Research Fellow of the Center for Iranian Studies.

The Alliance Center for Iranian Studies (ACIS)

Tel Aviv University, Ramat-Aviv 61390, Tel Aviv P.O.B. 39040, Israel

Email: IranCen@post.tau.ac.il Phone: +972-3-640-9510 Fax: +972-3-640-6665

Iran Pulse 6 ● December 7, 2006 © All rights reserved.