Barring any surprises, China’s enigmatic VP Xi Jinping, is set to assume the Presidential post of the Communist Party of China (CPC).
But with the well-known secretive nature of the CPC, it’s been difficult to determine exactly how Xi plans to deal with the country’s current economic challenges or keep the growth engine running.
In all likelihood, one of the key agenda items to fall quickly onto Xi’s plate would be that of energy.
To put it simply, China will continue to need more of it and soon.
The question is: from where?
Presently, oil imports have risen to about 55% of China’s total demand. From that, about half of the imports come from the Persian Gulf, namely Saudi Arabia.
In the first eight months of 2012, China brought in a staggering 35.5 million tons of crude from Saudi Arabia.
The price tag? A cool $29 billion.
This makes China the single largest market for Middle Eastern oil – and one very expensive way to fuel a nation.
The country reported this past September that it was refining oil at a record pace of 9.47 million barrels a day, up from the previous record of 9.38 million set in January.
At this pace, it’s estimated that by the end of the decade, China will need to import more than 60% of its oil and a third of its gas – unless Xi can zero-in on more energy resources within China’s borders.
Easier said than done…but not because these resources don’t exist or that they don’t have the finances to do so.
They certainly do exist, and China would have ample finances to kick-start development.
Here’s the problem: other countries in the region don’t believe that a particularly rich block of resources belong to China.
In fact, a growing dispute over the sovereignty of a massive oil and gas field in the East China Sea is on the verge of launching into an all-out turf war.
Just how much fuel are we talking about?
Chinese estimates peg oil reserves in the region at 212 billion barrels, which would place them third behind Venezuela (297 billion) and Saudi Arabia (265 billion).
On the low-end, a USGS estimate from the mid-90’s figured one-tenth of that amount, which would still be five times that of the Gulf of Mexico.
As for natural gas deposits, the US puts an ultra-conservative estimate of just 1-2 trillion cubic feet, which is quite significant.
China on the other hand, believes the East China Sea holds nearly 250 trillion cubic feet of gas.
Whatever the true figures are, obviously they’re enough to convince the likes of China, Japan and even Taiwan to each lay claim to the reserves.
In Japan these islands are known as Senkaku, while China calls them Diaoyu. Taiwan has named them Diaoyutai.
The region is approximately 81,000 square miles, or roughly the size of Kansas.
As the gist of the dispute goes, whichever nation has ownership of this tiny cluster of uninhabited islands will gain sovereignty over the surrounding water and seafloor – and most importantly, the resources they contain.
According to the UN Convention of the Law of the Sea, countries are given rights to exclusive economic zones which extend 200 nautical miles from their coasts.
Unfortunately, in regions such as East Asia, the law often results in overlapping claims, which means that the nations involved will need to sort it out among themselves.
China and Japan did sit down for talks, and an agreement was made to jointly develop underwater deposits found in the East China Sea.
But that was back in 2008.
So far, not a single joint project has been rolled out to date.
Now with the islands being brought into the equation, neither country is prepared to handover “ownership” to the other.
Almost daily, you’ll see vessels from all sides taking turns circling the islands to symbolize and support their rightful rule over the islands.
In September, a water-gun fight broke out – literally, between Japan and Taiwan Coast Guard vessels as both sides fired water cannons at one another.
While this may sound amusing, it could’ve easily taken a turn for the worse if one of them decided to turn hostile.
And let’s not forget who is caught up in the middle of this escalating dispute…
Prior to World War II, Japan had formally recognized the islands as Japanese sovereign territory even though China claimed it had ownership of the islands for centuries.
Upon Japanese surrender after the war, the islands fell under US administration. They were then “returned” to Japan in 1972 when Americans withdrew from Okinawa.
That decision never did sit well with the Chinese which is why the quarrel continues to this very day.
According to a post-war treaty that was signed, the US is obligated to defend Japan, should Japan come under threat by China.
Yet at the same time, Americans also have a strategic alliance with Taiwan.
Thus, having two close Asian allies involved in a three-way mudsling doesn’t exactly bode well for the US.
According to Alan Dupont, a strategic analyst at the University of New South Wales in Sydney, Taiwan’s involvement in the dispute is an unwanted complication for the US as it tries to strengthen its relationships in Asia to counter China’s rising power.
Should investors be worried?
Not unless your portfolio consists mainly of Japanese stocks.
Here’s a couple ways in which you can profit from this dicey dilemma.
As it stands, China’s biggest bone to pick is still with the Japanese.
Since the row began picking up steam earlier this year, Japan’s big car manufacturers have suffered massive sales losses on Chinese soil, while a number of Japanese-owned businesses and restaurants in China have been victims of aggressive protests and arson.
So if you’re a shareholder of Japanese stocks with high exposure to Chinese markets, the future is looking pretty grim until an agreement over the islands is found.
On the other hand, American companies who compete with these same boycotted Japanese firms are well-positioned to pick up the slack, especially carmakers.
The likes of GM and Ford are anticipating higher Chinese sales for the coming year, while Honda, Toyota and Nissan will continue to see their market shares decline as the dispute wears on.
For those of you who do not yet have US manufacturers on your to-buy list, this would be a good time to reconsider.
But what I’m probably most excited about is the rare earths play.
China is the world’s largest supplier of REE’s, while Japan is the world’s largest consumer of the metals.
Japan’s technology sector could be in for another rude awakening should China once again decide to impose a ban on REE exports to the island.
Back in 2010, another offshore tussle between the two countries persuaded China to halt REE shipments to Japan, impacting their production of high-tech goods.
I wouldn’t be surprised if another ban gets issued should this latest dispute intensify.
If China does decide to halt rare earth exports, this could lead to Japan desperately knocking on doors of non-Chinese producers.
Colorado-based Molycorp Inc. would likely be one of them. The recent expansion of their Mountain Pass, California production facility puts them on pace to produce approximately 40,000 tons of rare earth oxide equivalent per year by mid-2013.
Japan tips the REE consumption scale at about 27,000 tons, so having Molycorp’s ability to offset any potential shortfall would be significant.
No matter what happens in the coming months, it will be a fascinating time for investors as we watch the Asian powers exchange threat tactics with each other.
The eventual claiming of the islands could be an unprecedented butterfly effect in the making, so keep your eyes peeled.
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