China fears commodity squeeze as US conflict takes a more dangerous turn
Ambrose Evans-Pritchard
2 JUNE 2019
China’s leaders are tormented by the “Malacca Dilemma”. Their country is the world’s largest importer of oil and natural gas. It is acutely vulnerable to an energy squeeze on seaborne supplies.
Over 82pc of China’s total crude shipments and much of its liquefied natural gas pass through the Malacca Strait between Sumatra and the Malay Peninsular, and alternative passages further East. The US navy has unchallenged supremacy over this maritime choke-point, though not necessarily for long.
Energy security has long been a nagging worry among China’s defence strategists. They have studied the Royal Navy’s “limited blockade” of the Falkland Islands in 1982 as the modern textbook case of how maritime powers can tighten their grip. But it has mostly been an academic debate.
The issue became all too real last week when Fu Chengyu, ex-head of the state oil giant Sinopec, said the country must prepare for the awful possibility of a US oil blockade. “It is not to be alarmist. It is an urgent reality,” he told a forum in Shanghai.
China’s strategic petroleum reserve will not be complete before the early 2020s. The Chinese state media reports that stocks are barely enough to last 40 days consumption. The benchmark safety threshold for OECD states is 90 days. Platts estimates that Japan can last a siege for 222 days.
The Malacca Dilemma is of course a metaphorical term. The US would first try to achieve its objectives through financial power and control over the world’s dollarised payment and lending system. Naval blockades are tantamount to war.
America's huge Navy gives it undisputed control over routes through which Chinese oil imports flow CREDIT: AFP
Even so, a commodity squeeze would entail a worldwide recessionary shock and a crunch in the US oil patch. “It would cause the price of West Texas crude to crater. The Trump Administration has absolutely no interest in doing that,” said Ian Bremmer from Eurasia Group, the political risk firm.
“Trump has already rattled the cage with Huawei. This is all about technology not resources, and the one place where China really is vulnerable is on semiconductors. There are two tech-superpowers out there that can’t be reconciled. Countries like Britain are going to have to choose one or the other,” he said.
Yet the Chinese leadership has brought the Malacca Dilemma into sharp focus by threatening - through the state-controlled media - to restrict exports of rare earth minerals. This would purportedly cut off the lifeblood of the US technology industry, though to what degree is in dispute.
It is a high-risk gamble. The more that Beijing plays the commodity card, the greater the danger that the impetuous Donald Trump will play it back with interest.
What is clear is that the Sino-US trade war is suddenly taking a dangerous turn. Mr Trump may have pushed China too far in demanding changes to the country’s domestic law and a unilateral enforcement mechanism. This smacks of the “unequal treaties” imposed by Western powers on the Qing dynasty in the 19th century.
China is drawing up its own “unreliable entity list” to fight back against the US suffocation of Huawei. This will target foreign companies, organisations, and individuals that breach contracts or damage Chinese firms.
Google, Intel, and Qualcomm will almost certainly be on this list since they have begun halting critical dealings with Huawei. British firms may be caught up in the sweep. Any foreign executive or employee working for these entities could be prevented from leaving the country or face arrest on dubious grounds.
This has already happened to two Canadian citizens detained on espionage charges, deemed hostage taking in Ottawa. “If I were still living in China with my family I would be far along with my exit plan and ready to execute it at very short notice,” said Bill Bishop from Sinocism.
Mr Bishop said the People’s Daily has pointedly revived an expression with powerful symbolism in Chinese revolutionary history: “Don’t say I didn’t warn you.”
It was used in the 1960s when Mao Zedong’s China attacked a Soviet border post at Zhenbao Island, almost precipitating World War Three. The Russians had earlier cut off oil supplies to China and forced Mao’s regime to impose drastic rationing. That trauma is not forgotten.
The term was invoked just before the frontier wars with India and Vietnam. The episodes are known in China as the “three self-defence counter-attacks”.
While the quarrel with America has not reached such a combustible stage, it could escalate fast if the US Congress presses ahead with a bill mandating sanctions over the alleged incarceration of one million Muslim Uighurs from Xinjiang in political re-education camps.
Such a defence of persecuted Muslims would put Saudi Arabia and the Opec Gulf states in a difficult position if the Trump administration then went on to deploy the oil weapon in one way or another.
Laban Yu from Jefferies says the Chinese leadership is afraid that the US could use its global financial reach to try to quarantine the country. "China is now looking at its oil supply situation from the worst-case scenario, like what the US has done to Iran," he told Bloomberg.
Sinopec’s Fu Chengyu said China must accelerate the switch to electric vehicles, double down on domestic ‘clean’ coal, and launch shale gas fracking in Xinjiang and Sichuan on a vastly expanded scale with cheap credit. This would not come soon enough to make any difference in the current trade war.
President Hu Jintao first used the term Malacca Dilemma in 2003 at a time when China was spreading its naval reach into the East China Sea and southern waters. The chief concern was that Washington might constrict shipping if there were a serious clash over Taiwan. Few suspected then that a tariff dispute could ever reach this point.
China’s leaders know what happened to Japan in 1940 when the Franklin Roosevelt began to restrict oil export permits for the Tojo regime. It set off a spiral that led ineluctably to the Pacific war (in China’s defence on that occasion).
The Malacca Dilemma renders China’s rare earth weapon dangerously double-edged. The minerals are certainly a potent tool. China not only mines 80pc of world production. It has near total control of the global processing chain. Ore from the one US rare earth mine - Mountain Pass in California - is shipped to China for separation.
Beijing has systematically pressured foreign companies into locating facilities in China to secure rare earth supplies. Whole components of US manufacturing - car starters or aircraft parts - are pre-finished there before shipping to America. The US General Accounting Office says it would take seven to 15 years to set up a parallel supply structure.
“They know our supply-chains. They can target industries ,” said Clint Cox, a rare earth expert at Anchor House. “Basically, anything that moves in your car has rare earths in it. Most of our companies don’t have significant inventories,” he said.
Metals such as neodymium, europium, or dysprosium are critical for smart bombs, precision-guided missiles, lasers, long-distance radar, submarine sonar, and the F-35 Joint Strike Fighter. “They are used in everything but bullets,” Scott Kennedy from ThREE Consulting.
Yet China cannot embargo the US without disrupting the world’s intertwined supply chain and hurting everybody else. When Beijing cut off rare earth supply to squeeze Japan over the Senkaku Islands in 2010, the price of lanthanum (a catalyst in oil refineries) rose thirty-fold in panic buying.
To play this card would cut across Beijing’s other goal: to stake out the moral high ground in its dispute with Mr Trump, and displace Washington as the arbiter of 21st century globalisation.
Yet President Xi Jinping undoubtedly issued a veiled threat in late May when he combined a pilgrimage to the Jiangxi shrine of the Long March with a tour of a rare earth magnet factory. "The message was loud and clear," said Mr Cox.
The elemental problem for Mr Xi is that Washington could bring the Chinese economy to its knees by commodity strangulation before China’s rare earth blockade had seriously crippling effects on the US.
Mr Xi can try to ratchet up the pressure with a carefully calibrated constriction of rare earth components but if he pushes too hard against the volatile US president, he risks exposing the hard truth that the leverage of the two countries is not in fact symmetric.
Whoever you are, wherever you are, you must always assume the Donald Trump might out-escalate you.
