'Saudi's China oil play has no one over a barrel'

Saudi Arabia has traditionally had a lock on Asian oil markets. In Japan, Korea and Taiwan, the kingdom's barrels make up about one third of crude oil imports.

In China, that position is now under threat from Russia. Russia has shrugged off Western sanctions over Ukraine and enjoyed a plunge in production costs thanks to the ruble's slide against the greenback. It briefly surpassed Saudi as China's leading crude supplier in May and will strengthen its position over the next decade as it builds a second pipeline to the country, according to BMI Research:

Saudi Arabia isn't about to take the challenge lying down.

State-owned Saudi Aramco is looking at multi-billion-dollar deals to buy marketing, refining and retail assets from China's CNPC, Bloomberg News reported earlier this month. It's already receiving record quantities of crude at its leased storage tanks on Japan's Okinawa archipelago. Sabic, the world's biggest chemicals company after BASF, is planning at least three joint venture projects in China, Bloomberg's Deema Almashabi reported overnight.

This activity takes a leaf from the playbook of the Seven Sisters, the British and US giants who dominated global oil trade through the middle of the 20th century by owning every bit of the supply chain from the well to the pump. If you own the refinery, you can choose to buy crude from your own oilfields rather than the competition's.

Whether the strategy succeeds will be an interesting test of Chinese President Xi Jinping's efforts to reform the country's state-owned companies. Shaking up "zombie enterprises" by allowing more international investment is one thing; giving foreign governments a bigger say over China's energy supply is quite another. That's particularly the case when the motivation for Saudi's investment looks so clearly strategic.

If Riyadh was making a purely commercial decision about where to pick up downstream assets, China wouldn't be the obvious place to put its money. The country's energy industry is heavily regulated: Refined products are subject to price controls and independent refiners have only recently been allowed to buy oil on the international markets. Plants in the north of China are currently operating at about 57 per cent of capacity, according to data compiled by Bloomberg, versus a rate in the US that rarely dips below 80 per cent.

The risk to Saudi's Seven Sisters strategy is that it's a zero-sum game between producers and consumers. It only makes sense for an oil producer to own a refinery if it can use the relationship to buy crude from its own wells at uncompetitive rates. Beijing, whose primary interest is in guaranteeing the cheapest supply of refined products to its domestic economy, isn't likely to put up with that.