Is China the Real Winner from Iraq’s Oil Boom?

Iraqi oil production has boomed in recent years, and Chinese companies have been deeply involved in producing and buying the oil. That prompted headline writers to go with this for a New York Times story on Sunday: “China Is Reaping Biggest Benefits of Iraq Oil Boom”. There’s a lot of good stuff in the article, but the headline rests on a wrongheaded view of how oil trade is intertwined with countries’ economic fortunes. Indeed one could easily argue that the United States, not China, has been the biggest winner (aside from Iraq) from the surge in Iraqi supplies.

Every major country is involved in international oil markets in two ways: through its companies’ production activities overseas and through its consumption of imported oil. Chinese companies have done well in Iraq in substantial part because they’ve been willing to invest in oil production projects without taking an equity stake (or some approximation of that) in the fields involved; Western majors, in contrast, tend to be averse to that sort of arrangement. It’s difficult to estimate how much money Chinese companies are making from that role, but you can put an upper bound on it. It’s rare to hear of companies charging Baghdad more than a couple dollars a barrel to develop Iraqi oil (and numbers are often lower, particularly once you subtract costs). Now assume that Chinese companies are producing half of Iraq’s oil, i.e. about 1.5 million barrels a day – likely a very large overestimate but still useful for setting an upper bound on Chinese profits. That would yield a profit of about a billion dollars a year.

But China and the United States also benefit from Iraqi production as consumers. Let’s say Iraqi production is a million barrels a day higher than it would otherwise have been. And assume a fairly high long-run elasticity of oil demand of -0.25. Then added Iraqi production should have reduced world oil prices by around four dollars a barrel. Now let’s cut that by three-quarters to account for countervailing moves by other producers that may have balanced off the Iraqi increase, and say that Iraqi production has lowered world prices by just one dollar a barrel. This is a modest estimate of the possible Iraqi price impact.

In 2010, China imported 4.8 million barrels of oil a day, while the United States imported 9.2 million. If oil prices were a dollar a barrel lower as a result of increased Iraqi production, the United States benefited to the tune of nearly $3.4 billion a year as a result. China, by contrast, benefited by only $1.8 billion.

Juxtapose this with the estimates for production profits and it’s pretty easy to see how the United States could well have benefited even more than China from the boom in Iraqi oil production. (And that’s ignoring profits that U.S. firms, including service companies, are realizing in Iraq.)

This carries a broader lesson: It’s critical to think separately about countries as oil producers and oil consumers. Muddling the two together typically leads to confusion.