China's economy has been racing upward like a skyrocket celebrating the emperor's birthday. Gross domestic product climbed 9.1% during 2003, including a 9.9% growth rate in the fourth quarter. And in the first quarter of this year, China's GDP rose 9.7%, according to Cambridge Energy Research Associates (CERA). In a report titled "Riding the Tiger: The Global Impact of China's Energy Quandry," CERA's Daniel Yergin and Scott Roberts say that during that period, the nation surpassed Japan in oil demand to become the world's second-largest oil consumer, after the United States. This occurred despite the SARS scare that put a slight damper on the economy. "The global oil, gas and coal industries-and increasingly power as well-are now coming to terms with China's emergence, not merely as a new player, but increasingly, one of the most decisive factors in their markets. Between 2000 and 2003, China accounted for nearly 40% of total growth in world oil demand," CERA says. Net crude imports rose more than 30%, to 1.65 million barrels per day in 2003, and net imports of refined products grew 20%. CERA predicts both will accelerate this year. It's already happening. China consumed 6.09 million barrels a day in January, but that number rose to an average 6.17 million by the end of the first quarter, up 18.5% from last year's first quarter, according to the International Energy Agency. The IEA forecasts a 20% year-to-year gain in the second quarter. China represents the world's third-largest new-car market, the largest producer of steel and the largest consumer of cement. Its aluminum and petrochemical industries have grown at a similar pace. All of these industries are heavy energy users. If it keeps at this torrid pace, China will absorb 9% of the world's oil in 2010, up from 5% now, CERA reports. This anticipated demand has driven China on a worldwide search to get more oil and gas into the country. The situation is similar to what's happened in the country's coal industry. From being a coal exporter in the early 2000s, China's industrial and power demand caused coal shortages in many provinces by 2003. The state opened coal production channels just to try to keep up. According to the CERA report, "the explosion in energy demand in China has been the primary reason for a doubling in the world price for thermal coal and a tripling in price for metallurgical coke. The economic boom also doubled the price for coal and the cost of vessel transport." Most experts blame China's growth for a substantial portion of the continuing climb in oil prices, as well. A fear of running low on oil supply lies in the background. "Any growth in global economic activity increases oil demand such that at 1% demand growth, a production peak occurs in 2016. At 2% it occurs in 2012, and at 3% it occurs in 2008," says John Westwood, principal in Douglas-Westwood, a Canterbury, U.K., research and consulting firm. "The world's known and estimated yet-to-find reserves and resources cannot satisfy even the present level of production of some 76 million barrels a day beyond 2020." China is trying hard to fill its energy needs by maintaining domestic production. It's not going to be easy. Its largest field, Daqing, will produce 12 million barrels less this year than the 355 million barrels it produced in 2003, according to Agence France-Presse. China's offshore-focused company, CNOOC Ltd., announced plans to raise annual production to 293 million barrels of oil equivalent (BOE) by the end of next year, and increase that number 50% by the end of the decade. It wants to raise gas production to 353 billion cubic feet (Bcf) by the end of 2005 and triple that number by the end of 2010. It also is building 1,242 miles of natural gas pipelines from offshore gas fields to cities on China's coast. China's offshore oil and gas in place totals 296 billion BOE, according to a recent study. Sinopec, one of the onshore oil companies, has spent $362.3 million in Xinjiang province in the past two years and plans to spend another $5 billion to drill 776 wells in the area by 2020. By that time, it expects to add 12.1 billion BOE of reserves, principally in the central Tarim Basin and the southern and central Junggar Basin, according to an Interfax-China report. The Tarim Basin is off to a good start. The Tarim Oilfield Co. discovered 582 million barrels of oil and 3.5 trillion cubic feet (Tcf) of gas in the Yilake area of Wensu County in the northern part of the basin. PetroChina estimates resources in the basin at 73 billion barrels of oil and 282 Tcf of gas. These numbers are not proved reserves. Sinopec also found 706 Bcf of reserves at a discovery in Shengli oil field, China's second-largest field, just south of Bohai Bay. With new gas coming ashore from offshore fields and LNG terminals, and huge supplies of gas lying in sparsely populated areas in the Tarim Basin of northwestern China, pipelines are big business. Last October, China conducted its first test of the West-East pipeline, a 2,500-mile giant that will move 424 Bcf of gas a year from northwestern China to the Shanghai area of eastern China when it reaches full operation at the beginning of next year. From Russia with oil and gas That won't be enough. China also is arranging pipelines from Russia and Kazakhstan to help fill the supply gap. Kazakhstan and China have agreed to cooperate on a $2.5-billion pipeline to bring oil from Kazakhstan to western China with a completion date in 2005. Kazakhstan already has completed the western leg of the 1,863-mile line in that country. It sees the line as an outlet for supergiant Kashagan Field and other discoveries in the Caspian Sea. Major gas supplies will come from Kovykta gas field near Irkutsk in western Siberia. China and Russia already have conducted feasibility studies on the 2,570-mile line, which will bring gas to Shenyeang, Beijing and Dalian before crossing under the West Sea to South Korea. ChevronTexaco, ConocoPhillips and Total are trying to get a 25% share of Rusia Petroleum, operator of the field. BP-TNK already owns 62.4% of the company and has committed to spend $650 million in the surrounding area to get the 70-Tcf Koykta Field ready to ship gas. China and Russia also are cooperating on an oil pipeline from Angarsk, Siberia, to Daqing, which could either be an individual project or a spur off a main Angarsk-to-Nakhodka line taking oil to Russia's east coast. "How Beijing resolves its energy challenges will not only be felt within China, but will also reverberate around the world," CERA reports. "The aftershocks will be lasting: China's growing weight in world consumption virtually assures a heavy long-term impact on energy prices, trade and investment. "The pace and direction of China's short- to medium-term development is therefore less certain-and far more volatile-than most observers now anticipate. Indeed, there is the possibility within the next several years of a more significant slowing of growth, or worse, a so-called hard landing. Such new uncertainties are an uncomfortable consequence of China's expanding global role." Even though China's petrochemical industry apparently is booming and car sales surging, BP sold its 1.2% share of Sinopec, the nation's largest refiner. Last year, it sold its 2% share in PetroChina for $1.3 billion after the stock had tripled. BP said the sales don't affect BP's plans to spend $3 billion in China during the next five years. PetroChina, operator of the West-East pipeline, has been able to find firm take-or-pay contracts for only half of the 424 Bcf per year it expects to move to the east coast from the Tarim Basin. Most of the takers are municipal utilities looking for residential energy, while industries that can switch to cheaper coal are reluctant to sign up. In addition, Royal Dutch/Shell, ExxonMobil Corp. and Gazprom had committed to sign on for a 45% stake in the West-East line, but they still are negotiating terms on the $4-billion line with PetroChina. Xinhua News Service quoted a Chinese official who claimed Shell was holding out for a 15% return on investment, which PetroChina found unacceptable. Shell denied the report. Trouble ahead? That may be a symptom of other problems. In April, the China Banking Regulatory Commission suspended all bank lending in China for three days. It quickly denied issuing the order when news agencies picked it up, according to the Stratfor intelligence service. Any explanation of that move means that "there are extremely serious problems with China's economy in general-and with its banking system in particular," and the issue is whether the move by Chinese regulators indicated panic or just deep concern. Stratfor thinks China's economy might be following previous meltdowns in Southeast Asia and Japan. Both of those areas had sharply expanding economies and overblown expectations by Western lenders, just as China is experiencing now, Stratfor says. "The core problem in Asia-a problem that the Chinese government is trying to address belatedly-is that its banking systems do not allocate capital based on market forces. Loan decisions are made out of political and social considerations, and real interest rates vary depending on these relationships," says Stratfor. In addition, money for the growth comes from direct loans rather than from equity, for the most part. It's hard to sell stock when government policy doesn't allow shareholders to control the actions of the board. It also means that maximizing shareholder value is not a prime goal and rate of return is not critical. Since direct loans are the fuel, cash flow to repay those loans is critical. And since China lacks a retirement system, people tend to save their money, particularly since they can't invest in companies that work for a return. A strong savings economy also leaves less money for consumption, which means the system depends on exports. Exports mean goods sell near cost to generate maximum cash flow to cover debt service, and climbing debt continues to bolster growth, the intelligence service explains. Growing volumes of bad debt cause constant restructuring. That trend, combined with investments from foreign companies that may have no control over the way Chinese-run partners spend invested funds, creates a big problem. "This hollows out the banks. In Japan and Asia, it was the large financial institutions that first felt their foundations collapsing under them. At a certain point, the cash flow requirements outstrip debt service and export demand, and foreign direct investment can no longer make up for them. "The system erodes slowly but the perception of systemic failure comes suddenly," Stratfor says. "The banks, working with the government, hold things together until they can no longer do so. A crisis builds around the public realization that major financial institutions are failing, vulnerable to failure or can survive only through heroic measures. A period of sharp, intense crisis takes place, which does not solve any fundamental problems. A long period of malaise follows as some recover and others fall." Investors already "have seen a major outflow of money from China by individuals and institutions that know the jig is up," it says. The government may be able to provide the economy with a soft landing instead of a hard crash, but investors in China's economic miracle should perform due diligence before grabbing the Chinese tiger by the tail. CHINA'S BUYING BINGE The preferred method for sourcing oil and gas supplies outside China calls for one of its state-controlled oil companies to lock in a supply and take an equity position in the project as well. This summary of China's recent deals shows it has: • Acquired Talisman's stake in the Sudan oil fields in March 2003. • Arranged to buy oil from Gabon. • Arranged with Australia's North West Shelf group to get liquefied natural gas (LNG) supplies for a new terminal at Fujian and taken an equity portion of the expansion project that will supply gas to the LNG plant. • Made the same arrangement for LNG from BP's Tangguh Field in Papua New Guinea that will fill a new terminal in Guangdong on China's southern coast. • Arranged for supplies from ChevronTexaco's giant Gorgon gas field off the northwest coast of Australia. BP has spent some US$1 billion on pipeline and other infrastructure projects in the Guangdong area, and it plans to spend at least that much more. • Signed a deal to take $20 billion of LNG from Iran and get access to Iran's gas fields to produce some of the gas.