In 2005, the China National Offshore Oil Corporation (CNOOC, pronounced “See-knock” by Americans) made an offer for Unocal. The political reaction at home was ferocious. The opposition came from three sources:
- Fear of technology transfer. CNOOC might be able to acquire new techniques and abilities from its subsidiary. This is a reasonable fear in general, but not in the specific. Unocal was not really on the technical frontier ... and even had it been, all the evidence is that in the oil industry the benefits of propietary technology flow to the shareholders, not the citizenry. In that sense, then, China might have done the U.S. a favor by liberating whatever technical secrets Unocal might have possessed;
- Fear of foreign control over American assets. This objection never made much sense, as Bernard Guerrero pointed out here. CNOOC assets in the United States fall under the jurisdiction of the American government, and should the U.S. and China ever go to war (even a cold one) the U.S. government can and will easily do to Chinese assets what it did to German ones during World War One;
- Fear of foreign control over foreign assets. This was Paul Krugman’s objection to the deal. His worry was that the Chinese government might choose to keep oil from, say, Central Asia off the world market. That would drive a wedge between Chinese oil prices and world prices, damaging the rest of the world. The incorrect objection to this reasoning involved putting words in Krugman’s mouth, and assuming that he was discussing only military confrontations. The correct objection to this reasoning was simple: the Chinese government would incur a large opportunity cost from such a policy. Rather than sending cheap oil home, China could sell it overseas and pocket the difference. So absent the ignition of Cold War Two, what would be the point?
That last counterargument was very convincing. You can follow a microcosm of the debate at Crooked Timber. There is a wrinkle involving pipeline construction (short version: U.S. consumers have an interest in preventing China from building pipelines into Central Asia, just as we have an interest in preventing Canada from building them to the Pacific) but it is both minor and irrelevant to the CNOOC-Unocal controversy, simply because China was going to build those pipelines regardless.
End of argument? I would have thought so, but today I read that Delta Airlines was doing something interesting:
Delta Air Lines said on Monday that it had agreed to buy a refinery near Philadelphia from ConocoPhillips to offset the risk of higher jet fuel prices ... Richard H. Anderson, Delta’s chief executive, said the investment was a modest one, equivalent to the list price of a new wide-body plane like a Boeing 777. The company estimated that it would reduce its annual fuel expense by $300 million, once the refinery was refurbished and operating again. To achieve similar fuel savings, Delta would have to buy 60 new-generation narrow-body planes like the Boeing 737, a capital investment that would total $2.5 billion.
Huh! It looks like Delta Airlines has decided to do exactly what the economic theory predicted that China would not do. After all, there is an opportunity cost to locking up refined products: instead of selling them cheap to itself, Delta could sell it expensive to others. Moreover, it turns out that Delta isn’t alone. BP is also involved. The reason is simply that refineries cannot product only one product: you always wind up with other byproducts. So Delta will need to swap those other products for jet fuel. It could, of course, sell them and buy jet fuel on the open market, but that’s not what Delta has chosen to do:
Delta said it had also struck a three-year agreement with BP to supply crude oil to the refinery. As part of the deal, the details of which were not released, Delta said it would exchange gasoline, diesel and other petroleum products produced at the refinery for jet fuel from other sources like BP and Phillips 66. Combined with the jet fuel produced at Trainer, Delta said these deals would provide 80 percent of its fuel needs in the United States.
Delta has decided that it makes more sense for it to buy a refinery and sell fuel to itself at less than the market price than it does for it to buy a refinery and sell fuel to other people for the market price, pocketing the returns. Similarly, if the above description is accurate, then BP has also decided that it makes more sense for it to swap jet fuel for other products at less than the relative price it could receive from making that swap on the open market.
This is, it would seem, to be exactly the sort of behavior that people are worried that the Chinese government might engage in on a much larger scale. Two questions, then. First, is Delta making a fundamental mistake? (Many analysts think so.) Second, if it is in fact good for Delta, why wouldn’t it be good for China?