Two ‘Oil Drum’ readers, going by the aliases of Wildcatter and nebraska, recently held a very interesting online conversation about the unavoidable bidding war for the dwindling imports of crude oil between US and China.

We pick up the conversation from the point where nebraska wonders why the $145 oil price of summer 2008 did not lead to an increase in oil supplies coming into the U.S., whereas China was comfortably increasing imports at that price level. The conversation contains excellent insights on the interplay between oil and debt, and helps illuminate the rhetorical question posed a few days ago by Simon Johnson in his Baseline Scenario blog, namely Why Can’t Europe Avoid Another Crisis? Why Can’t The U.S.?

nebraska: Why didn’t $145 dollar oil bring more supplies into the US? China sure did not have a problem getting imports at that price?

Here is China’s net exports/imports for the last several years:

China's net exports or imports of crude oil

[Editor’s note: increasingly negative “net exports” represent increasing net imports]

Wildcatter: It’s primarily because China is capable of out bidding the U.S. for crude now. They have a much lower debt load and are the new 800 lbs gorilla in the global oil marketplace. Since the U.S. is now a debtor nation we have to borrow vast sums of money from countries like China to purchase our oil. This adds a significant premium to what we have to pay and essentially chokes off our ability to out bid China who is paying with not only cash but cash the U.S. is sending them to pay our debts.

They are in a superior financial position to out bid us for each barrel and as we have seen for each additional barrel that China consumes the U.S. loses. Since there is not enough additional supply for both nations to grow their consumption one has to give it up, since we are the debtor nation it is us. This is why we can watch the Chinese have a rising standard of living while ours goes down. The Chinese however are not invincible to the oil price and it’s effects and have already seen significant inflation especially with food prices.

nebraska: Do you think that the Brent crude price is what China is currently willing to pay for each barrel?

Wildcatter: Well, every contract is different. With Venezuela they are paying primarily with investment in Venezuela itself through infrastructure and technology, with some African nations they simply provide bribes. The other advantage China has is political. Much of the oil left in the world is in unsavory places run by corrupt regimes. China has a no strings attached attitude when it comes to procurement of resources. Like in Darfur or Nigeria the U.S. comes in with all these humanitarian demands and conditions that come with doing business. China doesn’t care if these regimes are committing genocide, they just want the oil and will pay regimes whatever it takes.

Because they are more ruthless and have no pre-conditions, they are able to outmaneuver us. Combine this with their financial superiority and aggresive resource procurement agenda and they will continue to suck up the worlds resources in a hurry. I mean if there was oil in North Korea the Chinese would be there putting Kim Jong up in a palace if it meant they could access it. The U.S. just can’t politically pull these things off.

nebraska: If you look at the graph of their imports, they are adding one million barrels per day per year. Are they adding refinery capacity at the same rate?

Wildcatter: Not sure, I know that in the case of Venezuela they are specifically building refineries to process their heavy crude from the Orinoco belt down there. Currently only the U.S. has refineries that can process Venezuela’s crude, once the Chinese refineries are complete this year or next Venezuela will start shifting exports from the U.S. to China, this will be another blow to our fuel supplies and economy. In my opnion it would be wise to have a military intervention down there to take Hugo out before this happens. Otherwise our economy is going to take yet another huge hit.

nebraska: Wouldn’t China respond by selling U.S. bonds en masse? They could really wreak financial destruction on us, by raising our iterest rates.

Wildcatter: It would have to be a covert operation I suppose. At a minimum we could fire up the rhetoric to put pressure on him. His government has run their oil industry into the ground due to mismanagement and corruption, Hugo went out to bid to find a buyer last month for much of his oil assets (like Citgo) to bring them back to full operation and no one showed up to bid for fear after they made a huge investment his government would seize the assets again without warning. This is a weakness we could expliot if we wanted. Venezuela is one of our top three crude suppliers and we can’t afford to lose them.

This is a huge problem for his government and funding their social programs. Yes, China could intervene and disrupt our debt markets but that would have huge negative implications for them as well as they are not yet entirely separated from us financially.

We either give up our oil consumption willingly through diplomatic complacency and thus deeper recession or we get aggresive like China. It’s really going to come down to eat or be eaten most likely but at the same time you obviously want to avoid an all-out resource conflict.

nebraska: At what point do you think that they will be able to separate from us financially? That will probably be the end game at that point. We will probably have to pay off our debt at that time like Germany after WWI. What will we pay it off with?

When China becomes the largest consumer of oil, I’ll bet the dollar really starts to decline in value.

Wildcatter: That’s a tough call but my assumption is that over the course of this decade it will take place. It’s a slow process but China has to replace U.S. consumption with its own domestic consumption. This is happening now, they have a growing middle class and we have shrinking one.

As their internal demand increases they will rely less on us for exports and buy less of our debt, treasury rates will spike and the U.S. will look like current day Europe – austerity being forced everywhere you look, high unemployment and social unrest all while the blame will be put on politicians who will be helpless to fix anything.

nebraska: I think this is happening right now, their exports to the U.S. are gradually declining even as their oil imports are rising. We are less and less able to afford our trade deficit so it continues to decline. Our debt has expanded to the point where any rise in interest rates will further cripple our economy. I wonder if anyone in Washington is paying attention to the situation.

U.S. Trade Deficit, SA (courtesy Calculated Risk)

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GCL: A round of applause for this very interesting discussion! Much of the strength of The Oil Drum blog comes from its highly knowledgeable reader base, which includes many who hold insider “ringside” positions at major oil or financial companies where all the real action is happening. These readers have valuable insights to share with anyone who cares to read and pay attention to their comments. The above dialogue is only a small part of the readers’ comments that followed the excellent Oil Drum post titled Will 2011 Be A Rerun of 2008 (Longer Version). The entire post and its comments threads are highly recommended reading.