The U.S. Has a Huge Advantage Over China in Energy—and It's Growing

Despite a large labor force and massive shale gas reserves, the Chinese market cannot overcome stifling political controls.

Workers carry out a practice drill in case of a hydrogen sulfide leak at a natural gas appraisal well of Sinopec in Langzhong county, Sichuan province. (Reuters)

Conventional wisdom says that by many economic measurements, China isn’t far behind the U.S.—and is catching up fast. But in one vital sector—energy—the U.S. leads and is pulling away. And the odds of this lead diminishing anytime soon, Beijing’s current plans aside, are close to zero. Considering China’s gains in other areas, why is energy so different?

In theory, both countries ought to have similar potential for producing energy. The U.S. and China have a roughly equal land mass, and while the U.S. has considerably more natural resources, the Chinese population is more than four times as large. Because labor is vital in production, it wouldn’t be too surprising if China's industry out-produced the U.S. And in certain industries, output between the two is comparable: For example, in chemicals, there are even claims that China is ahead.

No industry is more important than energy, however, and here, the United States is unquestionably stronger. The Energy Information Administration forecasts that daily oil production in the U.S. will reach three times that of China's next year, and the gap is widening: American energy production is now growing four to five times faster than Chinese output. At this rate, the U.S. will produce four times as much oil as China by the end of the decade.

The American shale gas boom is part of this, but it’s unclear how long the rapid gains in production can be sustained—and China has huge shale reserves of its own. So what else accounts for the American advantage? The reasons are simple: private property rights, industrial structure, finance, and prices—in other words, the very foundations of commerce.

In China, most land is owned by the State. On this surface this might seem to enable smooth transactions, but more often it causes problems as control over valuable land is politically contested and can involve considerable corruption. The majority of an estimated annual 45,000 rural “mass incidents,” a catch-all government term describing protests and unrest, are caused by land disputes. In contrast, clear property rights and well-established markets make for easy acquisition of land in the U.S.

The nature of energy companies themselves, too, is vital. The American energy boom is due to small, innovative businesses seeing an opportunity to expand, but neither such businesses nor the opportunity to expand exist in China. Instead, a handful of giant State-Owned Enterprises have been granted region or sector monopolies, guaranteeing them both sales and profits. As a result, there are no commercial incentives for a domestic Chinese breakthrough.

Financing, intimately tied to industrial structure, is another problem. The U.S. has a multi-faceted, deep financing system, where lending is made on a commercial basis. China, on the other hand, has an immature system where lending is mostly political. If innovative, private Chinese energy firms were permitted to exist, they would likely be credit-starved, just as small Chinese private firms in industries from advertising to zinc are. None could make the sort of investments that would allow them to challenge larger companies.

Finally, there are prices. In the U.S., rising energy prices drive exploration and technological advance. In China, the National Development and Reform Commission (NDRC) sets prices and price changes by making educated guesses. For example, the price of residential gas in China is about half the import price. High prices are a signal to produce more and, if possible, innovate. The NDRC blunts that signal for the sake of “social stability,” leading to less production and less innovation.

Is there anything in the short term that Beijing can do to close this gap? The most promising solution may be to buy American help.  The Communist Party knows this, as State-owned giants have taken minority stakes in multiple American shale providers. Even so, public ownership and mispricing will sharply reduce the gains from buying American knowhow.

Ultimately, the huge gap between the U.S. and China will continue to widen unless Beijing can manage sweeping market-driven reform in energy. Sure, China can always buy from others. But home-produced energy gives the U.S. a huge and growing advantage in a core economic sector.