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Iraqi embassy in Beijin
It says so much more than a flag hanging limply above the doorway. Iraq's embassy craves attention in Beijing. Scott Cendrowski—Fortune

China’s Iraq Oil Problem

Jun 30, 2014

The new Iraqi embassy in central Beijing makes the rest of the nearby foreign outposts look rather dull by comparison. The building’s façade is a replica of the Ishtar Gate to Babylon, a gleaming blue brick wall that was once the main entrance to the ancient city located just 50 miles south from modern-day Baghdad. Built by Babylonian King Nebuchadnezzar II and decorated with young bulls and lions, the structure even inspired Saddam Hussein to produce his own replica before the U.S. invasion.

The building, which doesn’t go unnoticed on the quiet dusty street in Beijing where workers nap at lunchtime, is the latest reminder of how close China and Iraq have become.

Thanks to China’s insatiable appetite for oil—last year it passed the U.S. as the world’s largest importer—the country has become Iraq’s top trading partner. After Iraq turned peaceful post-war, China’s state-run oil giants rushed to sign Iraqi contracts. They were largely low-margin, unprofitable deals, but the Chinese need crude and were willing to accept meager deals that other countries weren’t. There are now 10,000 Chinese oil workers in the country.

PetroChina, one of China’s four state-owned energy giants, purchased a stake from Exxon last year in the southern Iraqi oil field West Qurna. It has three other large fields. Sinopec and CNOOC are also pumping crude out of Iraq. According to U.S. Energy Information Administration, Iraq's exports to China rose more than 50% last year, making it  China’s fifth-largest oil partner, behind Saudi Arabia, Angola, Oman and Russia.

“Iraq is very important country for the Chinese,” says Simon Powell, head of Asia oil and gas research at CLSA in Hong Kong. “The Chinese were keen to be involved in Iraq when peace broke out.”

China’s dependence on Iraqi oil explains why Beijing is following today’s Iraqi violence so closely. People’s Daily, the Communist Party’s mouthpiece, runs Iraqi headlines every day. Xinhua, the state-run wire service, covered Iraqi elections. And during the June violence, an official from China’s foreign ministry reminded the press how many Chinese oil workers were in the country.

Until now, China’s role in Iraq has followed a simple directive: extract oil from the world’s sixth-largest oil producing country, no matter the cost. “The Chinese are very simple people,” an Iraqi Oil Ministry official told the New York Times last year. “They don’t have anything to do with politics or religion. They just work and eat and sleep.”

That simplicity is being put to the test in the latest breakout of sectarian violence between Sunnis and Shiites. The Chinese magazine Caixin reported that a Chinese employee of PetroChina working in southern Iraq was kidnapped before being returned. The company was said to evacuate some employees.

So far the Chinese companies have mostly avoided violence. Most of the Chinese oilfield operations are located in the southern Shiite-dominated areas of the country, where Sunni insurgents have yet to venture.

PetroChina’s operations include the Halfaya, Rumaila, Ahdab and West Qurna fields, all located in the middle or southern parts of the country.  Sinopec’s Taq Taq field is part of a joint-Iraqi operation in northern Iraq, where it employs no Chinese staff. And CNOOC’s Missan field in southern Iraq hasn’t been disrupted.

There are differing opinions about when, or if, the Chinese oil companies will flee violence. An employee of CNOOC told the state-run Global Times in eleven days ago that the company would pull out immediately once insurgents began attacking Baghdad. The Financial Times reported two weeks ago that ExxonMobil Corp. (xom) and BP Plc (bp) had already started evacuating staff.

“The Chinese aren’t going to throw up their sticks and run away at first sight of trouble,” says CLSA's Powell. “Is Baghdad a line in the sand?...All the ones we’ve asked aren’t saying much about evacuating people.”

He points out that China is increasingly dependent on Iraqi oil. Under normal circumstances, Iraq could meet a third of the world's incremental demand, according to a recent IEA report. However, the IEA warned that instability there would allow countries with fewer "above-ground" problems to fill the gap, such as the U.S. and Canada.

Iraq's beleaguered Prime Minister, Nouri al-Maliki said earlier this year that Iraq "has great confidence in Chinese companies and hopes more Chinese firms will invest in Iraq."

With militant Sunni groups now controlling great swathes of northern and western Iraq, and threatening the capital Baghdad, and with only a bedraggled Iraqi army and hastily-raised Shi'a militias between them and the Chinese, that confidence looks likely to be sorely tested soon.

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