Slak­ing the Dragon

China’s rapid eco­nomic growth over the last decade was cou­pled with the no­tion that its thirst for oil would con­tinue in­def­i­nitely. Now that its econ­omy has slowed, Canada’s oil patch is suf­fer­ing the con­se­quences


THEY SAY YOU DON’T KNOW WHAT YOU HAVE UN­TIL IT’S GONE. For Canada’s oil patch, China’s grow­ing de­mand for oil al­ways seemed like a per­ma­nent fix­ture – an ev­er­last­ing thirst that would never run dry. Chi­nese oil con­sump­tion sky­rock­eted after the turn of the mil­len­nium, from an average of un­der 4.4 mil­lion bar­rels per day (bpd) in 2000 to just un­der 11 mil­lion bpd 15 years later. A mas­sive in­fra­struc­ture build­out in the coun­try was fu­el­ing a bo­nanza, and in April 2014 China sur­passed the U.S. as the world’s largest net im­porter of oil. Even as U.S. shale pro­duc­tion boomed, there was an as­sump­tion that China (as well as fel­low BRIC gi­ant In­dia) would ab­sorb ex­cess sup­plies. But as its econ­omy shifted away from in­vest­ment and to­ward con­sumer-based con­sump­tion, it seemed one of the oil patch’s most bullish bell­wethers had changed di­rec­tion. Most fore­casts are now bear­ish on Chi­nese oil de­mand growth, and a re­cent re­port by Platts ex­pects China’s 2015 oil de­mand in­crease – when year-end data comes avail­able – to have slowed to 5.5 per cent (581,000 bar­rels bpd) year over year. Sud­denly, it’s a won­der how Canada’s oil patch is sur­viv­ing with­out dou­ble-digit growth in China.

An­a­lysts saw Chi­nese de­mand fall­ing for some time, but many un­der­es­ti­mated how sharply growth would de­te­ri­o­rate. To­day, the main driv­ers of China’s seem­ingly in­sa­tiable oil de­mand – an in­dus­trial-based econ­omy, a mas­sive la­bor force, and an in­creas­ing num­ber of ve­hi­cle sales – are soft­en­ing. Mak­ing mat­ters worse from an op­tics stand­point, Bei­jing sprang a sur­prise cur­rency de­val­u­a­tion in Au­gust 2015 to shore up its ex­port man­u­fac­tur­ing base. As in­vestor anx­i­ety about the cur­rency and econ­omy spread into the New Year, Chi­nese stocks plunged forc­ing of­fi­cials to halt trad­ing, and spread­ing the mar­ket tur­moil around the world.

So, will China ever re­turn to its po­si­tion as the world’s oil price safety net?

Not likely, ac­cord­ing to Jim Burkhard, vice-pres­i­dent of oil re­search at IHS. He says that all indi­ca­tors point to a fu­ture of slow­ing Chi­nese oil de­mand growth, not least of which is the coun­try’s shrink­ing work­ing-age pop­u­la­tion, which de­creased by 3.7 mil­lion peo­ple in 2014. “The work­ing-age pop­u­la­tion is the en­ergy-in­ten­sive age pop­u­la­tion – that’s where peo­ple are driv­ing, work­ing,” he says. More­over, the car sales boom has slowed and ve­hi­cles on Chi­nese roads are be­com­ing more fuel ef­fi­cient than ever. Some con­sumers are turn­ing to elec­tric ve­hi­cles spurred by in­cen­tives from the Chi­nese gov­ern­ment, though China still ac­counted for less than one per cent of global mar­ket share growth for elec­tric ve­hi­cles in 2015, ac­cord­ing to the International En­ergy Agency (IEA).

And it’s not just China’s ve­hi­cles. Its en­tire econ­omy is be­com­ing less de­pen­dent on oil. The IEA es­ti­mates China re­duced its oil in­ten­sity in­dex – oil burned per unit of GDP – by 18 per cent be­tween 2008 and 2014, and will con­tinue on a down­ward slope through to 2020. Premier Li Ke­qiang said last year that the gov­ern­ment aims to re­duce over­all en­ergy in­ten­sity by 3.1 per cent in 2015. All this means that China needs lower en­ergy growth to power its econ­omy and thus less oil, which makes up 20 per cent of its over­all en­ergy con­sump­tion. “There clearly has been a struc­tural shift in the na­ture of the driv­ers of Chi­nese GDP growth that makes the coun­try sig­nif­i­cantly less oil-in­ten­sive in terms of growth than it was be­fore 2010,” says Ed Morse, global head of com­modi­ties re­search at Cit­i­group. “No­body that I’m aware of had fore­cast that.”

For Burkhard, all this sug­gests that China is un­der­go­ing a tran­si­tion that will slow its pace of oil de­mand growth in the years ahead. “In the next 10 to 20 years, the pos­si­bil­ity of China hit­ting an un­du­lat­ing plateau is not fan­tasy land,” he says.

IF CHINA’S OIL DE­MAND WERE TO PLATEAU, IT WOULDN’T BE WITH­OUT prece­dent. Morse says China’s diesel de­mand, specif­i­cally, has al­ready reached its tip­ping point. In 1993, China had only a hand­ful of cities made up of a mil­lion peo­ple or more. To­day, that num­ber has risen to about 145. “That [kind of growth] is in­cred­i­bly com­mod­ity-in­ten­sive,” Morse says. “It’s in­cred­i­bly diesel-in­ten­sive be­cause of the amount of truck­ing ac­tiv­ity it takes to move equip­ment, to move parts, to move things in and out of a con­struc­tion site.” But in re­cent years con­struc­tion growth has tailed off, re­flect­ing a change in pol­icy and a de­mo­graphic shift, Morse says. That has greatly af­fected diesel de­mand growth, which went from about eight per cent ev­ery year for about a decade to neg­a­tive growth in 2013 and 2014. “It just reached the wall and changed,” Morse says. “And yes it’s ac­com­pa­nied by a lot of other noisy fac­tors. But the main fac­tor is a de­vel­op­men­tal change.”

In ad­di­tion to slow­ing ur­ban­iza­tion, China pledged in June to re­duce green­house gas emis­sions by 60 to 65 per cent below 2005 lev­els. It has al­ready been mov­ing in that di­rec­tion by adopt­ing more fuel-ef­fi­cient ve­hi­cles, less en­ergy-in­ten­sive man­u­fac­tur­ing and lower-emis­sions power-sources such as LNG, wind and so­lar. That has Morse think­ing that China’s over­all thirst for crude will fol­low suit – and level off.

That’s re­ally bad news for oil pro­duc­ers, as the rest of

the global econ­omy shows no sign of fir­ing back up. In 2014, the world con­sumed just 800,000 bpd more than it did in 2013. “That’s a GDP is­sue,” says Morse. The global GDP grew 2.7 per cent in 2014, ac­cord­ing to Cit­i­group, and Morse sug­gests it could stay that way for a while yet, with Cit­i­group pre­dict­ing 2.6 per cent growth in 2015. “If we had a world in which emerg­ing mar­ket GDP growth were health­ier, then we’d have a world in which de­mand growth for petroleum prod­ucts would be steeply higher, and the world would move into a bet­ter bal­ance.”

The sil­ver lin­ing of low de­mand and prices is that it gives China an in­cen­tive to start buy­ing and hoarding cheap oil. It may start four ad­di­tional strate­gic petroleum re­serves this year, in ad­di­tion to its ex­ist­ing eight, as part of its tar­get of stock­pil­ing enough oil to cover 100 days’ worth of im­ports by 2020. China has about 29 days of sup­ply to­day, ac­cord­ing to Bloomberg cal­cu­la­tions based on Bei­jing’s Na­tional Bureau of Sta­tis­tics data.

In very short or­der – at least from the per­spec­tive of oil pro­duc­ers – China has gone from a bullish con­sumer to a cau­tious hoarder. The sub­se­quent ef­fect on international oil mar­kets has yet to be fully un­der­stood.

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