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.