The regular reader of this column may be surprised to see me using almost the same heading as I used five months ago. Why am I using it? Because once again the world is looking to China to gain some insight into the direction of oil demand and oil prices. In that column I wrote “In early May 2008 prices for crude oil are hovering around US$ 120 per barrel, and some are suggesting that they may reach US$ 200 per barrel. What does this mean for demand for oil in the world, in developing countries and, particularly, in China?” . Then I added “The last thirty years of the twentieth century taught us very clearly that the basic laws of economics do apply to oil and ‘what goes up, must come down’”. As we look around us in the autumn of 2008 it is clear that these basic laws, or rather my simplification of them, have come true in the most horrific way as evidenced by stock markets, bank failures and even by the price of oil which is hovering around US$80 as I write this column.
I concluded that column by writing: “in the short-term, all the pressures on oil demand in China seem to be upwards. But the key unknown is the extent to which the economic downturn in North America and Europe will affect China and other emerging economies. A prolonged and deep recession in the West would undoubtedly have a significant negative impact on China’s economy and therefore on the country’s consumption of oil.”
Now that it is almost certain that the North America, Europe and other economies are indeed heading into deep and prolonged recession, or worse, what does this mean for oil demand in China?
Short-term oil statistics emerging from China tend to be either wrong, inaccurate, misleading, confusing or just impossible to interpret. Not only is reliable inventory data is hard to find, but the import behaviour of the oil companies can change very suddenly. China’s government can command the companies to increase or to reduce imports, and can introduce or withdraw tax incentives relating to oil imports. Further, sudden changes in the difference between domestic and international prices will result in rational reactions on the part of the national oil companies which will seek to maximise their profits or minimise their losses by adapting their production or import strategies.
The summer of 2008 has been especially confusing on account of the Olympics. The oil companies were commanded to build up stockpiles of petroleum products in order prevent supply shortages, industrial activity was suspended across a large swathe of northern China in order to reduce atmospheric pollution, and traffic in Beijing was drastically curtailed. So the fall in gasoline demand in August tells us nothing useful.
Recent years have seen a substantial decline in the annual rate of growth of China’s oil consumption: from 17% in 2004 to 4% in 2007. The year 2008 is set to see a rise of about 6%. Looking ahead to 2009, a brief survey of commentaries in recent weeks shows that two lines of thought exist. One which argues that the rate of growth of China’s oil demand is set to decline dramatically, whilst the other argues that the long-term trend will continue with only minor deviation.
The first line of argument draws on a number of hard facts. First, it is now clear that the western world is entering a severe recession. China’s economic growth relies heavily on exports. A sharp fall in exports will seriously impact China’s economic growth and consequently its consumption of oil, as trucks and trains have less freight to carry and as consumers have less money in their pockets to drive or fly. Second, the fuel standards of new vehicles continues to rise as the government sets progressively tougher standards. Third, the retail prices for oil products have risen sharply this summer. In June, gasoline and diesel prices around the country rose by 18%, and Beijing municipality has just imposed a further increase of 3-4% in order to compensate the refiners for upgrading their facilities to produce fuels meeting the required European 4 standard. Pump prices are now close to those in the USA, and yet average incomes are much lower. Finally, Beijing municipality is imposing constraints on vehicle use within the city; not as tough as those imposed during the Olympics, but enough to make some difference in vehicle use. Other cities may follow this lead.
The counter arguments draw on two observations. First, China’s government has shown in the past that it will take any measures necessary in order to prevent, or at least constrain, a slowdown in the economy, as its first priority is to maintain growth and development, provide employment and improve people’s livelihoods. This priority dominates over all others. As a result, it is likely that the government will find it hard to resist the temptation to boost the economy by investing directly in infrastructure and by taking other measures to stimulate industrial investment, even though these steps may act counter to priorities relating to energy efficiency and the environment. It will also seek to boost domestic consumer spending.
The second observation relates to the nature of the oil consumer in China. 60% or more of the future increase in demand for oil will come from the transport sector, and much of this will be for private vehicles and air transport. As decisions to buy and drive a private vehicle or to take a flight are often discretionary rather than absolutely necessary, it might be expected that these consumers would decide to economise by buying a smaller vehicle, driving shorter distances, taking public transport and flying less frequently.
Such a prognosis ignores a number of factors: the members of the new, affluent middle classes enjoy their new vehicles and many of them have enough spare cash to keep driving them at present oil prices; the alternative of using public transport remains an unpleasant choice, despite recent improvements in the capacity and conditions of the public transport networks; the size of the population of potential private car owners and air passengers continues to grow along with the economy; and, finally, it is unclear whether a modest slowdown in China’s economy would indeed affect their spending power.
So, we have a number of unknowns: How deep and long will the world recession be? What will be the impact on China’s economy? How will China’s government respond to stimulate its domestic economy? How will any economic downturn affect the spending beahviour of China’s middle classes?
Answer these questions and you can predict China’s oil demand for the coming two years. Given the tendency of China’s government to intervene to support economic growth and the apparent resilience of the spending power of the affluent classes, I would support those who foresee demand continuing to rise at 5-6% per year – unless there is a complete collapse of world economies and banking systems, and then all bets are off.
Philip Andrews-Speed is Director of the Centre for Energy, Petroleum and Mineral Law and Policy at the University of Dundee, UK