Reality check: another look at the Chinese economy
From the oil investor’s perspective, China is often cited as the main reason for the continuing relentless climb in global oil prices. However, a look at the data tells a different story
In 2004, China’s surprising 15 per cent increase in oil consumption was the main driver for the 34 per cent increase in global oil prices. In 2004, China was plagued by serious power shortages due to the rapid expansion of heavy industries and higher air conditioning demands, which forced families and factories to rely on diesel and fuel oil-based generators for power. Most of these power system issues were corrected so that crude oil consumption rose by only 2.5 per cent in 2005 and by five per cent year-over-year in March 2006. For 2007, the International Energy Agency is expecting Chinese oil demand to increase by 5.5 per cent.
According to CLSA, Asia’s largest independent research firm, an 8-10
per cent GDP growth rate would translate into a 5-6 per cent oil consumption growth rate based on a 15-year regression between GDP growth and oil consumption. If the Chinese economy slows down or is perceived to, it could have a material impact on world oil prices. For mature economies, a country’s oil demand growth is tied to economic growth. In emerging or rapidly developing economies, oil demand can, for a short period (1-3 years), grow faster than economic growth, but over time is tied to GDP growth.
Currently, diesel accounts for approximately 34 per cent of oil consumption and is driven by the transportation and agriculture sectors that represent two-thirds of diesel demand. The auto sector remains the largest driver of gasoline demand; today there are an estimated 17 million cars in China, with that number expected to double to 34 million by 2010 as many Chinese aspire to owning their first vehicle. Accordingly, gasoline demand is expected to increase by 8-10 per cent per year based on projected auto sales and, to encourage gasoline efficiency, the Central government has already implemented a new auto tax based on engine size.
The cost for regular gasoline in China is approximately C$0.60 per litre, compared to more than $1.04 per litre in Calgary. The price difference is due to China’s absence of fuel tax and government subsidies to refiners that keeps the price artificially low in order to reduce the impact on the agricultural sector of 800 million rural Chinese. Although Chinese retail gasoline and diesel prices have increased slightly over the past three years, they remain at a significant discount (30-50 per cent) to other free market countries. To offset refiner losses, the government has previously written a cheque for a portion or all of the refining losses. However, in April 2006, the government passed a windfall oil tax on upstream producers. Under the sliding scale formula, upstream producers pay a 20-40 per cent tax on earnings when oil is over US$40. It is anticipated that proceeds from the windfall tax will be applied to refiner losses.
In 2003, China announced a plan to build its own Strategic Petroleum Reserve, which would hold 150 million barrels of oil by 2010. The storage tanks for the oil would be phased in starting in 2006 at a total cost of US$1.3 billion and a reserve equivalent of 1.5 months of crude oil imports. Based on the current oil price around US$70, some predict the Reserve is not currently being filled and that the government is waiting for a lower oil price.
The Chinese natural gas market remains relatively small compared to oil and only represents three per cent of total energy used domestically. Although the natural gas market is small, it has a large opportunity to grow given the Central government’s desire to reduce the use of pollution-causing coal. Currently, China produces approximately 24 billion cubic meters of natural gas, representing a 25 per cent increase over the last six months. Recent gas discoveries both on- and offshore will likely lead to more gas usage over the next few years since the government has targeted that gas usage increase from three per cent to eight per cent of overall energy use by 2010.
The Chinese natural gas market also remains regulated with prices in the range of US$4.50/MMBTU, compared to about $5.25 in Alberta. Further natural gas deregulation is likely, as the government wants to provide financial incentive for companies to explore for more domestic gas. In 2005, natural gas prices rose by 10 per cent but still remain at a 70 per cent discount to U.S. prices at year-end. Higher natural gas prices will force higher input costs for power generators that face competition from coal-based producers.
Pages: 1 2
Issue Contents
Entries