China's Oil Demand: Challenging the Conventional Wisdom, China and Demand Elasticity
4 Dec, 2008 09:53 pm
Where is China's demand headed ? China's demand will be a function of several critical drivers. Paul Ting, top-rated oil analyst, analyzes these key factors. (Special dossier - Oil demand around the world: suppression or destruction? 3/4)
So where is China’s demand headed? China’s demand will be a function of several critical drivers. Let us analyze these key factors.
First and foremost, there is the macro-economic driver. We are already seeing China’s GDP growth falling to 9% in the third quarter, in addition, the October and November leading indicators (industrial value-added, exports, money supplies) portend sharper decline in the fourth quarter. The weakness is expected to extend into 2009.
Second, there is the price driver. While domestic consumers enjoyed a nice pricing subsidy in the first half of this year, the situation has reversed. After China increased domestic product prices on June 20th, global crude oil prices soon started to descend on the very steep slippery slope in July. China did not yet adjust the domestic prices to reflect the $100 decline of global crude oil price (China is expected to lower prices soon). More importantly, and this is a critically important issue, China’s demand has shifted from being inelastic to elastic. Due to the weakened domestic and global economic growth, combined with the artificially high domestic pump prices, China’s demand curve is displaying strong characteristics of elasticity. Where is the proof of this elasticity? We point out the fact that while the world is well aware of demand destruction in the US and other OECD nations, this awareness does not extend to China. Indeed, analysts almost recited the mantra of “strong oil demand growth from China and India” by rote. This mantra flies in the face of the sharp sequential decline of China’s oil demand. Between June and October, China’s consumption fell by a mind boggling 700-800 MBD! Even though there is still some modest year/year growth in demand, the demand pattern shows obvious sequential weakness. Indeed, demand destruction knows no national boundaries. Where are the main sectors of demand weakness? Just take a look at the fuel oil sector; October fuel oil demand dropped to half of the May level, and declined by 27% vs. last year.
Third, there is the inventory driver. China’s inventory is a source of great frustration for many analysts. The consensus view is that China does not release official inventory data. Because of the difficulty in obtaining inventory data, many analysts tend to conveniently ignore it. In fact, in analyzing China’s historical inventory data, prior inventory swings were not that material; certainly not material enough to alter the demand conclusion. However, this is not the case in 2008. Inventory swings were very significant. Inventory of key oil components have exploded upward. Some key products (such as diesel) saw inventory increase by almost three fold! Others, such as kerosene and crude oil, saw less build. This is not just true for oil, but also true for other commodities such as coal. While one can again conveniently attribute this build to the Olympics, latest inventory data challenges this conventional wisdom, as the inventory build continued beyond the Olympics. In our view, this massive inventory build reflects nothing more than the economic truism that inventory builds when supply exceeds demand. In fact this correlates to, if not corroborates, our thesis that China’s demand is elastic.
Lastly, there is the policy factor. China’s demand growth in 2009 and 2010 will be very much impacted by key policies, including the treatment of VAT, the consumption tax and most importantly, price reform. The combined effect of lowered GDP growth, high inventory, and high domestic prices (even if China were to reduce pump prices) point toward a weak demand growth as we enter 2009. However, we do note that as China’s pro-growth policies kick in towards the latter part of 2009 (low interest rates, lower prices, stimulus package etc), some pick up in demand growth is expected. Nevertheless, demand growth will be weaker before it gets stronger, longer term. This scenario suggests that downstream investment may become more attractive in China as margins obviously expanded compared to the first half of the year.
By Paul Ting, President of Paul Ting Energy Vision LLC (www.oilresearch.us)