By John Richardson
FOR a long while now I have been arguing that China will do “much, much more with much less”. Four years ago, when Paul Hodges and I first outlined the concept of the New Normal, we highlighted how doing more with less in China would profoundly reshape the nature and strength of economic growth.
It was also obvious back then that as China tackled its overcapacity and environmental crises, global oil, gas, refining and chemicals markets would behave very differently. This meant that the tools of analysis that we had come to rely on were at risk of becoming as redundant as an 18th century spinning loom.
Most people were, however, too wrapped-up in their jobs of providing forecast reports for their bosses to take much notice. Keeping the “day job” – i.e. earning enough to pay the mortgage and the health insurance etc. – made what we wrote intellectually interesting, but of little seeming practical use.
Why? Because thanks to the great central bank “wealth effect”, demand growth numbers from China defied our longer-term view. There was no point in rocking the boat because all the historical data pointed pretty much always in one direction – upwards.
This meant that there was a lot of useful life left in the 18th century spinning loom way of predicting the future: Take the historical numbers and simply project them ever-higher over the next month, quarter or year. If you were slightly too optimistic in your forecasts, it didn’t really make that much difference because China would soon catch-up with your estimates.
And, anyway, as I said, why on earth rock the boat when your boss and your bosses’ boss never gave any indications that this was at all necessary?
The core message of the study is this:
- The ‘New Normal’ of Chinese growth suggests slower economic growth rates and a shift away from energy-intensive sectors, including overcapacity industries such as steel, coal, and construction.
- The government will now champion new priority sectors such as higher quality manufacturing, agricultural modernisation, and healthcare. This, combined with policy efforts to reduce energy intensity, will lead to significantly slower oil demand growth rates than witnessed in the past.
- As the government charts a new macroeconomic trajectory, markets will need to adjust to new ways of thinking.
Take away the support that Chinese demand has provided to global oil markets and you are left with oversupply that can only get worse, in my view.
The oil bulls argue that cheaper oil always equals stronger demand because of greater affordability, but this is an oversimplification.
The study, for example, argues the following in the case of China:
The oil pricing mechanism reform introduced in March 2013 allows Chinese product prices to track global oil prices more closely, but they start from a government-set benchmark.
Gasoline prices for Chinese drivers are consistently higher than for their peers in the US. Moreover, the fluctuations in the domestic market are still less pronounced. Between June and December, when global prices fell by 55% Chinese retail diesel and gasoline prices only declined by 25%.
Moreover, Beijing has also increased the consumption tax on gasoline, naphtha, solvent oil, and lubricating oil three times since November23—the first such increases in five years.
This has contributed to the slower pace of deceleration in domestic retail prices and serves as testament to the government’s resolve to combat pollution. Funds collected from the tax will be used to promote NEV [new energy vehicle] development.
The effect of lower oil prices on end-users will be limited, given the government views tackling environmental degradation as a central policy priority.
Given that emissions from the transportation sector represent almost a quarter of China’s greenhouse gas emissions, increasing the fuel efficiency of China’s auto fleet, raising fuel quality standards, and promoting fuel-switching in the transportation sector are all high on the government’s list of priorities.
So China’s gasoline demand growth – and therefore, obviously, its growth in demand for crude – looks set to slow down.
In the case of the growth in demand for diesel, government policy changes are already having a profound effect.
Diesel has been a star performer over the last two decades because of the rise in the transportation requirements of the coal and heavy manufacturing sectors.
But as China weans itself off an over-reliance on highly polluting coals as a source of energy – and as it restructures its steel, cement, construction another heavy industry sectors for overcapacity and environmental reasons – growth in demand for diesel will also moderate.
This post just scratches the surface how “doing more with less” is profoundly changing the way we need to look at China. I can promise you much, much analysis in later posts.