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China’s ‘New Normal’ will hit oil demand

The world’s second-largest economy is undergoing structural changes to create more sustainable growth that will have long-lasting effects for oil demand

Communist Party officials in China have a new favourite slogan: The New Normal. Anyone who has spent time in Beijing recently will have noticed the phrase peppering the speeches of bureaucrats, academics and executives at China’s state-owned enterprises. 

Although easy to dismiss as empty sloganeering, the New Normal theme being pushed by President Xi Jinping is sending an important message to Chinese citizens and the wider world: the era of unrestrained growth in China has come to an end. In its place, Xi is trying to chart a more sustainable economic path, less reliant on the heavy industry that has fuelled growth – not to mention global commodity demand –and more efficient and environmentally sound.

The new normal will mean slower economic growth. The government is targeting “around 7%” growth this year, the slowest in more than 20 years, and well below 2014’s reported growth of 7.4%. Many outside economists expect growth to come in at around 6.8%, and slow again in 2016 to around 6.5%. In years past, the slowing economy would have prompted a massive government stimulus response aimed at juicing the GDP figure. In 2009, stimulus measures pumped tens of billions of dollars into industry and infrastructure projects that boosted growth and demand for raw materials, including oil. It also led to an enormous amount of waste, environmental destruction and has resulted in the severe overcapacity that many sectors of the economy are struggling to deal with today. 

But Xi has signaled that he is willing to tolerate a slower growth rate to further other areas of reform. He reiterated this month his belief that China should not focus as much on GDP growth as it has in the past, and instead focus on the “quality and efficiency” of the economy. 

Not that it will be a smooth shift. Old habits die hard, and there is resistance to the economic shift at the local level, where officials often ignore or do their best to undermine the edicts that come down from Beijing. This is especially so in China’s coal and industry reliant provinces such as Shanxi, Hebei and in the northeast. There, the economic changes are bringing deep economic pain and officials worry about the social disruptions cause by layoffs as coalmines and steel and concrete plants are shuttered. 

Still, Xi has amassed an enormous amount of power during the first years of his leadership and has pinned his legacy on the economic reforms. 

Oil markets should take heed. The new normal for China’s economy will mean much slower oil demand growth than the world has grown accustomed to. Between 2003 and 2012, China’s annual oil demand grew at a rate of around 500,000 barrels a day (b/d), more than 5% a year. Over the period, China accounted for more than two thirds of new global oil demand. Surging Chinese consumption helped to prop up global oil prices, fuelled billions of dollars of investment in oilfields around the world and fed a refining boom at home. 

But 2014 marked a step change for Chinese oil demand. The country’s consumption grew by around 270,000 b/d, a growth rate of around 2.7%. It was a healthy pace of expansion, but it was the slowest rate of growth for two decades. Many forecasters were caught wrong-footed and had to scale back their global oil demand forecasts as a result of slower Chinese demand. As analysts at Wood Mackenzie noted, it was the first year that energy demand and economic growth appeared to decouple as energy demand growth fell much more steeply than economic growth, reflecting structural changes under way in the country.

The trend is likely to continue. Chen Bo, the head of Sinopec’s oil trading business Unipec, said recently that China’s has entering a new era of slower oil demand growth. Even with relatively robust economic growth of 6% to 7%, Chen reckons oil demand growth will average just 2% a year from 2015 to 2020. That would equal around 200,000 b/d of new demand each year, less than half the growth rate seen over the past decade in gross terms. Chen reckons growth will slow further to 1% a year from 2020 to 2030, which would bring total oil demand to 13m b/d. 

In recent months, China has taken advantage of low oil prices to fill its strategic petroleum reserve, which has helped to boost demand. The Chinese government has been tightlipped about its strategic reserves, and hasn’t made public its plans. But Chen said that China’s strategic and commercial reserves were “nearly full”, indicating at least over the next few months that demand growth could slow. If prices stay low, China though will almost certainly try to accelerate the development of subsequent phases of its strategic stockpiling, which could provide a temporary boost to demand.

The changing makeup of the economy is also altering the structure of Chinese demand. As China’s economy shifts away from heavy industry, demand for the diesel that is widely used to fuel steel and cement factories has dropped sharply, and actually declined in 2014. Instead it is gasoline that is now driving oil demand growth thanks to the rising number of cars hitting the road. The most important indicators of China’s oil demand will no longer be industrial output, but will be automobile sales, miles driven and fuel efficiency.  

Even here, though, there is reason for caution. For now there is no large-scale replacement for the petrol-fuelled automobile, but Chen said that he expects a rapid rise in take up of alternative transport fuels such as natural gas vehicles, electric cars and biofuels that could temper gasoline demand. 

The market will also need to pay close attention to new regulations and shifting social norms. Regulators are already trying to keep cars off China’s clogged roads to try to clear up the smog-filled skies. Beijing in March, for instance, announced that it would be quicker to impose driving restrictions on smoggy days. It, like some other cities, already has a yearly licence plate lottery system that caps the number of new cars on the road, and offers incentives for electric vehicles. And local governments are only going to ratchet up smog-reduction measures as environmental management becomes a metric by which local officials are judged for promotion. 

All this could make car ownership a less attractive proposition for China’s new middle class, which has so far taken up driving with the same enthusiasm as pretty much everyone else. Bain & Co, a consultancy, recently carried out a survey in China’s largest and most prosperous cities and found that as many as 30% of drivers were considering giving up car ownership because of the hassles of traffic and tightening regulations. It also found that the car was losing its appeal as a status symbol as they have become more ubiquitous.    

The slower growth and restructuring of Chinese oil demand has had a major effect on the country’s refiners. As demand boomed over the last decade, China went on a refinery-building binge. China’s oil majors and local players had access to cheap funds from state banks eager to dispense stimulus cash. And local officials were keen to see refineries built in their districts to provide a boost in economic growth and jobs. 

But the sharp slowdown in demand has left the country with a large refining overcapacity. Last year, processing capacity hit 15m b/d, about a third higher than demand. According to Chen’s forecast, China’s demand will only be 13m b/d by 2030. That has left refiners with low utilisation rates, well under 50% for teapot refiners, and little choice but to export finished products. Analysts and some in the industry have questioned the economic rationale of the exports, saying there are limited arbitrage opportunities. But Chen says China will remain a major exporter of diesel, kerosene and gasoline.

If there is good news in these figures for international oil producers, it is that China’s domestic oil output appears to have plateaued, meaning new demand will have to be met almost entirely by rising imports. China is the world’s fourth largest oil producer, pumping around 4.5m b/d, and has seen steady growth in recent years as high oil prices allowed more complex fields to be developed. But output from the Daqing mega-field, the industry’s workhorse, and other mature oilfields have entered into decline. New offshore projects in the South China Sea and enhanced oil recovery at older fields will help keep production stable, but there is little in the pipeline that would suggest China will see significant production growth over the next decade. 

In 2014, China imported 6.17m b/d of crude, nearly 60% of total demand, according Chen. That figure will rise steadily to about 8m b/d by 2020, making up around 70% of imports, by which time China should easily be the world’s largest oil importer. 

This rising dependence on imports is prompting growing concerns in Beijing over energy security. The response has been to diversify its supplies, both by country and in how it is delivered. Seaborne shipments from the Middle East, dominated by Saudi Arabia, make up around half of China’s imports. It will be difficult for Beijing to reduce this reliance, and Chen expects imports from Saudi Arabia and Iraq to continue to rise. But China will also push forward new pipeline projects from Russia and Central Asia as part of the government’s New Silk Road strategy to add to overland flows now coming from Myanmar.  

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