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China's slowing economy may threaten energy markets

After a decade of rampant growth, the Chinese economy is cooling. The way the country uses energy is changing too

China's economic growth is slowing – that much is obvious. But energy statistics hint it could be losing steam faster than meets the eye with potentially big repercussions for global energy markets.

Official figures show China’s GDP expanding at a rate of 7.4% and down from 7.7% in 2013, marking its slowest pace of annual growth in 24 years.

Only two years ago it was hard to find analysts who expected average GDP growth over the rest of the decade to come in beneath 8%. These days the general consensus seems to have changed to between 6% and 7%.

“That we have been consistently surprised on the down side since 2010 has alerted most analysts to the possibility that we may continue to be surprised on the down side,” writes China expert Michael Pettis. 

Economic rebalance

Pettis, a China-based economist, has long suggested that even 3-4% should be considered a successful adjustment in the medium term, as China must rebalance its economy away from investment and towards consumption. Low-growth rates have hit every high-growth economy in the past and it will almost surely happen to China, he reckons.

The longer unbalanced high growth (7-8%) is maintained, the sharper the reversal must ultimately be, which would lead to average growth rates well under 3-4%, adds Pettis. 

Last year the growth in demand for power, gas, coal and oil demand fell more steeply than expected – even faster than the slight moderation in economic expansion signaled. 

There are also signs, buried in China’s electricity consumption numbers, that suggest the economy has started to cool faster than Beijing’s official growth figures suggest.

Historically, electricity consumption and economic growth have been closely linked in China. Industry makes up around 70% of China’s total electricity consumption, so sharp falls in power demand growth point to a slowdown in industrial activity, says David Fridley, a staff scientist in the China Energy Group at the US-based Lawrence Berkeley National Laboratory (LBNL). Data for past year have raised a few eyebrows as the expansion in electricity consumption fell dramatically – it halved from 7.5% in 2013 to just 3.8% in 2014.

Fridley, who has been involved with the Chinese energy industry for some 35 years, said that from 2005 to 2013, the average elasticity of electricity demand was 1.09, meaning electricity demand was up about 1.09% for every percentage point rise in GDP. But in 2014, that number dropped to 0.51, the lowest in this 10-year period.

“It’s a rather abrupt turn-around in the demand trend, and the first I remember since the early 1990s that wasn’t connected to a broader global or regional economic crisis,” says Fridley. 

Energy research firm Wood Mackenzie’s indicators also show activity levels were below those needed to fuel growth rates of 7%. As a result there has been a “bit of head scratching” going on, says Gavin Thompson, an Asian gas and power specialist at the company.

“It’s like pulling a rabbit out of a hat,” says Thompson. “Everyone would love to grow the economy, while using less electricity, but it’s not easy”.

The shift towards a service-based economy, which in financial terms is already larger than the industrial and construction sectors combined, both of which bolstered China’s economy in the past decade, will continue, but slowly, reckons Fridley. “It appears the irrational infrastructure growth of the past is over”, he adds.

LBNL’s modeling predicts peaks in nearly all heavy industrial production, except petrochemicals, within the next five years, which will translate into slower demand growth for all energy forms. Industry makes up nearly 80% of all energy use in China.

As China urbanises, consumers will still need housing, appliances, vehicles and so forth, which will translate back into industrial production. But the energy intensity of a tertiary-based economy will be much less than the industrial juggernaut of the past.  

Without a doubt China’s influence on global energy markets will be transformed by the structural shift in its economy, particularly as oil and coal demand growth slows, said analysts at investment bank Barclays. On the flipside, investment in green energy is likely to surge – by 2020 China could make up almost 40% of total global electricity generation from renewables. It will also become much more important in global gas markets with its share of global gas demand doubling to 10% over the next five years.

Gas remains one of China’s favoured environmental solutions, mainly to clean up the air in cities that are choked full of smog partly from coal-fired power. A rapid build-up of supply infrastructure, both in liquefied natural gas and pipelines, is planned, to help meet demand that is expected to double to more than 360bn cubic metres by 2020. Significant shale gas production eyed within the next 10 years would help too.

Long-term changes

The oil demand outlook will change considerably over the long-term too. This will affect the global market, which over the first 13 years of the century could always depend on China, a beacon of fast-rising consumption. The country still needs a lot of oil, but the growth in consumption is slowing markedly.

Even as the number of cars on the country’s roads soars, China may take the opportunity to avoid inevitable oil addiction. Although gasoline demand posted robust growth of 8% last year, reflecting rising personal car ownership, a strategy to promote electric transport, increasingly efficient combustion engines, biofuels, and natural gas is taking hold. As costs fall electric vehicles are eventually expected to make big inroads, especially in large urban regions, which could put a major dent in China’s future oil demand. 

Elsewhere, China last year extended its lead over the US as the world’s largest investor in renewable energy, with continued growth in its solar and wind power industries. Investment jumped 32% to a record $89.5bn – roughly three quarters of that going into wind and solar power, data from Bloomberg New Energy Finance, a research company, showed.

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