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India - the new demand-side dynamo

The oil market has been fixated on China. In 2017, it will have to start watching India and its booming consumer economy

Over the past decade, global oil-demand growth was driven mainly by China. But Beijing's effort to tilt its economy away from export-oriented heavy industry has changed this. China's annual oil-demand rise has slowed to around 200,000 barrels a day, compared with 0.5m b/d in the 10 years before 2013.

Now the market has a new contender: India. Its thirst for oil has not matched China's in the past, partly thanks to the strength of its services sector relative to manufacturing in GDP, and partly because political paralysis has deterred industrial investment. India's burgeoning budget deficit in recent years, aggravated by oil prices above $100 a barrel, also sapped the investment climate. Over the past decade oil-demand growth averaged just 130,000 b/d a year.

But a "new India" emerged in 2015. Oil-demand growth jumped to 300,000 b/d - a record high - and by September 2016 year-on-year demand was up by 370,000 b/d, leaving consumption above 4m b/d. In 2015, India was the largest contributor to non-OECD demand.

Falling prices since mid-2014 have helped stimulate the economy and therefore oil demand. India's GDP grew by 7.2% in 2015, outpacing China's 6.9%, and is expected to have remained at similarly lofty levels in 2016. It should sustain this in 2017 and beyond. On top of the boost from low oil prices, structural and policy-driven changes are underway which could see India's oil demand take off in a similar way to China's during the late 1990s, when Chinese oil demand was roughly equivalent to India's today. For one thing, per capita consumption in India is increasing thanks to cheaper oil prices, especially in big sections of the population that could not previously afford it. The automotive industry is one example. India is now the world's sixth-largest car market, with 29m units sold in 2015. Vehicle-sales growth remained robust through 2016, with passenger-car sales soaring, year-on-year, by 9% and 15.1% in August and September, respectively.

The Indian government's aim to increase the manufacturing sector's share of GDP should also lead to higher oil consumption. Also, a large-scale road and highway programme - partly funded through higher taxation of oil and oil products - will keep supporting oil-demand growth.

This is already visible in stronger demand for gasoline and diesel. Average year-on-year growth in the former has been consistently high, averaging 13% between April 2014 and September 2016. A record 25% (120,000 b/d) year-on-year growth was reached in August. For 2016, the rise amounts to about 57,000 b/d - most of it from the automobile sector, particularly two-wheeler sales and passenger cars.

Structural and policy-driven changes are underway which could see India’s oil demand take off as China’s did in the late 1990s

The potential here is even greater. Car and two-wheeler ownership and penetration combined amounts to 144 per 1,000 people. As India enters the stage of per capita income ($4,000-$10,000 in purchasing-power parity terms) when vehicle ownership grows rapidly before peaking and plateauing, much of the two-wheeler fleet will be replaced by cars.

Demand for diesel has grown more erratically due to the cyclical nature of consumption. The fuel is mostly used in goods transportation and agriculture (for tractors and the like). But the inconsistency of diesel demand also stems from the gradual removal of subsidies for the fuel since 2013, and the substitution effect with gasoline. This is reflected in the Indian automotive industry, in which product demand has swung towards gasoline. In 2013 and 2014, diesel-demand growth averaged a meagre 0.4% per year. The volatility was evident in 2015 as well. A record 20.1% year-on-year leap in September was followed by a dramatic slowdown to just 1.6% by November as floods in southern India curtailed economic activity. Since December 2015, however, demand growth has been steady at around 7.5% (except for September, when rainfall and floods again hit activity).

Much of the recent growth in Indian diesel demand (and by extension bitumen demand) is down to the government's pro-growth and pro-manufacturing policies. In September 2014, it announced a major policy initiative: "Make in India". This was aimed at expanding the share of manufacturing from 15% of GDP (its share for the past 40 years), to 25% by 2022. The policy is an effort to create jobs for India's burgeoning working-age demographic - an incredible 220m more jobs will be needed by 2025. India's manufacturing sector employs only 11% of the country's work-force, though, well beneath the 15-30% level in other emerging markets. Make in India aims to generate 100m manufacturing jobs by 2022. In turn, that will create demand growth in the manufacturing base of about 2-4% more than GDP growth. That's a pattern that has been seen in most other emerging market economies.

The infrastructure programme, which aims to construct 30km of highway per day, is part of that initiative. In the past, highway construction has been extremely erratic, with large additions seen in some years and no progress in others. But that's changing. Since coming to power in 2014, the government has earmarked $19bn for infrastructure projects, namely roads and highways, in the 12th Five Year Plan, with the bulk of that spending reserved for 2016 and 2017. Several projects are already underway, with 6,300km highways due for completion in March 2017. Another eight major roadways are also under construction, which will take the total build closer to the government's 30km-a-day target.

This is major growth: in the two previous full fiscal years, additions amounted to 3,161km (2014) and 2,337km (2015). It's not about to stop there either. In the next five years, the government plans to invest $31bn in new highways. The largest - the North-South-East-West Corridor - consists of building 7,300km of expressways connecting each corner of the country, and is in the final stages of completion.

But diesel won't be the only beneficiary of the manufacturing push. The Indian petrochemical industry will also grow rapidly as rising income levels and urbanisation bring a sharp increase in plastics demand. As of 2013, India had at least 0.5m tonnes a year of surplus capacity in ethylene, propylene, butadiene, and aromatics. Over the next five to six years, the olefinic base chemical capacity is expected to increase from 4.5m t/y to 8m-10m t/y, while that for the aromatic base should rise from 3.2m t/y to 5m t/y.

Robust expansions in the refining sector, together with surplus availability of naphtha as feedstock for petrochemical plants, has supported this growth. Over the next five years, the capacity-expansion projects announced by all major Indian petrochemical companies will lead to a reversal of balances, with excess naphtha supplies falling sharply.

So, rising per capita demand and the expanding share of manufacturing in GDP implies a concomitant increase in overall oil consumption, subject to improvements in the energy efficiency of GDP. For instance, manufacturing GDP in India in 2014 was estimated at $153bn, or roughly 15% of total GDP (of $1 trillion). By 2022, oil consumption in manufacturing is expected to be around a third higher.

A jump in oil demand has already been visible in 2016 - and it's also occurred despite the removal of subsidies and the imposition of excise duties. In short, the oil market should realise that China is no longer the only big game in town.

This article is part of Outlook 2017, our annual book looking at energy market trends for the year ahead. To purchase a copy, click here

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