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China's oil demand to slow as it enters new era

Shifts in China’s economy mean the days of fast-paced consumption growth are nearing an end

For the past decade, China’s booming economy has been the engine of global oil demand growth. From 2003 to 2012, the country accounted for two-thirds of all new crude consumption, adding an average of 0.5m barrels per day (b/d), around 5%, every year. In 2014, demand was 10.4m b/d, more than twice what it was at the turn of the century. China surpassed the US as the world’s largest oil importer in April, buying up 7.4m b/d in the month.

But after a decade of surging demand that has made China the world’s most important buyer, the country’s oil consumption is undergoing an important shift. Oil demand grew by just 270,000 b/d, or around 2.7% last year, the slowest rate of expansion in more than 20 years. 

The market is going to have to get used to this slower rate of growth. Crude demand appeared to pick up over the first quarter of 2015, rising by 7.7% from a weak first quarter last year. But much of that oil likely ended up in strategic and commercial stockpiles and the acceleration is unlikely to last. China National Petroleum Corporation (CNPC), the country’s largest state oil company, expects demand to grow by 3%, or around 310,000 b/d, this year. The International Energy Agency (IEA) forecasts growth of just 2.7%. Barclays, an investment bank, expects just 2%.

A new mindset

Two important factors are at work: China’s economy has slowed sharply and president Xi Jinping is trying to engineer a shift away from the country’s reliance on heavy industry and basic manufacturing to less energy-intensive sectors such as high-tech, healthcare and finance. 

China’s economic growth slowed to 7.4% in 2014, just below the government’s 7.5% target and well below recent years’ double-digit growth rates (though outside experts have long suspected the official figure is inflated). And 2015 is likely to see slower growth again.

The government is targeting “around 7%” growth, but many economists expect growth to again come in below the official target. The government has responded with rate cuts and other stimulus measures. Still, far from signaling that the government wants to see a return to the heady days of double-digit economic growth, officials in Beijing have taken to calling slower growth “the new normal”.

As the economy slows, Beijing is trying to steer it down a fundamentally different economic path. The country’s growth-at-any-cost economic model has produced decades of breakneck economic expansion and helped to lift millions out of poverty. 

But it has also wrought widespread environmental damage – most visible in the smog that hangs heavy over China’s cities and countryside – and has been criticised, both inside and outside of China, as unsustainable. Xi has staked much of his political capital on economic reforms aimed at making China’s economy more market-based and efficient, while making consumers, not industry, the engine.

These reforms are already having a major effect on the makeup of China’s oil demand. Over the past three decades the country’s industrial juggernaut drove oil demand growth, and its fuel of choice was diesel. China has laid down roads and rails and put up skyscrapers at a pace and on a scale never before seen. One historian estimated that China used more cement between 2011 and 2013 than the US used in the 20th century. That has made diesel the main component of oil demand over the past decade. Consumption of the fuel has grown nearly threefold over the past 15 years to 3.5m b/d, accounting for a third of overall demand and half of the total oil products consumed in China. 

But the country’s slowing industrial activity and housing slump has led to a sharp fall in diesel consumption. Demand fell by around 1% last year, and that slump has continued into the first part of 2015. Demand growth was around 5.6% over the first quarter of this year, but much of that appears to have gone into storage as refiners take advantage of low crude prices. The National Development and Reform Commission said that consumption, a smaller measure than demand because of storage, actually fell by 0.1% compared with the first quarter last year.  

Rising demand

Gasoline demand has taken up some of the slack and is becoming the most important source of oil demand as more and more cars hit China’s roads. It was up by more than 11% last year and around 9% year-over-year in the first quarter of 2015. But gasoline demand only amounts to 2.4m b/d, far less than diesel, so the rise hasn’t translated into equivalently strong overall oil demand growth yet.

The shifting makeup of China’s oil demand means the market will have to learn to read new indicators to understand what is going on. Industrial activity and the housing market will play a smaller role in driving growth, while barometers like car-sales numbers will become increasingly important. 

The market will also have to weigh up the risks to gasoline growth. Local governments have steadily tightened restrictions on the number of cars sold each year to ease traffic congestion – Beijing runs a notoriously difficult lottery system for new license plates. The emergence of alternative fuels could also temper gasoline demand growth. Electric vehicles have struggled in China, but natural gas is well established in the transport market, and in many cases cheaper for drivers than gasoline. Analysts at Jeffries, a US investment bank, say the payback for a taxi driver to switch from gasoline to compressed natural gas is less than three months, and less than a year for truck drivers. 

All of this points to a new era for Chinese oil demand. Chen Bo, the head of state-owned Sinopec’s oil trading arm, said in a presentation in Beijing recently that the country had entered a period of slower oil demand growth that will last for at least a decade. Even with relatively robust economic growth of 6% to 7%, he said, oil demand growth will average around 2%, or around 200,000 b/d, from 2015 to 2020, less than half the rate seen over the past decade. 

Chen reckons growth will slow further to 1% a year from 2020 to 2030, which would see China’s overall oil demand rise to around 13m b/d. If that view plays out, China will remain a force in the market, but its days as the world’s ever-reliable engine for oil demand growth could be at an end. 

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