Is China’s economy about to crash?
If you’re in the oil and coal business, the answer to that question is critical calculus for investment. Will demand for energy commodities be there?
Conventional wisdom inside energy industry boardrooms says yes. To Exxon Mobil Corp. and coal giant Peabody Energy Corp., China’s economy continues to soar, just at a slower rate, and a middle class is expanding there and in India. It’s widely assumed that population growth will fuel energy demand.
"The global middle class is expected to climb from about 2 billion in 2010 to almost 5 billion people by 2030, representing more than half of the world’s population," Exxon declared in its latest "Outlook for Energy," citing Brookings Institution research. "That middle class expansion — largely in India and China — will be the largest in history and will have a profound impact on energy demand."
At a recent event in Houston, John Hofmeister, founder of the group Citizens for Affordable Energy and former president of Shell Oil Co., repeated this consensus view, expressing confidence that crude oil demand globally will continue to rise at a strong pace for some time.
"Global demand is incessantly headed toward 100 million barrels per day," Hofmeister said.
He characterized the current oil price slump as a "refreshing opportunity" for the world to find a rational equilibrium that absorbs rising demand while holding the oil price at under $100 a barrel. The global oil price has plunged nearly 50 percent since June, as producers pump more oil into a slowing market.
February contracts for Brent crude oil traded under $53 a barrel yesterday, and U.S. West Texas Intermediate hit $50 a barrel.
Skeptics look at today’s collapsing oil prices and see the start of a long bear market. Fears are rising that a sharp slowdown in China’s economic growth, or an economic crisis there, could cement the declining oil price.
The gloomier version of the future espoused by some top economists does not assume emerging economies will continue growing rapidly. They say China isn’t immune from the kind of cyclical economic malaise and sharp declines that have plagued the United States, Japan and Europe for a century. In their telling, there are accumulating signs that China and India are entering tough times.
"Structurally, China has a fundamental economic problem, which is that its economy is overwhelmingly dependent on exports rather than on domestic consumption," said New York University political science professor Bruce Bueno de Mesquita.
The end of 2014 brought alarm bells over conditions in China’s economy. China’s growth rate could come in at under 7 percent, some predict, and others are pointing to signs that growth since 2008 has been inflated and propped up by overspending on real estate and manufacturing capacity.
David Hoffman and Andrew Polk of the Conference Board, an economic consulting group, note in a recent report that the government is injecting more capital to achieve less economic growth. Not only is stimulus spending increasingly less effective, but productivity in China is slowing, they say, which shouldn’t be happening in a rapidly urbanizing country.
They theorize that powerful state-owned companies or companies with cozy ties to government authorities are squeezing out foreign competition. Fostering competitive enterprises is getting harder. And they worry that any reforms that could boost the economy and aid long-term commodities demand are stymied by the resistance of influential insiders.
China’s stimulus spending in response to the 2008-09 global financial crisis "bore within its successes the seeds of potential crises caused by the distortionary impact of the State’s role in the economy," their report states. "Put simply, it bore the potential for a deceleration at least as rapid as its acceleration."
Political theorist Bueno de Mesquita has modeled China’s political and economic future using game-theory-based modeling methods outlined in his books "The Predictioneer’s Game" and "The Dictator’s Handbook." In an interview, he argued that the extremely unequal distribution of wealth in China will lead to rising political tensions, which could be exacerbated by an economic and financial crisis of the sort other rising Asian nations have faced in the past.
"If the economic crisis stops being a crisis and becomes a long-term malaise coupled with this uneven growth in different parts of the country, that eventually could reach a tipping point, and I think it will," he said.
The Conference Board report made headlines because it predicted a "long soft fall," in which Chinese economic growth would drop from about 7.5 percent today to 4 percent by the end of the decade.
India might be farther along this trend line. Economic reports say India’s gross domestic product growth for 2014 will register closer to 5 percent, down from more than 8 to 10 percent a few years ago. Manufacturing output in India has fallen even lower.
For China’s economy, there are plenty of red flags, aside from the famous "ghost cities" phenomenon, the subject of multiple news reports showing miles of empty apartment buildings and shopping malls, built so that local officials could showcase growth to Beijing and their regional government.
Imports are falling. Factories are reportedly producing surplus goods, with stockpiles of unsold materials rising. Debt has exploded since 2008, though the debt-to-GDP ratio for China’s federal government is viewed as modest. There’s also growing concern that China’s wealthy are leading an accelerating trend of capital flight from the country, with theorists pointing to Chinese interest in foreign real estate as one indicator.
Meanwhile, outside Asia, worries over the economic well-being of the developed world were outlined by contributors to an e-book published by the London-based Centre for Economic Policy Research, titled "Secular Stagnation: Facts, Causes and Cures." The debate in economic circles over "secular stagnation," or persistent low demand, was inspired by a now-famous November 2013 speech by former Secretary of the Treasury Lawrence Summers before the International Monetary Fund (IMF).
Secular stagnation "provides a possible explanation for the dismal pace of recovery in the industrial world, and also for the emergence of financial stability problems as an increasingly salient concern," Summers writes in his contribution to the book. The argument holds that the economies of Japan, Europe and the United States are so weak structurally, and that demand is so low, that even 0 percent interest rates are not enough to spur new investment and new growth, which would boost energy demand.
Summers’ launching of the secular stagnation debate was preceded by a paper he and fellow Harvard University scholar Lant Pritchett published predicting that both India’s and China’s economies will experience rapid drops in GDP growth, and not a "soft landing" as many believe. "Hitching the cart of the future global economy to the horse of the Asian giants carries substantial risks," they wrote.
Pritchett and Summers’ points have recent historical precedent. In the early 1990s, Indonesia, Malaysia and Thailand were the "Asian tigers" posting 8 to 9 percent annual economic growth or higher, according to World Bank data, and were viewed as poised to join Japan and South Korea in the ranks of high-income nations. Then, growth rates abruptly slowed right up until the 1997 Asian financial crisis.
For the Organization for Economic Cooperation and Development (OECD) nations, the energy industry is already expecting energy demand to grow only slowly or remain stagnant in much of the European Union, Japan and United States for decades to come. But some fear the stagnation will be even deeper than the industry is predicting, and at least one prominent economist fears that Japan’s and the E.U.’s current economic malaise — slow to no growth — could be in store for the United States.
Slow U.S. growth, too?
Recent data fly in the face of this dim view. The latest figures posted by the U.S. Bureau of Labor Statistics show unemployment is steadily falling and incomes are possibly on track to rise again.
Northwestern University economist Robert Gordon still sees worry over the future of the long-term U.S. economy, arguing that "headwinds" and secular stagnation will conspire to drag down growth, and that any economic growth the United States experiences could be driven almost entirely by immigration. In the Centre for Economic Policy Research book, Gordon writes that he’s troubled by the fact that the U.S. economy has managed only 2 percent annual growth over the past four years, even as unemployment dropped from nearly 10 percent during the financial crisis to less than 6 percent.
Gordon predicts that slow U.S. growth will continue for the next 25 to 40 years. Even so, much of the oil industry already sees fuel economy standards for cars and other forms of efficiency putting the brakes on U.S. energy consumption.
"U.S. potential real GDP over the next few years will grow at only 1.4 to 1.6 percent per year, a much slower rate than is built into current U.S. government economic and budget projections," Gordon says.
Gordon points to the aging U.S. population and retiring baby boom generation; poor education outcomes and record student debt loads, exacerbating income inequality; and rising government indebtedness that restrains the government’s ability to inject new economic stimulus into the system. In a separate paper Gordon wrote for the National Bureau of Economic Research, he adds that the U.S. health care system also strains growth. The expectation that employers provide health insurance will discourage full-time employment and repel potential foreign direct investment.
John Kingston, a senior writer at the commodities pricing and information hub Platts, recently pointed to weak U.S. oil demand, even as a recovery is supposedly taking hold. Demand for refined products fell 200,000 barrels per day in September compared to a year ago, and U.S. consumers were using only 190,000 barrels per day more than they were three years ago.
"The increase in U.S. demand while its economy slowly grows is stunning in just how puny it is," Kingston wrote. "This sort of anemic growth, seemingly divorced from the state of an inconsistent yet clearly growing economy, is the great understated factor in the collapse of the price of oil."
It’s not at all clear that shifting global demographics change this equation.
Deutsche Bank global strategist Sanjeev Sanyal has argued that the world’s population was on track to expand much more slowly than official United Nations projections suggest.
The U.N. believes global population may expand to as high as 9.6 billion by 2050 and as high as 10.9 billion by 2100. Exxon’s outlook predicts a world population of 9 billion by 2040.
Sanyal argues that world population is growing far more slowly, and will start to decline by midcentury. By 2055, the population may grow to 8.7 billion, he predicts, but then fall again to 8 billion by 2100. He says the U.N. is ignoring the effect urbanization will have on encouraging even lower birth rates, pointing to steep declines in fertility in developed and developing nations alike.
Demographic forecasts also predict China’s society will age more quickly, and the workforce there may start to shrink, even as China’s overall population grows.
Still, economic growth could remain steady or even rise in many large countries, aided by the recent plunge in crude oil prices. Just as abundant and inexpensive natural gas has revitalized many sectors of the U.S. economy, optimistic economists predict the world benefits from cheaper oil.
If nothing else, there’s gas
The IMF and World Bank expect lower oil prices will spur more GDP growth and, eventually, greater energy demand. In a recently published white paper, the Economist Intelligence Unit makes this case, arguing that weaker growth seen recently in India, Brazil, Turkey and other large emerging economies was partly caused by inflation linked to high oil prices.
"The winners would be many of those that have over the past year been making the wrong headlines," notes the economist group. "The inevitable easing of oil import costs, and the ensuing improvement in their terms of trade, will provide a much-needed fillip to their vulnerable currencies, with India and Indonesia … especially well-placed to benefit."
Optimism among energy industry insiders and analysts about the role of fossil fuels in the coming decades tends to put natural gas at the forefront. Gas turbines replace some coal-fired electricity generation in a world beset by the effects of climate change.
"It is increasingly likely that key parts of the world — ranging from China to the United States — will put in place increasingly stringent public policies over the coming decades to reduce their emissions of greenhouse gases, including carbon dioxide," said Harvard University business and government professor Robert Stavins in an email exchange.
Jeff Moore, an energy analyst with Bentek, also sees a promising future for gas, with a nod to investments in liquefied natural gas export projects in the United States, rising interest in LNG in Europe and Asia, and a massive buildup of petrochemical production.
"We see plenty of fundamental support for prices at the end of the decade due to incremental demand growth from the shift away from coal to natural gas and the introduction of exports in the form of LNG," Moore said.
But gas producers will have to wait a couple more years before they may see any tangible benefits from this trend, Moore predicts. "Bentek doesn’t see the big demand response kicking in until the 2017-2018 time frame, and demand is expected to really ramp up through 2020."