World’s energy markets stuck as China ‘rebalances’ its economy

By Saqib Rahim | 04/28/2015 08:14 AM EDT

U.S. coal and oil companies have enough on their minds trying to cut costs, protect cash flows and placate investors who keep glancing at the exits. That leaves very little time to contemplate the giant in the east: China, whose energy demand is shifting and setting it up as a wild card in world energy markets.

U.S. coal and oil companies have enough on their minds trying to cut costs, protect cash flows and placate investors who keep glancing at the exits.

That leaves very little time to contemplate the giant in the east: China, whose energy demand is shifting and setting it up as a wild card in world energy markets.

Coal and oil prices are stuck in deep troughs, and analysts believe that won’t change until their global oversupplies are corrected. But a growing body of analysis indicates that China’s future demand for these fuels — long taken for granted — won’t grow as quickly as it has in the past.


This weaker growth could hit U.S. producers where it hurts: lower prices.

"China’s impact on global energy markets will be transformed as its oil and coal consumption growth slows fast," analysts with Barclays wrote last month. "Investment in renewables is likely to surge and China is likely to become much more important in global gas markets."

Prices haven’t been a problem for some time. Since the start of the century, China — foremost among the "emerging market" economies — has driven seemingly bottomless demand for steel, coal, oil, copper and other commodities. By 2014, energy and food prices averaged between 150 and 60 percent higher than in 2000 to 2002, according to the World Bank.

But high prices encouraged production, and in coal and oil, markets have said there is too much. Benchmark export thermal coal prices have fallen about 60 percent from a 2011 peak, according to the Financial Times; Brent oil prices have fallen 49 percent since June. Top economic bodies have wondered about "secular stagnation" (EnergyWire, April 13).

This is happening just as China begins an economic transition it calls "rebalancing." After more than a decade of feverish growth, led by manufacturing exports, Beijing wants to change emphasis. It wants to depend less on manufacturing and exports and more on domestic consumers. It wants to focus less on growing gross domestic product for its own sake and more on quality of life for its growing middle class.

This has implications for energy. Not only will natural gas get ramped up for power and industrial uses, but the goal is to loosen coal’s stranglehold on China’s energy portfolio — at present, a 70 percent share.

"China demand drove the investment commodity (e.g., coal, iron ore, aluminum, etc.) super-cycle over the past decade," Laban Yu and a team of analysts with Jefferies Group LLC said last week. "It will drive the consumption commodity (oil and gas) boom in the next decade."

Diminished demand for coal

"China’s structural shift diminishes the main demand growth engine for mined commodities globally," Daniel Rohr, director of basic materials equity research at Morningstar Inc., wrote last month. "Weak Chinese demand takes a sustained price recovery off the table for most commodities."

He projected seaborne thermal coal prices at $67 per metric ton for the rest of this decade, compared with an average $94 over the last five years.

This could present a problem for U.S. coal producers, who have pitched foreign markets — especially in Asia — as a beacon of hope. China and India have driven about 80 percent of increases in global coal growth since 2000, according to the Carbon Tracker Initiative.

Instead, six coal-export terminals in the United States have been canceled over the last three years "because of poor economics and strong opposition," the Oxford Institute for Energy Studies said in a report last month.

At current prices, almost 17 percent of U.S. coal production could be idled or shut down, consultancy Wood Mackenzie said last month.

"China’s structural moves away from coal have been a major reason why we have been bearish on coal prices for the last few years," Thomas Pugh, a commodities analyst at Capital Economics, said by email. "We expect this trend to continue into the future as China moves towards more renewable, nuclear and gas sources for its power."

Still, there are reasons to question this scenario.

"I don’t think they’re really rebalancing the country. They’re just saying it, their execution hasn’t really shown it," said Mickey Kwong, a director at ClipperData, an energy data provider.

Kwong, who has done a comprehensive study on China’s energy balances, said provincial officials still get ahead by promoting "growth over all," and they’ll happily use coal unless Beijing rewards them for something else.

"It’s going to slow down, but it’s not really going to arrest the growth of coal and oil," he said. "They’re stuck. In many ways, they’re still stuck."

What about oil?

On oil, though, there are questions about how "stuck."

The International Energy Agency has called China "the leading engine of global oil demand growth for the last 15 years." Before shale oil came onto the scene, China was a major reason Wall Street leaders thought oil could hit $150 or even $200 a barrel.

Today, even with Brent prices in the $60s, China’s oil demand has yet to respond. It’s gotten analysts thinking: Is something deeper going on?

One hypothesis: The Chinese economy is getting more efficient with its oil.

"Our research shows that oil demand grew about 0.69% for every 1.0% of GDP growth in 2014, which is significantly lower oil intensity than the 0.94% ratio that prevailed ten years ago," Kohlberg Kravis Roberts & Co., an investor group with $99 billion under its management, wrote in February.

On top of that, China is changing the way it uses oil — less in industry and more in vehicles — with the net results difficult to predict.

The Barclays report, for instance, sees weaker growth in the grades of oil used for factories, trucks and older-generation heaters. But in gasoline and jet fuel — the preferred fuels of a consuming middle class — Barclays sees much stronger growth.

The net result: Chinese oil demand will grow, but nowhere near its recent clip.

"China’s share of global oil demand is now close to peaking and will rise by only another 1% to 12% by 2020," the report said.

Big cars drive gas demand

Meanwhile, at Chinese auto dealerships, sport utility vehicles are flying off the lot.

The country’s auto market has grown 8 percent a year for the last five years, said James Chao, managing director at IHS Automotive and general manager for Beijing Polk-CATARC. The SUV segment, however, has grown at a 27 percent clip.

So as China’s middle class buys cars en masse, the question — from an energy point of view — is how many cars, and how fuel-efficient are they?

The Jefferies analysts see an impending "inflection point" where China’s oil demand takes off.

"We believe the inflection point for China’s car penetration will occur 2016-17, at which point oil demand growth will accelerate," they said last month. "We believe China will reach car saturation (oil demand plateau) in 10-20 years."