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All eyes on China (part 1)

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World Pipelines,

More than three years into the global energy price collapse, complacent consumers could be ripe for another shock from “substantially higher oil prices” in the next few years, according to two economists at the Federal Reserve Bank of San Francisco.

In a research paper, Deepa D. Datta and Robert J. Vigfusson predicts China’s strong oil appetite will be the market’s main driver in the coming years. The paper’s thesis differs from today’s widely accepted view that oil prices will remain under pressure from a prolonged supply glut, weak demand growth and the growing popularity of electric vehicles.

The oil market has seen two major surprises in the 21st century, according to their paper, ‘Forecasting China’s Role in World Oil Demand’.

The first sucker punch was delivered in 2008 when crude prices surged to a record US$147/bbl on the back of years of unexpectedly strong consumption growth in China and other developing countries.

The market was caught out again when the US successfully exploited its massive shale reserves to unleash new supplies of oil and gas, which led to crude prices crashing from more than US$100/bbl in early 2014, to a 13 year low of less than US$30/bbl in early 2016.

Chinese oil demand is on course to double by 2025 on a combination of sustained economic growth at current rates and further expansion of energy-intensive activities. Even in a moderate growth scenario, the economists said China’s oil demand would still grow by over 30% by 2025.

Why China?

Between 2005 and 2015, China’s oil consumption increased by 4.8 million bpd. Although China accounted for only 12.2% of global oil demand in 2015, it accounted for almost one half of the increase in demand between 2005 and 2015.

“These increases more than offset decreases elsewhere over the same period, as the US reduced its oil consumption by 1.3 million bpd, and other advanced economies reduced their oil consumption by 2.9 million bpd,” they wrote.

In a slow growth scenario, Datta and Vigfusson project China’s oil demand to increase from 11.5 million bpd in 2015, to 15.2 million bpd in 2025. In a fast track scenario, they said China’s oil demand could reach 20.8 million bpd in 2025.

The economists acknowledge that their projections could be derailed if China implemented policies to greatly discourage oil consumption, and adopted technologies that are energy efficient and reduce carbon emissions.

The case for higher oil prices

In both scenarios, the economists noted that they have taken a more bullish outlook on China’s oil market than the US Energy Information Administration (EIA), which expects Chinese demand to reach 13.8 million bpd by 2025.

Datta and Vigfusson think prices will far exceed the EIA forecast, stating crude prices would have to rise to US$172/bbl by 2025 for the market to balance out.

China’s oil self-sufficiency on path of ‘structural decline’

With oil prices stuck in the US$40 - 50/bbl range for most of the past 18 months, China has been boosting its crude imports to record levels. They rose to an all-time high of 9.2 million bpd in March, compared with 7.6 million bpd for all of 2016.

Stockpiling is driving China’s rush to buy even though global oil and gas markets are forecast to remain glutted for years.

So, why is the world’s second largest oil consumer hoarding oil like a survivalist?

BP’s latest annual review of energy statistics offers some clues. China’s relatively small domestic oil production and reserves have grown little over the past decade, while its consumption has surged by 65% to reach a record 12.76 million bpd in 2016.

Despite government support and a reported 12.6% increase in domestic upstream investment between 2012 and 2016, China’s oil reserves and production remain insignificant on the world scale. Its reserves are stuck at just 1.5% of the world’s total, while its production has never risen above 5%.

Consumption surging amid declining production and reserves

Chinese planners are coming around to the grim conclusion that the country’s oil self-sufficiency will deteriorate as the country’s consumption will continue to grow, while production and reserves stagnate or even decline.

China’s oil appetite may have slackened in recent years on account of improved energy efficiency and slower economic growth, but it remains strong by world standards.

BMI Research confirms the opposing trends: “Despite concerns of slowing demand, China will remain a formidable consumer of crude oil and refined fuels, with demand for jet fuel, LPG and petrochemicals particularly set to outperform.”

At the same time, it expects China’s crude oil production to continue on the path of “structural decline due to asset maturity and shifting investment towards natural gas. This will drive greater reliance on oil imports over the next decade.”

Part 2 coming soon!

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