China’s Future Energy Demand – 2/18/16

Pessimism about China’s future is rampant. Although the country’s growth is still the envy of most major economies, investors are pulling out capital on doubts that Chinese officials will be able to fix the nation’s broken growth model that relied heavily on excessive investment in heavy industry and infrastructure. Boosted by cheap credit, massive state enterprises managed to deliver good economic growth on the back of overcapacity making officials reluctant to tackle the unsustainable system. Years of promises to enact market reforms resulting in lackluster progress and sudden interventions in recent stock market woes explains some of the anxiety among foreigners. Authorities, after claiming support for loosening their grip on the economy, were quick to bar large investors from selling and make moves to prop up state-run businesses when the most recent bout of irrational exuberance went south.

Capital outflows, speculative attacks on the yuan, and overcapacity issues aside, China is relatively stable. The government’s leadership is taking steps to support the economy which should, at the very least, prevent a hard crash even though many easing tools at the government’s disposal rely on funding new infrastructure projects and industry already weighed down by overcapacity. The relentless overproduction fueled by cheap credit has especially hurt smaller cities in China. Looming debt problems have led to a pullback on credit and support for production of unneeded goods resulting a disproportionately large slowdown in non-coastal cities that won’t see the new tech companies and industrial upgrading needed to replace the jobs lost in the overcapacity cuts. Guiding the economy towards a consumer spending focus while minimizing strain on the industrial backbone of the economy will not be an easy task but proactive government policies should stave off a doomsday scenario.

With the slowdown and overcapacity cuts, Chinese energy needs are nowhere near what they once were. China’s crude oil imports are falling by hundreds of thousands of barrels a day as state refiners slow output amid stockpiles of fuel. When crude prices crashed, refined oil products initially benefited from lower input costs. The result was a flood of diesel and kerosene onto the market which was met by weak demand leading to a rapid increase in stockpiles that eroded the price of such products as storage and strategic reserves became filled. Coal imports also fell by about 9% from a year earlier. China’s commitment to curtailing wasteful production in heavy industry combined with Chinese support of unprofitable state coal companies will continue creating a downward force on global coal prices currently at 1/3 of their 2011 peak.

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