China's appetite for crude will determine whether prices hold at current levels or collapse entirely.
Can China help pump up price?
If Saudi Arabia is oil's key producer, China has become its key consumer. But now, according to analysts, China's appetite for crude will determine whether prices hold at current levels or collapse entirely. As high petrol costs and an economic slowdown reduced demand for oil in the US this year, China happily soaked up the extra crude on the market with imports surging and oil demand increasing by 6 per cent. With the slowdown in demand in the US, Europe and Japan now factored into the price, analysts and traders agree China remains the key variable in the equation. The trouble is, no one can be sure which way China's appetite for oil will go. Chinese oil demand will be determined by two major factors: a change in the government's policy on fixing fuel prices, and the health of the economy, said Robin Mills, a Dubai-based oil economist. Both are now uncertain. If the growth in demand for oil slows substantially - whether as a result of a change in fuel prices or an economic slowdown - it is likely that world oil prices will continue their steep declines. Chinese officials jolted markets earlier this month when they announced the country's economic growth slowed to 9 per cent in the third quarter, down from 11.3 per cent a year before. The news suggested slowing economic growth in the West was taking its toll on China's export-driven economy as consumers scaled back their purchases from the world's factory. But many analysts believe China's huge national savings and growing domestic economy will ensure it weathers the crisis with little damage, which will in turn support the high growth in its oil demand. Last week, the chief economist of the World Bank, Justin Yifu Lin, predicted the country's economy would grow between 8 per cent and 9 per cent next year. "There will indeed be an adjustments of 2 per cent or 3 per cent, but viewed globally, China will remain a fast-growing country," he said. He added he was "confident that China has the ability to smoothly pass through this turmoil and continue rapid growth". The fantastic growth in the nation's oil demand in the past decade mirrors its transformation into an industrialised, consumer-focused economy. Diesel is the fuel of choice for both urban construction vehicles and road freight transport. Ethane and naphtha are key feedstocks for the chemicals and plastics industries. Petrol use has soared as millions of Chinese convert from bicycles and buses to private cars. In 1993, the country was the world's fourth-largest oil consumer and domestic production met all of its needs. Ten years later, it surpassed Japan to become the world's second-largest consumer. It now needs about 7.5 million barrels of crude oil a day (bpd) to fuel its economy, of which 3.8 million are imports, according to PFC Energy, a US consultancy. Consumer demand has been supported by government regulation of pricing, which ensured Chinese consumers have been shielded from world market prices. PFC predicts crude demand will grow by 8 per cent to 8.1 million bpd next year, partly because the country is expanding its refining capacity and filling a 100 million-barrel strategic reserve. The International Energy Agency, a group of energy-consuming nations that issues monthly demand forecasts, is even more optimistic, and predicts the country will need 8.4 million bpd next year. Now, oil market analysts are examining how a slowdown in the economy could soften demand. The country's oil demand has historically followed GDP growth closely, according to Mr Mills. To predict Chinese appetite for oil, "we'll have to look at China's GDP", he said. "So far we haven't seen convincing data of a big drop in Chinese demand." PFC noted the correlation between oil demand and GDP was especially close in the manufacturing sector, which is both energy intensive and has served as a key driver of the country's growth. "The manufacturing sector, which contributes over 40 per cent to China's GDP - and consumes large volumes of middle distillates - has experienced a marked decline in activity for several months now, as orders from China's principal export markets shrink and domestic demand cools," PFC said in its most recent report on Asian oil demand. According to Reuters calculations, China's oil demand rose by only 2 per cent in September, its slowest rate in 10 months. Net imports of products fell to their lowest monthly level since 2003. But PFC cautioned that oil product demand was lower partly because the country was using up stocks of fuel it accumulated in preparation for the Olympics. The group's report held to its prediction that oil demand will increase next year because it believes the Chinese government will spend part of its accumulated reserves on infrastructure projects such as road building in order to maintain economic growth. "PFC Energy sees an uptick in government expenditure on infrastructure and development projects in 2009 aimed at countering slower growth in other sectors of the economy - providing continued support for strong oil demand." Mr Mills noted, however, that the country's economic growth was not the only factor potentially affecting its demand for oil. Several times this year, the government has considered eliminating its regulation of petrol and diesel prices. In June, the government raised prices by 18 per cent, a move that slowed the rise in petrol demand. Now that prices have fallen, however, Chinese media report that state oil companies are under pressure to cut prices. Scrapping the price regulation might not lead to higher prices for petrol in the short term. Petrol in China now costs Dh14.34 (US$3.90) per UK gallon, according to government price guidelines, compared with Dh11.28 a gallon in the US and Dh6.25 a gallon in the UAE. But for most of the year, Chinese motorists paid lower prices than drivers in the West. The country's pricing policy has a huge effect on its demand for oil that lies outside the fundamentals of the global market. Mr Mills noted that the government could see the current environment as a good time to end subsidies, because crude prices have fallen and the threat of inflation is reduced. At the same time, however, lower oil prices make subsidies more affordable, and the fiscal pressure to end them is reduced. "As the oil price falls, it obviously takes the pressure off subsidies a little bit," Mr Mills said. "I'd incline towards the thought that with the oil price cooling down, the Chinese government will want to keep growth growing." The government has said in recent weeks that it sees continued high growth as the centrepiece of its economic policy. Growth is the government's "first priority", Wen Jiabao, the Chinese premier, said last Saturday. His message was underscored by the central bank, which has cut lending rates three times in the past two months. The world's big oil producers, which have seen prices steadily fall to levels where they threaten national budgets, can only hope that China's economy will pull through the crisis, and leaders will maintain their policy of regulating prices. Two weeks ago, Opec slashed output by 1.5 million barrels in the hope that it would arrest crude's fall. The same day, light sweet crude dropped more than $3. What is clear is that the world oil market now lies in Beijing's hands. * with agencies firstname.lastname@example.org