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FEATURE STORY: What Cheap Oil Means For China and What Weak Chinese Demand Means For Everyone Else
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What Cheap Oil Means For China and What Weak Chinese Demand Means For Everyone Else

By Michael Dow


BT 201602 040 10 Feature story 004This time two years ago, when a barrel of crude oil was hovering above 100 USD, nobody would have believed that prices would soon come crashing down to below 30 USD. Yet, from that point on, that's exactly what happened. Oil prices haven't been this low for more than a decade. It is a colossal crash that seemingly came out of nowhere and has sent the financial world into panic mode once again.


Everyday there are new headlines warning that if oil goes any lower then it will be a catastrophe. The current situation is especially bad if you are living in a resource-based economy like Russia, Norway or any part of the Middle East. If crude prices slip further, then these nations are in serious trouble. But how about the countries that import massive amounts of oil and rely on the so-called 'black gold' as a primary source to fuel their burgeoning economies? Even if it has a knock-on effect on stocks and other asset classes, are the plummeting prices bad news on the whole?


The world's biggest importer of crude oil is of course China. According to the most recent data, the Middle Kingdom currently imports a staggering 7.4 million barrels of it every single day. When you are buying up any commodity on that scale, even a slight change in the price will have an enormous impact of the annual bill. Well before prices fell below 30 USD a barrel an article in The Economist reported that "the recent fall, if sustained, lowers China's import bill by $60 billion, or 3%. Most of its exports are manufactured goods whose prices have not fallen. Unless weak demand changes that, its foreign currency will go further, and living standards should rise". Furthermore, it was noted that "cheaper oil will also help the government clean up China's filthy air by phasing out dirty vehicle fuels, such as diesel. Lighter fuels are dearer and, under current plans, drivers could pay up to 70% of the extra; lower prices will soften that blow".


An enlightening study by Oxford Economics showed that the change in oil prices will ultimately have a significant impact on every country's GDP growth this year. It highlighted the obvious fact that oil producing nations are in for a very rough ride, with rock bottom crude prices potentially shaving more than 3% off GDP growth from the Saudi and Russian economies. China, on the other hand, will be one of the biggest beneficiaries of the downward trend. According to the study, the Chinese economy could receive around a 1% boost in its gross domestic product in 2016 if oil prices stay near their current levels throughout the year.BT 201602 040 07 Feature story 001

At the moment consumption is the key to China's economic future. Over the past few months we have seen the retail sector leading the way when it comes to growth. Traditional growth engines like manufacturing have taken a big hit. In terms of boosting domestic consumption even further going forward -- which is a crucial component of the Chinese government's economic transformation plan -- cheap oil will undoubtedly help as it will lead to lower prices and therefore encourage consumers to keep spending. It should also help to keep energy prices lower for a while, which in turn will be good for manufacturers who have been feeling the squeeze from rising production cost in recent years.


The hard truth that many economists are arriving at is that while cheap oil may be good for China's goal of restructuring their economy, it is precisely their economic transformation that is fuelling the crude price crash. As Forbes contributor Doug Nathman points out: "Over the past couple of years, the country has purposely moved from a manufacturing-oriented economy to a service-driven one, using a less-energy intensive approach to growth. As a result, the demand for crude oil in the world's largest oil consuming country has gone down drastically". Moreover, he says, that "due to the sluggish Chinese demand for oil over the past year, EIA projects that the country's contribution in global oil consumption growth will go down to almost 25%. Although the decline in Chinese oil consumption is huge, the country continues to account for a significant proportion of the overall consumption growth".

BT 201602 040 06 Feature story HighlightIt is true of course that weak demand from the world's largest importer of crude oil will have a big impact on prices. The basic mathematics speaks for itself. However, traders might be jumping the gun a little in panicking about China's decreased appetite for oil and its impact on the global economy. But although the move away from a traditional reliance on heavy industries means less demand in those sectors, demand for crude products with other purposes is still soaring. According to Keith Johnson of Foreign Policy Magazine: "Chinese gasoline demand grew almost nine percent last year, and according to the IEA's latest figures it will grow another eight percent this year. Passenger car sales grew more than seven percent in 2015 to a new record high, fuelled by a government tax cut in the fall meant to tempt wary buyers to make big-ticket purchases; passenger car sales are expected to grow even more this year. Sales of SUVs in particular are booming".


BT 201602 040 08 Feature story 002Other areas of demand include jet fuel, which rose by a whopping 15 percent last year and will rise by around eight percent over the course of 2016. If the IEA's figures are correct, other oil products, such as liquid petroleum gas (LPG) -- which in China is used for heating, in industry and petrochemicals -- are also growing steadily. LPG consumption jumped more than 20 percent last year and will grow another eight percent this year.


Moreover, since prices started tumbling, some believe that the central authorities and a number of major players in the Chinese energy sector have been preparing to buy up tonnes upon tonnes of crude oil in order to create stockpiles for when prices go back up to normal levels. The fact of the matter is that if China's demand for oil remains strong like it has over the last two decades, then, in the long run, there should be a normalisation in the pricing of crude. Antoine Halff, former head of oil industry at the IEA and now director of the global oil markets program at Columbia University's Center on Global Energy Policy quite rightly pointed out in a recent senate hearing that "some of the very factors that have pushed prices down in the last 18 months will cause them to rebound in the next 18 months".


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