We've known it for the past decade: The primary factor underpinning strong oil prices was China's fire breathing demand for more and more energy. Based on today's updated outlook from the International Monetary Fund (IMF), the Dragon's economy is pausing to inhale. And oil prices are showing signs of asphyxiating.
But like breathing in and out, oil prices and the economy are cyclical. The question beyond our noses is: Does the Dragon have another exhale cycle coming that heats up prices again? Notionally, the answer is "yes," if China's economic indicators like industrial production and gross domestic product (GDP) strengthen again. On the other hand, it is "no" if the carbon-ingesting beast has permanently tamed its oil-consuming habits – in other words, if it can expand its economy without additional oil. So which is it?
Growth in China's oil consumption has slowed considerably relative to the pre-2008 oil gluttony period. In fact, its rate of growth is half what it used to be. The combination of an economy that has lost some of its GDP mojo (next year's IMF forecast is for only 7.2-per-cent growth) and a weakening correlation between Chinese GDP and oil demand – otherwise known as "oil intensity" – may challenge the go-forward idea that the Dragon's appetite for oil will stress the supply side as much as it has in the past. Let's look at the data.
During the voracious growth years, between 2002 and 2005, China's oil consumption was ballooning by an average of 500,000 barrels a day (b/d) per year, with high correlation to an economy that was expanding at over 10 per cent a year. At the peak just prior to the financial crisis, for each percentage of growth in annual GDP, oil demand grew by 0.80 per cent. That high level of intensity, which is typical of countries in their early and aggressive stages of industrialization, had been constant since 1980 (see Figure 1).
Since 2009, the downward kink in Figure 1 shows that China's oil intensity has dropped to less than 0.40, which means its oil growth is now only half as fast as its economic growth.
History shows that every industrializing country eventually goes through such a "break point," or a transitional period in its economic development. It is a unique and fairly abrupt point in time when a nation starts taming its adolescent energy appetite by diversifying its fuel diet, switching to lower carbs and generally consuming less through better habits.
Subsequent downward kinks in intensity can lead a country to "peak demand" – the condition whereby it can expand its economy without any incremental pull on oil demand (a flat or declining slope in Figure 1). Most Western countries are already at this peak demand state, with notable examples being the United States, the euro zone, Japan and South Korea.
But China's industrial-driven economy is far from peak demand (the slope in Figure 1 is still quite steep), which means that its oil demand will still vary cyclically with its economy. The Dragon has more fire to exhale. At its current rate of about 10.3 million barrels a day of consumption, every 1-per-cent change in its GDP translates into approximately plus-or-minus 350,000 b/d in oil demand. That's bearish when its economy slows, but still bullish on recovery.
If China's rate of oil consumption doesn't grow again, it won't be because it has fully tamed its consumption habits, it will be because the economy is stalled or permanently slowed down. In other words, it will be because the Dragon is holding its breath.
Peter Tertzakian is chief energy economist at ARC Financial Corp. in Calgary and the author of two best-selling books, A Thousand Barrels a Second and The End of Energy Obesity.
(Editor's note: An earlier online version of this story stated that China's oil consumption rose by an average of 500,000 barrels a day per year since 1990. The correct base year is 1980.)
Peter Tertzakian