Wood Mackenzie: How economy may affect China’s energy demand

Wood Mackenzie says that 2014 was a significant year for China as economic rebalancing led demand growth – for a range of major energy commodities – and GDP growth decoupled significantly for the first time. Over the past two decades, commodity demand growth had maintained relatively proportionate annual increases to GDP growth. In 2014, however, the pace of power, gas, coal, and diesel demand increase fell more drastically than the slight GDP moderation, beyond expectations.

Wood Mackenzie expects gas demand will recover in one to two years as the key drivers of slower growth are mainly cyclical but power, coal, and diesel demand will see their outlook change notably over the long-term due to major structural changes in the economy and policy. Global energy sector will need to identify which changes are structural or cyclical in to determine future demand patterns and opportunities.

China’s GDP grew by 7.4% in 2014 compared to 7.7% in 2013, a modest decline. Meanwhile, compared to 2013 power demand growth fell by almost half; gas demand growth fell by more than 8 percentage points; coal demand barely grew; and diesel demand actually contracted for the first time in more than a decade.

Cynthia Lim, principal Asia economist for Wood Mackenzie, says, “7.4% is still a large year-on-year GDP increase for any economy so this fall in commodity demand is counter-intuitive, and we have only seen the tip of the iceberg. The Chinese government is moving away from the post-2008 investment binge and gradually moving towards a more moderate but sustainable consumption-led economic growth. There are two aspects of rebalancing: one, away from investment towards consumption, particularly in the developed coastal region; and two, a shift in economic gravity away from the coast and towards the inland region. Both trends will have significant implications on commodity demand shifts. An important indicator for the energy industry to watch will be the weakness of industry versus the strength of the consumer in China.”

The research company expects industrial recovery and related investment will remain subdued in 2015–2016, but should see robust growth through the medium-term supported by urbanization. Key sectors such as coal and steel are weighed down by overcapacity, tighter environmental regulations and the property market slowdown. While the government has relaxed both house purchase restrictions and credit conditions through 2014, recovery in real estate will be slow as inventory levels remain high and potential buyers stay on the side line due to market uncertainty.

Wood Mackenzie analyzes which sectors will be most affected in the near term (one to two years), medium term (two to seven years), and long term (over eight years):

The short-term weakness in the industrial sector will continue to subdue power demand growth, especially as high inventory levels are reduced. Gavin Thompson, principal analyst for APAC Gas & Power research says, “Industrial output will eventually recover from overcapacity and weak demand, but China’s rebalancing away from industry to the service sector will have a longer-term structural impact. In tandem with the geographic rebalancing of China’s economy, regional power patterns will also change with higher demand growth concentrated in the western provinces where industrialization processes are focused, compared to coastal markets.”

Wood Mackenzie forecasts that power demand year-on-year in the western regions will rise at around twice the pace of coastal markets through the medium term of 2–7 years, with significant implications for capacity and fuel choices.

The pace of annual coal demand growth slowed to 4–5% in 2012 and 2013 from (what the previous year), particularly in coastal markets with near-zero growth in demand for power generation. However, Thompson asserts, “Coal remains king in China but growth has been severely reduced, due to industrial weakness as well as cyclical weather patterns that saw higher rainfall boost hydro output. Through the short term, coal-fired generation will likely be muted by lower power demand, environmental policies and a rise in non-coal generation including hydro. Longer term, coal demand pace and patterns will be impacted by structural changes, with demand rising fastest from inland provinces and the acceleration of ultra-high-voltage (UHV) transmission lines to export power to the coast.”

Over the past decade, gas demand in China increased by 16% a year on average between 2004 and 2013. Last year, however, gas demand growth slowed notably from over 13% in 2013 to around 8% in 2014. Thompson explains, “This was influenced more by cyclical factors. In addition to slowing GDP growth, evolving environmental policies, higher hydro output, mild winter weather in northern China, and high domestic gas prices relative to oil were key factors that saw gas demand growth fall sharply. In 2015, the government’s decision on domestic gas price reform will be a key influence on demand. While we expect domestic demand growth over the next few years to return to historic levels, a swift return to double-digit growth may not be achievable without lower city gate gas prices.”

2014 was the fourth straight year of a decoupling relationship between China’s GDP and oil demand growth as the effects of the 2009 stimulus began to fade. However, growth in oil demand has varied by oil product since then given each product’s distinct drivers: Diesel demand is estimated to have contracted 0.7% in 2014 as commercial transportation demand reduced. Thompson explains, “We believe we are now witnessing a structural change in China’s diesel demand as the economy rebalances away from heavy industry. In contrast, gasoline demand, which reflects personal car ownership, maintained a robust growth of 8% in 2014. Healthy growth momentum for gasoline demand will likely be sustained as the economy shifts further towards consumption.”

Lim concludes, “The rebalancing of China’s economy will play an important role in shaping the energy demand outlook for 2015 and beyond. We believe a recovery in demand for power, coal, and diesel in particular is closely tied to the industrial demand outlook. While these commodities will experience a moderate recovery in the medium term as over-capacity is reduced, the on-going transition of China’s economy away from an industry-led model suggests their relationship with GDP growth will weaken permanently in the longer-run. As a result, the energy sector must keep attuned to both China’s underlying changes and also shorter-term developments to position itself for the changing opportunities the market offers.”

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