Chinese Oil Demand Shock

Running through many historical scenarios for other developing nations such as Brazil and Thailand I have come to the stark conclusion that the market could be underestimating Chinese oil demand growth by a huge amount over the next 2 to 4 years.

China is at a major inflection point in terms of oil demand. This has been borne out by many other countries at similar development stages. If anything, China is 2-3 years overdue an oil demand growth spurt given its income growth. The August 2009 82% year/year jump in annual Chinese auto sales is a harbinger of what is about to come. That 82% is not a typo. China has skipped its traditional seasonal summer decline in vehicle sale entirely so far in 2009 (see chart below).

Chart: Chinese Total Monthly Vehicle Sales in Millions

(click to enlarge)

If China follows a similar pattern to other developing nations then Chinese demand is likely to not just grow by its past 5 year rate of around 5% per year over the next 2 years. Chinese oil demand is on the precipice of a significant jump in annual growth over the next few years. The absolute barrel volumes of oil are enormous.

Great Wall, Currency Fall

People I met in China (the final country on my Asian tour) earlier this week are optimistic about growth. Chinese stores are bustling and general economic activity appears to be quite healthy. The Chinese have turned bearish on the US dollar and have slowed their purchasing of dollar assets such as US Government Treasury and Agency debt, as well as US equities and corporate debt. This is bullish for oil in dollar terms and a reason for recent strength in oil prices (in addition to the global physical oil market beginning to tighten and a recovery in equity markets).

The chart above shows the fall in the purchasing power of the US dollar since the 1920s. A chart of most other paper currencies would show a similar if not greater declines. As Anatole Kaletsky says in an interesting article in today's Times:

"The currency game is not a beauty contest but an ugly contest, in which investors must choose the currency that is least ugly."

Oil is a currency itself, a hard currency floating stronger against these more ugly paper currencies.

Oil Markets and Economic Recovery

Two interesting monthly oil numbers which came out today are US vehicles miles travelled (upper chart) for February and Chinese oil demand numbers for March (lower chart - with US data superimposed). Chinese new vehicle sales were up 10% year on year in March 2009 and so the resumption of strong positive Chinese oil demand growth is likely soon. The question is, will oil demand in the US and the rest of the world turn positive soon also. The trend, at least in US vehicle miles traveled, would indicate so.

Oil Demand Wave Crests Across Globe

China's General Administration of Customs released trade data for February on Monday March 23, 2009. As you can see from the chart above, China's apparent total oil demand grew by 0.5% in Feb 2009 versus Feb 2008. This is the first yr/yr growth figure to come out of China following three months of negative oil demand growth. The Lunar New Year fell in January this year and February last year, with distorts the numbers somewhat.

The Chinese data shows that the lag between the bottoming of US total oil demand (1st week of October 2008) and Chinese demand growth was four months. This appears to sync with market anecdotes of the wave length of the economic slowdown (and possible recovery) moving across the globe from the developed world to emerging markets.