OIL March 2017
Towards the Lighter End of the Barrel

New crude oil demand patterns are being established as the demand gradually shifts from heavy industry to high-end manufacturing, commercial services, and personal consumption. The social and economic incentives to downsize industry are mounting as the country considers its environmental agenda, rising levels of urbanisation and personal income. It will accelerate the shift in product demand from middle distillates to light ends.

 

  • China’s economy is becoming less oil intensive. Growth in oil products consumption vs GDP fell to a ratio of 0.14 in 2016, below the 0.62 average over the past 16 years. However, the country is rapidly increasing its import dependence already over 65% last year.

  • Passenger car sales passed industrial activity as the main driver of fuel consumption. Gasoline is expected to overtake diesel as the main petroleum product by volume in 2020. Household consumption is boosting demand for petrochemicals and LPG.

China recently released its 13th Five Year Plan (FYP), a guide for policy framework and future energy trends in the market that has accounted for nearly 50% of global oil demand growth in the past decade. The government is tackling debt and industrial overcapacity by placing greater emphasis on environmental protection, urbanisation and innovation which will accelerate the shift in product demand from middle distillates to light ends. China’s economic growth is slowing and the focus has shifted from an export growth path to a consumer driven model. 

Environmental concerns are replacing security of supply as the main policy drivers. In the past, when Chinese oil demand was growing over 0.5Mbpd per year and the economy was expanding at double digit rates, the government’s main priority was ensuring that the economic system would be amply supplied by energy. This entailed securing supplies from a diverse number of global sources, with a preference for crude that could be processed domestically, typically heavier grades.

Now that oil demand growth is expected to slow to around 2–3%p.a. and its oil sources are more diverse, the government is increasingly focused on qualitative improvements, such as efficiency, emissions control and fuel quality upgrades.

China’s economy is becoming less oil intensive with oil product consumption vs GDP falling to a ratio of 0.14 in 2016, much lower than the 0.62 average over the past 16 years. China’s oil demand growth has declined at an annual rate of 3–6% over the past decade, and this trajectory is expected to continue. In the previous 12th FYP, China aimed to reduce energy consumption by 16% compared to 2010. It overshot this target, achieving an 18.2% reduction in total energy consumption. In the 13FYP, the target is set at 15%, in recognition of the fact that additional efficiency gains will be more difficult over time.

The 13FYP has a strong supply-side focus. Reducing overcapacity in heavy industry and fostering industrial consolidation was placed among the government’s main tasks for the five-year period. The National Energy Administration (NEA) plans to shut-down 500Mt of coal production capacity. This trend will accelerate the structural shift in end-product demand. For the better part of the last two decades, diesel has been the predominant fuel for road freight transport—especially for the transportation of coal from producer to consumer areas—as well as rail and marine transportation. Diesel consumption increased from 1.4Mbpd in 2000 to 3.5Mbpd in 2015, representing one third of the total Chinese oil demand. Since then Diesel demand has been in steady decline. Huge investments in infrastructure projects (from housing to railways), a centre piece of the government’s efforts to meet its growth targets, will not lead to a surge in diesel demand, but rather prevent it from falling sharply.

 The lighter end of the barrel

Product demand now comes increasingly for transportation and consumer goods, shifting oil demand from middle distillates to lighter products.  A growing emphasis on quality and safety across the economy will bolster the petrochemical segment. The non-durable food segment and the flourishing e-commerce, healthcare and pharmaceutical sectors will further support demand for plastics and disposable packaging.

Gasoline consumption has also remained strong in recent years rising on par with car sales. Gasoline demand is intrinsically linked to driving. The rise of automobile sales has led to steady increases in gasoline consumption, from 0.86Mbpd in 2000, gasoline usage has tripled to 2.7Mbpd in 2015. After a slump in gasoline demand growth last year, strong car sales towards the end of 2016 is likely to support growing gasoline consumption in 2017. We expect total gasoline consumption will surpass diesel in China by 2020

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Made in China?

While the 13FYP may include an objective to maintain or even increase domestic oil production from bases in Xinjiang or in the South China Sea, the reality of low oil prices is pointing toward a decline in output as upstream investment has continued to decline since the price of oil dropped in 2014. The government had set a target for crude oil imports to stay below 61% of total consumption in the 12FYP, but since 2014 the proportion of imported oil has reached 65%. Imports are expected to remain strong over the coming quarters continuing the trend seen in 2015 and 2016, when crude imports grew by 9.3% and 5.6% respectively. State stockpiling and increased demand from a growing refining sector may continue to support imports, despite a slowing economy resulting in weak underlying demand for fuels.

The government’s encouragement of greater private participation in the refining sector will continue to boost domestic production and reduce China's dependence on imports. In fact, increasing crude import licenses to the private teapot refiners has driven a surge in refined fuel exports over recent months. Net exports of diesel more than doubled during 2015–16. China is slowly beginning to open up its domestic oil industry to private participants and this reform is likely to see more financial discipline and corresponding upstream cost reductions.