"There is no way demand will drop in China until the RMB weakens or the government throws in the towel on subsidies."
China situation is quite interesting. The supply is artificially restricted because of the price control. So if China remove the subsidies gradually, consumption actually will raise until demand destruction start to kick in.. But note that right now, they have to wait for diesel in line for 8-10 hours to get a truck 2/3 fill. So demand is really strong at the current price.. We may have a good 9 month to a year if and when China decide to remove the subsidies graduately. And I think diesel is the thing to watch instead of oil price. Refinary crack has moved up almost linearly for the last 5 weeks or so and it seems diesel is the one that leading the chaarge.
investorvillage.com
China news
This was posted by KevenKT on the RNO board. I deleted most of the non-energy material.
China Commodities Weekly for the Week of May 26-30, 2008
Na Liu, MBA, CFA - 416-945-4235 na_liu@scotiacapital.com
¦ Last week China’s base metals markets were down, while steel markets remained strong. Iron ore prices stabilized after the recent retreat. Grain prices were flat, while fertilizer markets rallied again, led by DAP and urea. Anything containing “Btu” was up over the past two weeks, including oil products, coal, coke, and methanol.
¦ In this note, we explain why, despite the recent pullback of crude oil prices, we are sticking with our major investment theme over the past eight months; that is, “All about Btu”. We examine China’s “Btu markets” (i.e., oil products, coal, urea, and methanol markets), which are all getting increasingly tight going into the summer. We also explain our views on the sustainability and impact of China’s oil subsidy, which is apparently a hot topic.
¦ Also discussed in this note are the recent developments for China’s fertilizer, nickel, and aluminum markets.
Strategy – Still “All About Btu”
¦ Since last November, we have been promoting two major investment themes: first, “Bullish for 1H/08; Cautious for 2H/08”; and second, “All about Btu”. Luckily, both themes played out well in the first five months of this year. Although we maintain our “overweight” recommendation for the global raw materials sectors from a China perspective for the time being, over the next couple of months it is very likely that we will change our recommendation to “market weight” from “overweight,” in line with our first theme. We have explained the reason in our May 5 Weekly under the section called “Time to Think Beyond the Spring Revival.” For us, the remaining issue is market timing to make the change.
¦ On our second theme, however, we are very likely to maintain our preference for major commodities that contain “Btu,” such as crude oil, thermal coal, coking coal, methanol, and urea, even in the second half of 2008, when we will take a more cautious view for the overall raw materials sectors. Interestingly, the Chinese government seems to have exactly the same concerns as we do – that is, the lack of “Btu” for the country.
¦ Last Wednesday, China’s Premier, Wen Jiabao, called for an increase in coal production and transportation to ward off power shortages in the peak summer season, and for oil firms to ensure fuel supplies. The government is also concerned about output and prices of chemical fertilizers according to the minutes of a cabinet meeting chaired by Wen. “In some areas supplies of thermal coal, power and diesel are still tight, and pressure on stable prices of fertilizer and other agricultural products is rising,” the minutes said.
¦ The cabinet meeting urged oil firms to bring new refineries on line as soon as possible, and to make sure farmers had fuel for summer agricultural work and harvesting. It said the government would step up price monitoring and cut back on power use by energy-intensive and polluting enterprises to ensure adequate supplies for civilians and pioneering clean firms.
¦ The government’s close attention to coal and oil products supply is well deserved. It is only some 70 days before the Summer Olympic Games now, and the coal and oil supply is actually getting tighter, not easier, even after the restocking efforts in 1H/08.
Oil Products Shortage Worsening
¦ Last week, petrol stations in at least three major Chinese cities – Beijing, Shanghai, and Guangzhou – began to ration diesel, causing long queues of trucks. This is in addition to at least seven provinces in which some petrol stations ran out of stock before the day ended.
¦ Alarmingly, the latest bout of shortages come at a time of record high diesel and gasoline imports and the commissioning of a new refinery by Sinopec, suggesting that major oil firms may not be wilfully withholding supplies from the market.
¦ “Normally we have to start queuing at seven or eight in the morning. If you are lucky you get your fill by five or six in the afternoon but only 500 to 1,000 yuan worth,” said a driver in Ningbo, a container tanker hub and also site of the country’s largest oil refinery. That equates to about 100-200 litres of diesel. A regular five-tonne truck needs 300 litres for a full tank.
¦ In response to the shortage, Sinopec said last Wednesday it was halting gasoline and diesel exports to ensure supply for the domestic market and to rebuild demand after the devastating earthquake. In addition, Sinopec’s new 200,000 barrel per day (bpd) refinery in the eastern port of Qingdao should be running at about 120,000 bpd from June through the third quarter. (The new refining capacity addition should increase China’s crude oil demand in 2H/08.)
¦ In the near term, we expect China’s diesel shortage to persist on the back of tight domestic supply caused by earthquake reconstruction work and the upcoming driving season and wheat harvest season. In early May, China’s Ministry of Agriculture announced that 335,000 harvesting machines will take part in the rice and wheat harvest. Adding to the pressure, hundreds of heavy trucks and trailers are participating in the relief efforts in Sichuan Province.
Coal Shortage Might Prompt More Export Control
¦ China’s coal shortage continues to manifest itself as the weather warms up into the summer. Some 6.82 gigawatts of coal-fired power capacity (or 0.95% of total installed capacity) had been shut down as a result of coal shortages, the State Electricity Regulatory Commission (SERC) said last Tuesday. In the meantime, coal prices in China continued to climb to new highs for the third consecutive weeks.
¦ To mitigate the emerging domestic shortage, a senior official at the National Development and Reform Commission (NDRC) said last week that although he did not expect any major disruption in the supply of coal, China would curb coal exports. “At the current stage, we should focus on guaranteeing the domestic demand, and we don’t encourage large-scale export of coal,” said Mu Hong, deputy director of the NDRC.
¦ In our opinion, China should act as quickly as possible to further curb coal exports and increase domestic output, as imports are becoming increasingly unreliable. As Indonesia talks about preserving coal resources for its own use, and Australia continues to face logistical problems, Vietnam is adding to the supply constraints in Asia as it may ban border trade of the fuel into China, cutting off southern China’s last sources of the low-priced hydrocarbon.
¦ Vinacomin, Vietnam’s largest coal producer, and local authorities from Quang Ninh province told local media the government would stop exports of coal via border trade to China beginning June 1 at Van Gia port in the town of Mong Cai. Last week, the Saigon Times Weekly reported that the government had decided as of June that businesses must stop exporting coal through small-scale border trade.
¦ If Vietnam suspends coal border trade, the market in southern China will become even tighter and prices could go up further, in our opinion. It was not clear to us how much coal arrives in China via border trade or the port of Van Gia. Yet in addition to official border trade, we understand that low-priced Vietnamese anthracite is often smuggled into China in trucks across the border with the Guangxi region.
¦ One of the solutions to the emerging coal shortage is to reopen small coal mines that were shut down over the past two years due to safety concerns. In fact, both the State Council and the NDRC were talking about this last week. In the past three years, some 11,000 small coal mines were shut down due to safety concerns. The NDRC said that safety inspections on smaller coal mines will be quickly carried out to enable qualification for operation during the summer season.
¦ In our opinion, however, this solution might not be as easy as it seems, as many local governments have become increasingly concerned about coal mine safety. Fearing another string of fatal disasters like those in years past as well as having such an incident occur during the upcoming Olympic Games, local governors may not give the green light to many mines to resume production.
Impacts on Other Commodities
¦ The shortage of oil and coal in China has profound impacts on a wide range of commodities. Here, we briefly mention three of them:
¦ Methanol: China’s oil products shortage usually leads to higher blending demands for methanol. This happened in October and November last year, and is happening again. The methanol price at Chinese ports has rallied to over US$580/tonne last week (a record high) from US$350/tonne in early March.
¦ Urea: As we will discuss in the “Fertilizer” section of this report, some of our local contacts estimate the coal cost for mainstream urea producers has increased 100% compared with year-ago levels. We estimate that over 65% of China’s urea output is coal-based.
¦ Aluminum: If an electricity shortage emerges in the summer, power supply is usually cut to aluminum producers first. As we will discuss in the “News in Brief” section, the Chinese government has already begun to think about another hike of aluminum export tariffs to curb the export of energy via aluminum.
Oil – The Sustainability and Impacts of Subsidies
¦ Over the past week, there was a lot of talk in the press about subsidies in Asian countries keeping demand destruction at bay, whereas in the United States and Europe demand destruction caused by higher prices is already underway. After a host of small Asian consumers like Indonesia, Taiwan, and Sri Lanka sharply raised subsidized domestic fuel prices, two legitimate questions were raised. First, can China afford to continue to subsidize oil products prices? And second, if China does hike oil products prices, what kind of “demand destruction” can we expect?
¦ On the first question, our answer is that China can afford to continue to subsidize oil products, even if crude oil prices remain at around US$130/barrel for the rest of the year. China is expected to consume 7.9 million bpd of oil products this year. Some of the products, such as naphtha and fuel oil, are not subsidized. Only diesel and gasoline are subject to regulated prices in China. In 2008, China is expected to consume 1.35 million bpd of gasoline and 2.83 million bpd of diesel. Compared with “normal international prices,” Chinese consumers are paying some US$90 billion less than they should.
¦ Among this US$90 billion, if the Chinese government continues to forgo fuel tax (note that a big chunk of the gasoline price at most countries’ pumps is fuel tax), and if refineries owned by PetroChina and Sinopec (the duopoly) continue to forgo their refining profits (as they have been), and if the duopoly continues to use some of its profits from its upstream oil production to offset some of its refining losses, China would probably need to hand out some US$30 billion-US$35 billion in subsidies to the duopoly to ensure it continues to supply the country with sufficient oil. This number is large in absolute terms, but it is still less than 1% of China’s GDP, and apparently much less than China’s foreign exchange reserve of US$1.7 trillion. And most of the US$30 billion-US$35 billion subsidy could be dealt with via VAT rebates for crude oil and oil products and the raising of the windfall tax threshold. For instance, China handed out a US$1 billion rebate to Sinopec Corp. in April as part of a deal to rebate much of the 17% value-added tax on imported crude. For PetroChina, the ideal case is a reset of the starting point of the windfall tax to US$60/barrel from the current US$40/barrel. Industry insiders said that such a reset would keep some US$5 billion-US$6 billion in revenue in the hands of the duopoly.
¦ China’s situation is in sharp contrast to some Asian economies. In India, at the current market price of crude, subsidies in 2008 could amount to over 1.5% of Indian GDP, and for Indonesia it could be well over 3.5%.
¦ On the second question, our answer is that if today China hiked oil products prices to international parity prices immediately, we do believe that China’s oil demand would be hurt severely. However, if China chose to hike oil products prices by only 15% at a time, the effects could be debatable or even counterintuitive. In fact, the initial result of such a modest hike could actually be a boost of apparent consumption of oil, as it will encourage refiners, through improved refining margins, to increase oil products supply to meet demand. We saw this counterintuitive effect many times over the past three years – each time oil products prices were hiked, crude runs increased, shortages eased, and apparent consumption grew.
Fertilizer
¦ Due to an acute shortage of coal and sharply higher coal prices, the urea market in China rebounded over the past two weeks after the small pullback triggered by the block of exports in place since late April. Some of our local contacts estimate the coal costs for mainstream urea producers have increased 100% compared with year-ago levels.
¦ In the meantime, the massive Sichuan earthquake has impacted some 4 million tonnes of phosphate rock capacity in the province. In addition, much of the shipping capacity in southwest China has been siphoned into the relief efforts for the earthquake, resulting in difficulties shipping phosphate rock out of the Yunnan and Guizhou provinces, China’s top two phosphate rock-producing regions. As a result, the DAP price continued to rally in China’s local markets. Mainstream ex-factory quotations remain at RMB4,000-RMB4,200/tonne, and we have begun to see some factory-raised quotations to as high as RMB4,500-RMB4,800/tonne.
¦ On potash, local markets seemed to stabilize at lofty levels. At the same time, the potash inventory began to be drawn down.
News in Brief
Coking Coal – Local Coke Price Hiked Again
¦ Chinese coke producers once again hiked coke prices due to soaring coking coal prices. Many producers in Shanxi, the top producing province, raised coke prices for June by RMB300/tonne (US$43/tonne).
Economy – PMI Falls from Record High
¦ China’s official purchasing managers’ index fell to 53.3 in May from the record high of 59.2 in April, the China Federation of Logistics and Purchasing said on Sunday. We are still examining the reasons for the sharp fall, other than normal seasonality.
Recap of Our Calls
¦ The sole purpose of our China strategy research is to answer one question: purely from a China perspective, should investors in the western world overweight, market-weight, or underweight the global raw materials sectors? To this question, effective August 16, 2007, our answer is “overweight” (upgraded from “market weight”).
¦ We are now bullish on the coking coal, iron ore, copper, zinc, aluminum, molybdenum, oil, methanol, DAP, urea, soybean, and hardwood pulp sectors. We are neutral on wheat, corn, potash, ethylene, steel, and nickel. We are cautious on paper products on a relative basis from a China perspective. |
