Jeff Rubin: Who’s in the driver’s seat?
By Jeff Rubin, Special to the GazetteJune 11, 2012
Vehicles are stuck in a traffic jam along a major thoroughfare in the central business district of Beijing. Change in world oil consumption isn’t coming – it’s already here. Photograph by: Claro Cortes , reuters file photo
Persuading North Americans that their oil-guzzling days are over is a hard sell – but that doesn’t change the facts. The old economic order is shifting, notes economist Jeff Rubin, author of The End of Growth. Here is an excerpt from Chapter 7, Zero-Sum World:
Why China can afford triple-digit oil prices while America can't
Most fans of business television are familiar with Squawk Box, a daily morning show on CNBC that runs prior to the New York Stock Exchange’s opening bell. The hosts talk fast and a bit too loudly, I suppose to mimic the energy of a trading floor. It’s not a bad program, if you’re into that kind of stuff. Back in 2007, I’d just released a research report at CIBC World Markets predicting that nearly all of the future growth in world oil consumption would occur outside the United States and other OECD markets. A CNBC producer called wondering if I would talk about the report on his show. I was happy to oblige since I would already be in New York speaking to clients.
The producers set me up in a camera-crammed studio above the floor of the exchange. Right out of the gate, I could tell that the interviewer had already written off the report. Did I really believe, he asked, that starving peasants in China would be filling up their gas tanks while motorists in Manhattan wouldn’t be able to afford to drive? I tried to manage the tone of my response, attempting to counter his sarcasm with what I hoped was a more thoughtful note (though a matching touch of derision may have snuck into my answer). The upshot was, yes, absolutely, the numbers show that’s exactly what will happen, I said. I couldn’t help but point out, moreover, that not everyone in China was starving, and certainly not the folks that I expected to be buying cars. But the interviewer, and probably most of the audience, wasn’t buying what I had to say.
Persuading North Americans that their oil-guzzling days are over while people with a fraction of their average national income will be filling up at the pumps was a hard sell back then. And despite recent demand numbers that tell the same story, it still is. But to close your eyes and hope the world stays the same is really just sticking your head in the sand. Change in world oil consumption isn’t coming – it’s already here.
Growth in oil demand is heavily skewed toward emerging-market economies and away from advanced industrialized countries. Consumption in China and India is increasing at roughly 10 percent a year. In 2010, China added almost a million barrels to its daily oil intake. And it doesn’t seem to matter what’s going on in the rest of the global economy, those countries are only getting thirstier for oil. During the last recession, for instance, nearly all of the demand destruction that occurred for oil happened in OECD countries, such as the United States and Europe. Just prior to the recession, in the winter of 2007, OECD oil demand reached 50 million barrels a day. At the bottom of the recession in the spring of 2009, that consumption had fallen to 45 million barrels. On a peak-to-trough basis, the OECD shed 5 million barrels a day in oil demand. In contrast, oil consumption in China and other emerging-market economies barely dipped over the same period. Since the economic recovery took hold, oil-demand growth in China has resumed at its prerecessionary pace of around 10 percent a year. OECD countries, meanwhile, continue to see consumption flatline or even decline.
The numbers show that oil demand in emerging markets is far less sensitive to triple-digit oil prices than demand in more traditional oil markets. When energy analysts, who are still in a US-centric mindset, attempt to explain why higher prices aren’t affecting demand the way their theoretical models suggest they should, the first reason they reach for is state subsidies. In the big picture of global oil demand, however, that’s a pat answer that falls well short of capturing what’s actually going on. In India, for example, the state’s total annual subsidies for gasoline and diesel amount to less than $10 billion a year. That’s not much more than American taxpayers used to shell out to fund corn-based ethanol production. Indeed, when it comes to subsidies, the definition is very much in the eye of the beholder.
In some countries, determining the shape of a fuel subsidy is straightforward: governments step in and regulate prices at the refinery, a classic form of subsidy that directly cuts fuel costs for citizens. In the United States, refineries are free to sell their products at market prices, but that doesn’t mean subsidies don’t exist elsewhere in the system. The United States has some of the lowest fuel taxes in the world. While most Americans wouldn’t consider low fuel taxes a hidden subsidy, low taxes mean cheaper fuel, which lets drivers burn more gasoline and diesel; the effect on consumption is the same. You don’t have to look any further than our bike-riding Danish friends in the last chapter for evidence of the relationship between taxes and consumption. High fuel taxes mean Europeans have been paying the equivalent of triple-digit prices for years. And their declining fuel consumption bears witness to how tax-driven pump prices can change transportation habits.
The biggest reason why fuel consumption in places such as China and India is so resilient in the face of triple-digit oil prices has little to do with subsidies and much more to do with what’s driving demand. Oil consumption in emerging-market economies is much more sensitive to income growth than to pump prices. Many auto purchasers are first-time drivers who have only recently made the jump from living off the land to earning a regular paycheck in a city like Beijing or Mumbai. Turn off the road from any of those new superhighways in China and you don’t have to travel far before the familiar trappings of the developed world fall away. Instead of seeing an Audi whiz by on a paved road, you’re more likely to pass an oxcart on a narrow dirt track leading to a village. That’s the world from which China will recruit its future drivers. If you’ve never owned a car before, changes in the price of gasoline aren’t going to determine how much fuel you will burn. If you can afford to trade in your bicycle for a new car, then it’s a safe bet your income has just gone up by leaps and bounds.
In China and India, incomes are growing several times faster than in North America, western Europe or Japan. Static income growth in OECD countries means that higher gas prices have a meaningful impact on household budgets. Spending more money on fuel means there’s less money to spend on everything else. When incomes are rising as quickly as they are in China and India, then on a relative basis everything is much more affordable. The faster your income grows, the cheaper cars become, and the more you have the wherewithal to fill up your tank at whatever the world oil price happens to be.
If incomes were still growing in OECD markets at the same pace they are in China and India, vehicles would be flying off car lots in those countries as well. But they’re not, and they’re not likely to anytime soon. Give North American households, which typically own several vehicles, the kind of income growth that’s happening in emerging markets and the extra money would buy a yacht, not another car. In China and India, a brand-new car isn’t replacing an older vehicle with too many miles on the odometer; it’s taking the place of walking or riding a bicycle. For people who were living as peasants less than a generation ago, earning a regular wage is a transformative development in the way life is lived.
The use of oil-fired power generation also separates emerging economies from most developed nations. With the notable exception of post-Fukushima Japan, few OECD countries generate a significant amount of electricity using oil. In North America, coal, natural gas and hydroelectric do the heavy lifting for the electrical grid. In China and India, power generation can still consume a significant amount of oil. China’s fleet of coal-fired power plants handles most of the country’s electricity needs, but when coal supplies get interrupted, the country falls back on its network of diesel-fueled power stations to make up the shortfall. That’s exactly what happened when floods hit Australia a few years ago, shutting down most of the country’s coal exports to China.
Fundamental differences exist in oil consumption trends between the developing world and OECD countries. The OECD is becoming the junior market for oil, a situation that becomes more apparent with each passing year. Oil consumption in those countries peaked right around the time oil prices first hit $70 to $80 a barrel. In the United States, the quintessential car-loving nation, oil consumption has dropped more than 10 percent, about 2 million barrels a day, from its prerecession peak. The US economy is still the world’s fuel hog, gobbling up around 19 million barrels a day, but consumption is clearly heading lower. After the next recession, the US economy’s daily oil intake could drop as low as 15 million barrels a day. Over time, it will drop even more. Indeed, in a zero-sum world, such a decline is actually inevitable if economic growth in China and India is to continue. That’s the picture I was trying to paint for CNBC’s audience a few years ago. Today, that landscape is much easier to see.
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Oil Rout Has China Hoarding Most Since Olympics: Energy Markets
By Bloomberg News - Jun 14, 2012 4:00 PM PT
China is hoarding crude at the fastest rate since the Beijing Olympics four years ago as the slump in international prices prompts it to import unprecedented volumes even as refining slows.
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