# Why is Asian Oil Demand Declining?



## MARKETWAVES (20 July 2005)

*Why is Asian Oil Demand Declining?*

Summary and Investment Conclusion

Recent data point to continued weakness in Asia's oil demand. This is 
such a contrast to the opinions in the oil market, which attribute 
the current high prices to strong Asian demand. Instead, in my view, 
speculative demand is the reason for the high prices. The speculative 
demand could be equivalent to half of China's demand, I believe.

Asian economies are decelerating. China has just begun to decelerate. 
At some point, the oil market will abandon the fiction of endless 
Asian or Chinese demand. As we have learned from the past bubbles, 
when the expectation turns, oil prices are likely to collapse.

Asian Oil Demand is Rapidly Declining

Asian oil demand continues to decline. China reported that its crude 
imports dropped by 1.3% and refined products by 21% in June from last 
year. For the first half of 2005, China's crude imports rose by 3.9% 
compared to a 34.8% increase in 2004, and refined product imports 
dropped by 21.1% compared to a 34.1% increase in 2004. In contrast, 
China's coal imports rose by 58% in the first half of 2005.

Korea's oil imports are also declining. The value data on oil imports 
in Jan-May 05 showed a 3.6% decrease in volume from last year, if 
adjusted by the Dubai crude price, and 7.6% decline in volume, if 
adjusted by the Brent price.

From Taiwan's reported value data on crude imports for Jan-June 05, 
we could deduct a 1.8% increase in volume from last year, if adjusted 
by the Dubai price, and 2.3% decline, if adjusted by Brent price.

Thailand's volume data showed that its crude imports declined by 0.7% 
in Jan-May 2005 from last year.

From India's import data on crude and refined products for 1Q05, we 
could calculate that its import volume increased by 2.5%, if adjusted 
by the Dubai price, and declined by 4%, if adjusted by the Brent 
price, from last year.

The above economies accounted for 16% of global consumption and 44% 
of the increase in global consumption last year. But the demand 
picture in 2005 is clearly negative. The evidence is in sharp 
contrast to the chat in the oil market on surging Chinese or Asian 
demand.

Why is Asian Oil Demand Declining?

First, high oil prices have depressed the oil-intensive Asian 
economies. Korea, Taiwan, and Thailand stand out in that regard. 
Thailand is 3.3 times as dependent on oil as the US, Korea 1.8 times, 
and Taiwan 1.6 times. This is why these economies are slowing under 
the burden of skyrocketing oil prices.

The story in the oil market is that these countries' governments are 
subsidizing prices to keep the consumption prices low. There are two 
aspects to this. First, a high share of oil consumption is for 
industrial production. There are little government subsidies there. 
Second, the prices are rising for final consumers too. The bills for 
absorbing the price increase are too high for governments. Developing 
Asia consumes 17.3 million barrels per day. With prices up by 
US$25/barrel, to absorb the cost, the subsidy would be US$158 billion 
per annum, equivalent to nearly 4% of the region's GDP and one-fifth 
of the fiscal revenue of the region. It is quite absurd to believe 
that these governments could absorb such high costs.

Second, the substitution effect is working as oil becomes more 
expensive relative to other sources of energy. Chinese data give an 
unmistakable picture that the demand for diesel for generating 
electricity has eased due to the rapid increase in coal-fired power 
plants. *China is essentially substituting oil with coal*. The high 
coal prices have caused frenzy in coal production.  The rapid 
production has kept a lid on coal prices. It is another example how 
fast China's supply response is. The coal prices are not as high as I 
expected (see `Coal vs. Oil', January 17, 2005). Thus, the incentive 
for substituting oil with coal is even more powerful.

The substitution effect is working in Japan also. Its petroleum 
imports dropped by 2.1% but LNG imports rose by 7.1% in volume 
between Jan-May 05 from last year.

China's economy is just beginning to slow down due to overcapacity 
and the unwinding of property speculation. Thus, China's demand is in 
my view likely to decline in 2006 also.

The slowdown of other Asian economies is also continuing. Indeed, 
recession among some oil-dependent economies is a possibility in the 
second half of 2005. Hence, the overall demand picture for oil is, I 
believe, very negative for the months ahead.

Oil Prices Could Collapse Soon

Oil is a speculative bubble. I have never seen people buying 
something on what I believe is so much misinformation. While oil 
traders debate if China's demand is growing at 5% or 8%, their demand 
could be equal to half of China's.

The new twist is supply constraint. When a conservative won the 
presidential election in Iran, it was another excuse to push up 
prices. The Yukos affair is another talked-about story. However, it 
is not clear that all these supply side stories amount to meaningful 
production reduction. By most accounts, oil production is still 
rising, but Asian demand, which accounted for 44% of the demand 
growth last year, is falling.

The real story, I believe, is that financial institutions have hired 
so many oil traders in recent years and the money is still available 
for punting. This is just another speculative bubble on the credulity 
of the participants (with other people's money, of course) and the 
availability of cheap money.

Oil bubbles do not last, because they depress economies and, hence, 
demand. Other bubbles (e.g., technology or property) tend to increase 
demand initially. This is why I believe that the days for the oil 
bubble are numbered. As the weak economic and oil demand data pour in 
from Asia, some speculators could run, which could, in my view, 
trigger a stampede.

Morgan Stanley


----------



## DTM (20 July 2005)

G'day Market.  I noticed those figures myself last week and made some enquiries.



			
				DTM said:
			
		

> Just out of interest, I read on the NY times that China had less oil imported than last year (???).  Sorry, saw the article this morning and I can't find it now.




Some very good discussion on it here.

https://www.aussiestockforums.com/forums/showthread.php?t=1154&page=2&pp=10


----------



## wayneL (20 July 2005)

Have you joined the nightshift Danno?


----------



## excalibur (20 July 2005)

MARKETWAVES said:
			
		

> *Why is Asian Oil Demand Declining?*
> 
> Summary and Investment Conclusion
> 
> ...





Hi Market,

Doesn`t this contradict your past report about Coal?
See following link:

https://www.aussiestockforums.com/forums/showthread.php?t=1295


Report from May 9 2005


----------



## DTM (20 July 2005)

wayneL said:
			
		

> Have you joined the nightshift Danno?




G'day Wayne

I was just making a bottle for my 2 year old and I decided to check the markets, then had to check asf.  Bit of a junkie really..., as to joining the nightshift, maybe one day.   

There's some nice trending movements there in the US.


----------



## mime (20 July 2005)

I saw a report on the news that said consumption in Asia has risen. I don't know what to think. However what's the definition of bubble? Oil in the past year I think has gone up around maybe $20 a barrel. That's maybe 50%. That's a fair rise but I don't know about a bubble. I'm still going to hold me energy stocks regardless of what the artical says.


----------



## Smurf1976 (20 July 2005)

WARNING - this is about the longer term fundamentals of the Chinese situation with diesel and yes, it's a somewhat technical (engineering) post. Just skip to the end if you only want the summary.   

Electricity generation is always key in any discussion of fuel markets for two reasons.

1. It is by far the largest single fuel using industry unless the supply is overwhelmingly hydro-electric or nuclear. 

2. It is unique in that ANY commercial energy source can be used to generate electricity and indeed many energy sources can ONLY be used for this purpose. By contrast, coal-fired aeroplanes or running computers directly on wood has a few problems...

From a resource perspective, oil and natural gas are relatively scarce and in very high demand for transport fuels, fertiliser production, plastics etc. A point which few seem aware of is that for both oil and gas the peak rate of discovery was some decades ago with oil discovery rates now a mere fraction of demand and gas heading the same way. If this continues then there is only one possible outcome and it isn't pleasant...

By contrast, coal represents most of the world's stored conventional fossil fuel energy. Also, nuclear energy is normally useful only for electricity generation and of course hydro, wind etc. are the same in this regard.

With oil prices having greatly increased, oil is no longer an economic means of electricity generation. The marginal operating cost of oil-fired steam turbine power stations is around 8 times that of coal and 4 times that of gas in Australia. Overseas it's much the same and diesel is far more expensive with marginal costs using untaxed fuel in the order of 12 times that of centralised coal-fired generation.

It therefore comes as no surprise to find that China's temporary diesel generators are being phased out as more grid electricity, mostly from coal, becomes available. The commissioning of new hydro-electric and nuclear generation will add to this trend.

Is this a direct response to the oil price? NO. Coal-fired plants have long lead times (around 3 years even if all the approvals stuff is ignored and it's built as quickly as possible) and China has basically been planning and/or building such plants flat out for quite some time. They would be coming online now even if oil were $10 a barrel although the high oil price obviously does add to the incentive to keep on building.

In any power grid there is what's known as the generation merit order. Since electricity is not stored but is generated on demand and demand is always changing, some generating capacity will be idle except at times of maximum demand. 

Go to the "Real time 5min price & demand graphs" at www.nemmco.com.au if you want to see how demand has varied over the past 24 hours in your state. "SN" is not a state but refers to the pumps that make the Snowy scheme work - the electricity industry treats this as a separate state due to the way it interracts with the rest of the grid. The green line is the demand, red line is the market spot price. (The very high price in Tasmania is a consequence of the drought there). The graph should be up to the minute but note the scale - demand in megawatts on the right hand side, Regional Reference Price (RRP) on the left. The bottom of the graph is not zero!

Under normal circumstances, power plants with the lowest cost will run flat out 24-hours a day except when shut down for maintenance. As demand rises throughout the day, progressively higher cost plant is brought online to meet that demand. Note that we are talking about MARGINAL (mostly fuel) costs here rather than total costs including capital. The exceptions are wind, solar etc. which obviously run only when the resource is available and tend to have near-zero marginal cost and hydro generation where it's position on the merit order varies according to water availability. 

Now, what all this means is basically this. China's new coal-fired plants will run flat out 24 hours a day unless there is no need for the power produced. Diesel generation is therefore being progressively shifted from constant use towards the peak demand periods whilst even there the scale is reducing. This is dramatically reducing diesel fuel use and as such *future coal-fired plants will have progressively less effect on reducing Chinese diesel fuel use*.

The future role of diesel in China thus becomes one of meeting peak loads largely via centralised generation plants rather than small plants out the back of factories. This is exactly the same manner in which most Australian gas and diesel-fired power stations connected to the main grid operate. The largest examples include Newport (visible from Melbourne CBD), part of the capacity at Torrens Island (Adelaide area, the plant also runs at reduced capacity at other times since it's by far the largest power station in SA) and Kwinana (WA, near Perth). Smaller examples are the gas turbines (kerosene fuelled) in the Hunter Valley (NSW), Snuggery (SA) and numerous oil product fuelled gas turbines in Queensland. 

The merit order is typically as follows. Low grade coal (brown coal), high grade coal (black coal), efficient gas-fired plants, old gas-fired plants, oil-fired. Hydro, wind etc. fit in as available with hydro typically sitting between black coal and gas.  

Bottom line - The diesel use reductions are permanent but the scope to reduce demand is limited and will be fully exploited in due course. We still need oil for vehicles etc. no matter what the price does.


----------



## DTM (20 July 2005)

Good post Smurf.    

Question.  Is the Yangtze river hydro-dam up and running yet?  Does it have any effect in reducing need for diesel fuel generators during peak hour?


----------



## mime (20 July 2005)

I skimmed over the artical but didn't it say oil is being replaced with coal??


----------

