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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
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
