China continues to industrialise and urbanise at an unearthly pace. Fixed asset investment (roads, bridges, dams, airports, and real estate) in China correlates nearly perfectly with growth in steel consumption (as the chart below from ABARE shows). China’s rapidly urbanising economy is in its most metals intensive phase. But can it survive higher oil prices?
Better yet, is oil going to break the back of the global economy? Let’s think about that for a moment. Can the world keep growing this fast if energy prices keep going up?
The villain du jour in stock markets is the credit crisis. But it could be the oil price that derails China’s industrial economy, and in turn knocks Australia’s resource economy (and its sharemarket) back a few paces. It could even be that the oil price is already causing social turmoil.
For example, it looks like the rising oil price is indirectly behind the protests in Burma. “In Asia, hiking fuel prices can be a perilous political move. The recent protests in Burma that were later brutally repressed began in August, after diesel prices doubled overnight. Commuters unable to pay higher bus fares had to walk to work, and their plight became a lightning rod for dissent,” reports Simon Montlake in the Christian Science Monitor.
Fuel subsidies are widespread in Asia. That means rising oil prices haven’t yet been passed on to the retail user. It also brings us to an interesting conclusion: Asian economies may be far more sensitive to higher oil prices than Western economies.
Yes, we know this is a shocking and fascinating observation for a Monday. But bear with us. Western economies have proven resilient to higher oil prices for a trio of reasons. First, since the first oil shock in the 1970s, Western economies have diversified their source of energy. Oil is important, but primarily as transportation fuel.
Then there is production. With China’s emergence as the world’s workshop, the West has used less oil for industrial purposes. You have fewer factories, you use less oil. More Wal-Marts, fewer steel mills (although it would be interesting to see what the oil footprint of a Wal-Mart superstore actually is). We know the decline in production has generally been bad news for Western labour markets and wages, but it has made those economies less susceptible to oil shocks.
The third reason that the West has absorbed higher oil prices (so far) without a major economic hiccup is that oil use is concentrated at the consumer level. At the consumer level, you can modify your behaviour in response to higher prices. Most Americans can afford to drive less if they have to, or even take public transportation. That does not appear to be the case in Burma. Why does this matter?
China can’t simply stop producing stuff as a response to higher oil prices. In other words, China can’t readily modify its economic behaviour to cope with higher oil prices. That matters.
China’s macro-economic growth engine is export driven. That means it is production driven. Factory production requires energy and, for China, that means oil (and a lot of sooty black coal). China’s economy is heavily dependent on oil, and thus vulnerable to a crude oil shock. And don’t expect that to change any time soon.
The industrialising world is going to need increasing amounts of oil to keep industrialising. This is why Industrial Revolutions, as my colleague Byron King once said, can also be described as Energy Revolutions. The Energy Information Administration (the statistical arm of the US Department of Energy) reports that, “Industrial sector energy consumption is projected to increase by 2.5 percent per year in the non-OECD countries between 2004 and 2030.”
You wonder if there’s really enough crude oil in the world for China and India to enjoy the same per-capita living standards enjoyed in the already-industrialised West. They will need more energy for industry.
The EIA reports that, “The non-OECD economies generally have higher industrial sector energy consumption relative to GDP than do the OECD countries. On average, the ratio is almost 40 percent higher in the non-OECD countries.”
A proper oil shock shocks China most, and will continue to do so as long as China and Asian economies are overly dependent on production and exports for economic growth.
Add the oil story and the BHP/Rio drama and what do you get?
It all feels a little toppy, to be honest. This would go with our intuition that oil prices are on the verge of destroying demand and limiting growth. It’s the way high prices do their work.
Markets and Money