Reading the tea leaves: China and commodities in 2020
China’s voracious demand for commodities and energy continued unabated in 2019 despite a slowing economy and uncertain external environment.
But what will be on the agenda in 2020 as the economy, environment and energy security come into greater focus? Here are are some key trends to watch over the coming year and what they mean for commodities.
The recent signing of the first phase of a trade deal between China and the US may herald a truce between the world’s two largest economies and give markets something to cheer but it will do little to address fundamental structural issues in the Chinese economy, which slowed to 6% growth in the third quarter.
A few clues as to what to expect in 2020 can be glimpsed from December’s Central Economic Work Conference, a high-level meeting that set the economic tone for the coming year. Don’t expect a wide-ranging stimulus to boost growth in the short term. Instead expect a focus on financial stability and longer-term economic priorities like restructuring.
Official GDP targets won’t be announced until March but many analysts expect the government to target growth of around 6% in 2020. S&P Global economists expect it to come in lower at 5.7%. But if growth starts to look weaker, approaching 5.5%, expect to see the government step in with targeted stimulus for sectors like infrastructure to maintain economic momentum.
While a managed slowdown sounds benign, slower growth and tighter credit, especially if accompanied by continuing industrial deflation, raises the risk that more private companies will come under financial pressure. Last year a number of private companies in Shandong province struggled to repay short-term debts, making it harder for them to continue to access the loans they need to keep operating.
The situation is further complicated by the complex web of financial guarantees that exists between many private companies; a default at one company may result in financial distress at another which is partly liable for their creditworthiness. The situation is most acute in commodity industries plagued by overcapacity like petrochemicals, steel and aluminum.
The most recent economic data from late 2019 indicates a slight rebound in manufacturing and industrial production, which suggests a more positive outlook. But look out for weakening margins which might herald further financial distress in the private sector.
Rising crude oil imports, oil product exports
There will seemingly be no letup in China’s insatiable demand for crude oil, as the new Hengli and Zhejiang petrochemical refineries ramp up throughput and Sinopec’s new Zhongke refinery in Guangdong comes online. But product demand is changing as factors like the switch to low sulfur marine fuels, weakness in the auto sector and economic transition herald a shift in consumption patterns.
China’s desire to increase domestic supply of IMO-compliant bunker fuels should spur demand for gasoil as low sulfur marine fuel blendstock. Petrochemical output should also rise with a number of new propane dehydrogenation plants driving demand for LPG imports. Gasoline is expected to be weaker as a decline in new auto sales and increasing fuel efficiency across the auto sector heralds a slowdown in demand growth.
The increase in refining capacity could put pressure on China’s independent refineries, with exports the only release valve for an oversupplied domestic market. So far refineries owned by national oil companies (NOCs) have been the only recipients of government-sanctioned product export quotas, though selected large independent refineries are expected to be granted quotas later this year. S&P Global Platts Analytics forecasts China’s gross exports of oil products (gasoline, jet fuel, diesel plus LPG and fuel oil) to grow by a little over 270,000 barrels per day in 2020, a 40% rise on last year’s increase.
Domestic shale gas, imported LNG
China’s rapidly growing reliance on imported oil and gas has prompted a drive by China’s upstream companies to increase domestic production. While Chinese NOCs have managed to reverse the decline in oil production, upstream efforts have been most successful in natural gas where output has risen by 8% a year over the last three years. Much of the increase has come from unconventional production, especially from the shale deposits in and around southwest China’s Sichuan province.
Sinopec’s EDRI, a research institute, estimates that shale gas production could reach 20–22 Bcm this year, a significant rise on estimated 2019 shale production of around 15 Bcm. Although total volumes are still very modest at 8% of total output last year, the rapid sustained rise in shale gas production does demonstrate sustained progress in drilling for shale gas in China’s geologically complex deep reservoirs.
China’s other big strategic initiative to reduce its dependence on seaborne imports has been the opening of the Power of Siberia pipeline, which by the time it has fully ramps up in 2025 will supply 38 Bcm of Russian gas to China. But with PetroChina only expecting total volume of 5 Bcm this year, for the moment there’s still plenty of room for LNG imports. According to Sinopec’s EDRI, imported LNG could account for for 27% of China’s total gas consumption in 2020, equivalent to 90 Bcm.
Ray of light for auto sector?
After nearly 18 months of continuous year-on-year declines, the latest data suggests that sales of internal combustion engine passenger vehicles have returned to growth, and it’s likely that ICE passenger sales will stabilize this year. There is talk of the government offering subsidies to rural buyers but last year’s wide-ranging tax cuts to stimulate domestic demand have left government finances under pressure and any subsidy may be less generous than hoped for.
The outlook looks less rosy for battery electric and plug-in hybrid vehicles. The most recent statistics suggests that the rate of decline of electric vehicles sales has turned a corner, but sales are still down 25% in December year-on-year, after last year’s sharp reduction in government subsidies.
In an effort to steady sentiment in the EV market the government recently announced that it will not significantly cut subsidies further this year. But this may only give a few months reprieve, as the government has stated that it will remove all buyer subsidies on electric and fuel cell cars by the end of 2020. Wait to see whether the government extends this deadline if sales continue to be poor throughout the year.
Subsidies have not only supported sales of EVS but also helped China gain a position of global leadership in the electric vehicle value chain from raw materials through to batteries. In other technologies, like fuel cells, China remains a relative laggard. At the end of 2018 China was home to just 14% of the global stock of fuel cell vehicles (FCV), well behind Japan with 23% and the US with 46%.
Sales of FCVs in China surged over 1,400% year on year in the first 11 months of 2019 to more than 2,100 vehicles, but that’s still miniscule compared to the more than 1 million battery electric and plug-in hybrid vehicles sold over the same period. Expect to see a lot more talk about hydrogen in 2020, with a focus on building out charging infrastructure. But it will likely be closer to the end of the decade before we see significant numbers of fuel cells vehicles on China’s roads. For the moment the focus will be on electric vehicles, especially in the passenger car segment.
The “dual credit mandate”, a cap-and-trade scheme which compels manufactures to produce a target number of electric and fuel cell vehicles or face financial sanctions, should over the next few years incentivize the production of a whole range of electric cars at a price that is competitive with ICE vehicles.
Platts Analytics forecast that this will rise fivefold from last year so that by 2025 annual sales of electric vehicles will be around 5 million units. But right now it’s all too easy for car makers to meet the targets set by the mandate. Until the targets get tougher in the next few years, ratcheting up the pressure on manufactures to produce EVs that in the eyes of consumers are as good as ICE vehicles, sales are likely to remain in the doldrums.
On the margins the government can support EV demand through mandating procurement of electric vehicles for government and public transport, but for the moment the years of double-digit EV sales growth are over. If we see any growth at all in 2020 it’s likely to be very modest.
China ETS no game changer for climate change
After several years of careful planning, China’s national carbon emissions trading scheme (ETS) is expected to finally start trading in 2020. Initially the cap-and-trade scheme will only cover the power-generation sector, which accounts for a third of China’s total carbon emissions. But such is the size of China’s carbon footprint, the ETS will still be the largest carbon market in the world in terms of total emissions covered.
The 2015 Paris Agreement on Climate Change saw China commit to ensuring that its carbon dioxide emissions would peak no later than 2030, as well as pledging to reduce its carbon emissions per unit of GDP by as much as 65% compared to 2005 levels.
While the ETS undoubtedly sends a signal to markets that China wants to get a handle on its carbon emissions it’s unclear whether it will have much impact in helping China meet its Paris Accord commitments. Platts Analytics expects that even without the introduction of the ETS China’s emissions would be likely to peak by the mid-2020s as the use of renewables grows and the economy moves away from energy-intensive drivers of economic growth.
It’s possible the ETS may help reduce emissions in the power sector by incentivizing the use of more efficient capacity at the expense of plants with higher carbon emissions, but until there is greater clarity from the government on details like baseline emission allowances and how these will change in the future, it will be difficult to assess the impact the ETS will have in shaping China’s low carbon future.