China's Debt Bubble and Demographic Stagnation Pose
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ISSUE BRIEF 08.13.20 China’s Debt Bubble and Demographic Stagnation Pose Major Risks to Global Oil Prices—and U.S. Shale Prospects Gabriel Collins, J.D., Baker Botts Fellow in Energy & Environmental Regulatory Affairs “The crisis takes a much longer time coming than you think, and then it happens much faster than you would have thought.” —Rudi Dornbusch1 China has become the global oil consumer global economy. Various analysts may of last resort—accounting for 63% of reasonably apply different weights to the global incremental liquids (i.e., “crude oil”) chicken-and-egg loop described above, demand growth in 2019.2 The oil markets but the virtually inescapable bottom-line now understandably focus on near-term conclusion remains: China’s rise has been pressure factors such as OPEC+ behavior indispensable in shaping the global oil and coronavirus-induced shutdowns.3 architecture and underpinning new capital But looking a few quarters further out, a flows and wealth creation, including in sustained slowdown in China’s oil demand Texas, where the author is based. growth is, from the risk perspective, a My calculations indicate that between lurking crocodile.4 If the croc bursts onto 2003 and 2014 (when oil prices first the riverbank, it could set in motion a crashed), China’s own oil demand grew complex chain of events that would likely by about 5.4 million barrels per day. But reset the global oil supply/demand picture, the combined oil demand growth in cost curve, and investment thesis in ways Africa, Central and South America, the deeply challenging to multiple oil exporters former Soviet Union, and the Middle East as well as U.S. unconventional liquids plays, (commodity exporting regions heavily Looking a few quarters even the Permian Basin. leveraged to Chinese growth) clocked in at further out, a sustained Three key ingredients made the U.S. 7.3 million barrels per day—134% of China’s slowdown in China’s oil 5 shale boom work: (1) cheap capital made own demand growth. demand growth is, from available through quantitative easing by From 2015 to 2019, the major commodity central banks around the world, (2) China exporters’ oil demand only rose by 32% the risk perspective, a adding several hundred thousand barrels of what China’s did, a far slower rate even lurking crocodile. per day or more of incremental crude/ adjusting for the shorter time frame. The liquids demand annually in most years core commodity exporting regions—led since 2004, and (3) U.S. oil patch ingenuity by the Middle East—saw a meaningful and entrepreneurial spirit. But factor #3 uptick in incremental oil demand growth in would never have blossomed without #2, 2019. Whether this is an outlier remains to and #1 would likely have been much less be seen. If, for instance, proposed cuts to possible without China’s need to recycle fuel subsidies are postponed as a result of its massive savings glut back into the the coronavirus pandemic, or conversely, RICE UNIVERSITY’S BAKER INSTITUTE FOR PUBLIC POLICY // ISSUE BRIEF // 08.13.20 during the shale boom period, China FIGURE 1 — CHINA HAS BECOME THE WORLD’S OIL CONSUMER accounted for a nearly identical 38% of OF LAST RESORT net global oil demand growth. 5 70 2. During the past 20 years, seven of the 60 10 highest annual oil demand increases 4 50 of any country were posted by China. 40 The U.S. accounted for the other three. 3 There is no country—or even group of 30 countries—that in the foreseeable future 20 2 could consistently generate sufficient oil 10 demand growth to offset a significant 1 0% slowdown in China’s oil consumption, -10 were that contingency to manifest itself. 0 -20 -30 -1 THE “DEBT THREAT” -40 China as % of Global Incremental Liquids Demand Incremental Change in Liquids Demand (’OOO Bpd) One of President Xi Jinping’s major policy -2 -50 -60 priorities has been to shift China’s economy from a model led by investment in fixed -3 -70 infrastructure, like buildings, bridges, roads, 1966 1968 1970 1972 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2010 2012 2014 2016 2018 2000 2002 2004 20062008 and the like, to a model that more heavily China liquids demand, year-over-year change Global incremental liquids demand, excluding China emphasizes domestic consumption. With the dramatic deterioration in U.S.-China ties China as % of total incremental global liquids demand over the past two to three years, China’s leadership is now doubling down on the SOURCE BP Statistical Yearbook 2020, Author’s Analysis domestic economy via a concept dubbed “dual circulation theory.”6 In a nutshell, dual accelerate with a change of leadership in circulation entails an economic architecture certain key regional countries, oil use could dominated by China’s domestic economy move significantly in either direction. and backstopped by external trade designed But a question now arises: How much primarily to feed raw materials into the more runway for growth does China’s oil Chinese manufacturing machine. How this demand have? If examined through the plan unfolds in practice remains to be seen, lenses of demographics, debt, and other given that most of the world’s advanced emerging slowdown factors, the picture economies are not eager to embrace and increasingly trends toward pessimism. The accept Chinese mercantilism. Nonetheless, issue deserves special attention because it the policy thrust clearly highlights how is structural, and if it happens, will unfold Beijing is pinning its hopes on the domestic and exert itself for years to come—unlike market and expected consumption potential the coronavirus lockdowns, which are latent in China’s hundreds of millions of short-term demand catastrophes with middle-class citizens. impacts that should rapidly recede once The challenge is that those same men governments choose to lift them. and women Beijing now looks to as engines To quantify the impact that China’s of economic growth (and liberation from emerging demographic decline, debt burden, the “Chimerica”—or China and America— and increasingly likely structural economic growth model of the past 30 years) have, growth downshift could have on oil and gas over the past decade, increasingly turned to markets, consider the following facts: debt as the fast path to personal economic fulfilment. As Logan Wright and Allen 1. During the past 20 years, China Feng of the Rhodium Group aptly put it in accounted for 39% of net global oil a May 2020 research note, “historically demand growth. From 2010-2019 underleveraged household balance sheets 2 CHINA’S DEBT BUBBLE AND DEMOGRAPHIC STAGNATION POSE MAJOR RISKS TO GLOBAL OIL PRICES—AND U.S. SHALE PROSPECTS were the last frontier of China’s historic credit expansion.”7 Between 2013 and FIGURE 2 — ANNUAL CHANGES IN MAJOR COMMODITY EXPORTING 2019, that “frontier” came to be settled REGIONS’ OIL DEMAND (1965-2019) by an estimated 35 trillion RMB ($5 trillion) 1.5 $140 expansion in the debt held by households in China.8 Empirical investigations suggest that 1.0 $120 household debt levels have significant impacts on consumers’ subsequent abilities 0.5 $100 to spend and contribute to economic growth. One paper from 2015 analyzed data 0 $80 from 30 countries between 1960 and 2012 and found that a one standard deviation increase (6.2%) in the ratio of household -0.5 $60 debt to gross domestic product (GDP) over Average Crude Oil Prices ($/bbl) Average the prior three years was associated with Oil Demand Increase (’000 Bpd) -1.0 $40 a 2.1% decline in GDP over the next three years.9 Likewise, a 2017 working paper published by the Bank for International -1.5 $20 Settlements (BIS) found that “a 1 percentage point increase in the household debt-to- -2.0 $0 GDP ratio tends to lower output growth 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 in the long run by 0.1 percentage point,” suggesting that credit expansion amps up Middle East Central and South America Africa consumers’ near-term contributions to GDP Commonwealth of Independent States (CIS) Crude prices (2019 $/bbl) growth, but at the expense of longer-term sustainability of that growth.10 SOURCE BP Statistical Review of World Energy 2020, Author’s Analysis While these research results are NOTE Major commodity exporting regions’ oil demand growth declined dramatically as commodity prices broadly downshifted during the 2011-2014 time period. not deterministic for China’s future, the fundamental economic concepts underpinning them—such as consumers’ Accelerating credit (i.e., “debt”) growth reduced spending capacity when they matters, because while the amount held by face large debt service burdens—apply debtors grew faster over time, it is unlikely across any society on the planet. Indeed, that the quality of assets they borrowed the BIS working paper found that once against, the supportable value of the the household debt-to-GDP ratio exceeds properties purchased (for secured debts), 60%, “[t]he negative long-run effects on or the strength of household finances (for consumption tend to intensify.”11 China’s unsecured debts) improved commensurately household debt-to-GDP ratio is rapidly as the overall debt burden increased. approaching that empirical danger threshold. Asset quality questions become Dismissing the “debt threat” would especially pertinent when considered in the also be unwise given the rapid expansion context of residential property markets— in household credit, a.k.a “debt,” in China. which Goldman Sachs estimates were worth Let’s take a look at the numbers. From 2013 $52 trillion in 2019—and which are one of the to 2019, household debts rose by nearly 35 primary storehouses of wealth for consumers trillion RMB, according to BIS data (Figure in China whose assets are stranded by 3).