Yesterday's commentary looked at the overall energy picture since British Petroleum (BP) began collecting data in 1965. What stood out like a sore thumb when analyzing the rate of growth in energy consumption was the surge in Chinese energy demand that began between 2001 and 2002.
Figure 1
Source: BP Statistical Review of World Energy 2007
Looking at the different primary energy components reveals a surge in every category since 1994, with nuclear generation (uranium consumption) up 368%, natural gas consumption up 326%, oil consumption up 239%, and coal consumption up 184%.
Figure 2
Source: BP Statistical Review of World Energy 2007
The Link Between a Disappearing U.S. Manufacturing Base and Chinese Energy Demand
When trying to figure out what led to the surge in Chinese energy demand between 2001 and 2002, the first thought that came to mind was the U.S. recession and subsequent exportation of U.S. manufacturing to China. At first glance, when looking at the U.S. manufacturing utilization rate, where the utilization rate returned to 2000 levels last year at roughly 80%, this would seem to not be the case as manufacturing capacity rates returned to pre-2001 recession levels.
Figure 3
Source: Moody's Economy.com
However, what appears to have occurred was a change in corporate action to the normal business cycle, where corporations contract capacity and labor when heading into a recession, and expand capacity and labor when emerging from a recession as the economy revives itself.
Though the manufacturing capacity utilization rate returned to 2000 levels, the key is to understand the rate is a percentage, a ratio. For simplicity sake, let's say the U.S. had 10 manufacturing facilities in 2000, and only used eight at the time to lead to an 80% utilization rate. The same rate could be achieved with operating four out of five factories, where the manufacturing capacity shrunk and jobs along with it, though the utilization rate remained the same.
The normal pattern in U.S. corporate hiring in response to economic activity abruptly came to an end during the 2001 recession and was the catalyst that lead to the surge in Chinese energy demand.
Instead of revamping its manufacturing base when emerging from the 2001 recession, corporate America continued to gut its manufacturing base, exporting jobs overseas as manufacturing employment has been a one-way-street, down.
The loss in U.S. manufacturing jobs became a boom to China's economy as their manufacturing base surged, leading to a higher demand in energy consumption as their economy heated up. The relation between the loss in U.S. manufacturing employment and Chinese energy consumption can be seen in the figure below, where the plummeting U.S. manufacturing employment that began in 2001 corresponded to a surge in Chinese energy demand.
Figure 4
Source: BP Statistical Review (2006)/ Moody's Economy.com
Trade Implications
The result of exporting our manufacturing base overseas, predominantly to China, directly led to a surge in imports of the goods we consume from overseas instead of from within our own borders.
The resulting shift in trade has resulted in a significant trade imbalance with China as we buy from them the goods we used to produce. The correlation between a disappearing U.S. manufacturing base and the trade deficit with China is clearly seen below.
Figure 5
Source: Moody's Economy.com
As our manufacturing base evaporated, the relative importance of trade with China has directly increased as a share of our total trade deficit, where the peak in U.S. manufacturing employment prior to the 2001 recession corresponded to a trough in the Chinese share of our total trade deficit.
Figure 6
Source: Moody's Economy.com
The shift in manufacturing's relative importance to the U.S. economy has steadily declined after World War II, which saw the manufacturing base representing nearly half of total U.S. employment. Since WWII, the U.S. has shifted from a manufacturing economy to a service economy as is seen below, where service employment now makes up nearly 84% of total employment.
Figure 7
Source: Moody's Economy.com
The result of the dwindling manufacturing base is the need to purchase goods overseas as they are no longer made domestically, directly affecting our trade balance as shown below.
Figure 8
Source: Moody's Economy.com
So far this has been a win-win situation between the U.S. and China, where China benefits from strong U.S. demand that supports the industrialization of their country while we benefit from their cheaply made goods. For this arrangement to continue China has needed to re-circulate our dollars back into the U.S. by buying U.S. Treasuries to keep their currency artificially cheap. This has been a benefit to the U.S. via lower interest rates, which also helped fuel the housing boom this decade.
The one problem with this arrangement, where our manufacturing base has been shipped overseas to China, is the resulting increased energy demand from China to support their economic activity. The explosive increase in Chinese economic activity has put them front and center on the world energy scene.
Falling Eagle, Rising Dragon
The transformation undergoing in China's economy can be seen in the country's population demographic shift towards urbanization over the past two decades, with this trend projected to continue according to the United Nations. The chart below shows that the percentage of the Chinese population in rural areas is expected to decline from 80.4% in 1980 to 39.5% by 2030 and conversely, the percentage living in urban areas to triple from 19.6% in 1980 to 60.5% by 2030.
Figure 9
Source: United Nations
As this population shift has occurred, Chinese energy consumption has surged with the country playing a greater global importance by gobbling up incremental energy supply. The relative importance of China on world energy consumption growth this decade is clearly visible in the figure below.
Figure 10
Source: BP Statistical Review of World Energy 2007
China has represented a staggering 72.2% of the incremental consumption growth in coal since the start of this decade, nearly 36% of oil consumption, 16.7% of nuclear consumption (uranium), and 7.5% of natural gas consumption.
Not only has China represented the largest contribution to the growth in world incremental demand since the turn of the century, but the country has also risen in importance of aggregate world energy consumption.
In terms of total world primary energy consumption, China accounts for 38.6% of coal consumption, 8.9% of oil consumption, 2% of natural gas consumption, and 2% for uranium consumption. Though the country only accounts for 2% of natural gas and uranium consumption, the country's share in total consumption is only going to increase as its growth rate of consumption of those energy sources is surging (Figure 2).
Figure 11
Source: BP Statistical Review of World Energy 2007
As China's share of total world energy consumption has risen, a subsequent decline has been witnessed in U.S. share of total world energy consumption. The U.S. share of natural gas consumption has plummeted from 66% in 1965 to 22% currently, with oil falling from 37% to 25% over the same period. Uranium consumption in the U.S. peaked in 1975 at 50% and subsequently declined after the Three Mile Island accident in 1979, with the U.S. representing 30% of uranium consumption currently. Coal consumption peaked in 2000 at 24% and has fallen to 18.4% currently.
Figure 12
Source: BP Statistical Review of World Energy 2007
The figure below ties together the previous sectional comments on the 2001 U.S. recession and exportation of the U.S. manufacturing base to China, as well as the emergence of China on the world energy seen with a fading impact of the U.S. This link can be seen with a plunge in the U.S. share of global energy consumption of 25% in 2000 to 21% currently, while China surged during the same time frame, rising from 10% to 16%.
Figure 13
Source: BP Statistical Review of World Energy 2007
The dramatic rise in Chinese economic activity has not only had a significant impact on crude oil prices, but also on commodities in general. Figure 14 below shows Chinese oil consumption growth having a greater impact on oil prices than the U.S. oil consumption growth. The surge in commodity prices in general starting in 2001 can be seen by the Reuters-CRB Spot Index, which coincided with the overall surge in Chinese demand that began in 2001 with disappearing U.S. manufacturing jobs (Figure 15).
Figure 14
Source: BP Statistical Review of World Energy 2007
Figure 15
Source: Moody's Economy.com
The increase in Chinese demand for all types of commodities, energy, base metals, softs etc., has made the world commodity market fiercely competitive at a time when the U.S. has become increasingly dependent on imports, a very negative development indeed.
U.S. Energy Dependence
Since the mid 1980s the U.S. has been steadily reliant upon crude imports to meet its consumption needs. Crude imports reached a low of total consumption in 1983 at 25% as U.S. production rose from 1980 to 1984. As U.S. production fell sharply starting in 1986, imports began to account for a larger share of total U.S. consumption, rising to 66% currently.
Figure 16
Source: Moody's Economy.com
Despite U.S. refinery capacity rising from 1993 to the present, U.S. refinery capacity has been insufficient to meet total U.S. gasoline consumption demands as gasoline imports as a percentage of total gasoline consumption has risen as well, rising nearly five fold from 2% in 1993 to nearly 15% in 2006.
Figure 17
Source: Moody's Economy.com
Part of the reason why gasoline imports as a share of total consumption has risen despite risen U.S. refinery capacity is the result of the aging refinery industry that has lead to a record number of outages this year alone, with refinery utilization rates in a consistent downtrend since 1997, increasing the need for gasoline imports.
Figure 18
Source: Moody's Economy.com
Jim Puplava commented on the aging refinery complex as well as the difficulty in building a refinery in the U.S. in the Part 2 ("Eyes Wide Shut: The Politics of Energy") of his energy series, "Powershift: Oil, Money & War."
NIMBY, BANANA, CAVE, & NOPE
In a remote location 100 miles southwest of Phoenix, CEO of Arizona Clean Fuels, Glen McGinnis is trying to do the impossible--something that hasn't been done in the U.S. in over 30 years--build a refinery. The last refinery built in the United States was back in 1976. McGinnis faces a daunting task. He needs to raise .5 billion: the cost to build the refinery. So far he has raised million, which he has spent over the last six years in obtaining permits and fighting legal battles. The American Petroleum Institute says they are unaware of anyone else pursuing a similar project.Over the last 25 years the number of refineries in the U.S. has dropped to 149, roughly half of the number of refineries in place in 1981. Since that time, companies have upgraded or expanded their aging facilities with the result that refinery capacity has shrunk by only 10% from its peak of 18.6 million barrels a day. Yet, while our refinery capacity has shrunk by 10%, our consumption has risen by 45%...America may be the largest consumer of energy in the world, but its citizens no longer want to have anything to do with its discovery or production. Instead of finding, discovering and refining energy, the country is increasingly looking to foreigners to supply our energy needs, especially north and south of our borders.While the U.S. strong arms the energy industry by denying them permits to build new refineries and has a failing energy policy, China is moving full steam ahead in expanding its energy infrastructure through plans to build tens of nuclear reactors, coal-to-liquids (CTL), gas-to-liquids (GTL) projects, and countless coal and natural gas fired power plants.
To support their economic needs, China is taking strategic action to secure their future resource needs. China has been wooing Hugo Chavez to receive more the country's exports at the expense of the U.S. who has seen imports plummet from Venezuela ("Crude Reality: Dependent and Deprived," Figure 8).
Not only is China courting South American and Middle Eastern oil exporters, but the country is also significantly investing in Africa. An article entitled, "Enter China, the Giant," by Sebastian Junger appears in the July 2007 issue of Vanity Fair, reveals the aggressive surge in Chinese interest in the country, with excerpts are provided below:
According to experts, Chinese construction firms regularly underbid Western rivals by importing cheap Chinese workers and slicing their profit margins to as little as 3 percent.I asked an American military officer with long experience in the region how the Chinese can be so successful doing business in one of the poorest and most unstable parts of the world. The man's answer came out in one long rush."The Chinese say to these countries, 'Look, roads will help your economy, so let's build a road, and we'll provide most of the money for it,'" he said. "The rest of the loan is then provided by Chinese banks and secured against future oil revenues from the country. The road-building contracts go to Chinese construction firms with Chinese engineers, workers, and equipment. All of this comes in a package. Why internationalize something when you can do it yourself? The construction materials come on Chinese ships and are moved on Chinese trucks and Chinese equipment that use Chinese-made rubber gaskets. The Chinese Embassy in Chad is totally self-contained--they even grow their own vegetables. The U.S. government can't plan past six months from now. The Chinese think a hundred years in advance." (Emphasis added).With foreign-currency reserves topping trillion and an economic growth rate of 11 percent a year, China is both desperate for natural resources an din a position to spend enormous amounts of money to get its hands on them. Oil is of particular concern.China now gets 31 percent of its oil from Africa and is the top trading partner for several major oil-producing African countries. Chinese trade with the continent has quadrupled since 2000 and is expected to triple again by 2010, blowing past the United States to hit 0 billion a year. To top it off, China has cancelled more than billion worth of African debt. On a continent as mired in poverty and corruption as Africa, that kind of money will buy you a lot of friends.Both the U.S. and China are currently dependent on each other. China dependent on the U.S. to keep its manufacturing base going, and the U.S. dependent on China to fuel our debt appetites by buying our treasuries and keeping our interest rates low. However, China has the upper hand by slowly developing a self-sustaining consuming economy as its population reduces their savings rate and increases consumption. The more the Chinese economy develops domestic consumption, the less reliant they become on U.S. consumption.
Therein lies the trouble for the U.S. as China will no longer need to reinvest their dollar reserves back into the U.S. which will cripple the U.S. dollar. Instead, we will find China diversifying their reserves, such as China's billion investment in Blackstone Group, increasing its gold reserves, and investing further in Africa. On Tuesday of this week, China launched a billion African Fund (The China-Africa Development Fund) to finance Chinese companies' investment in Africa.
As China's economy continues to grow, with its energy demand along with it, competition for the world's oil supply will intensify. With China becoming less dependent on U.S. consumption, the U.S. will have less economic capital to wield. We will find that the U.S. and China will both be fighting for oil supplies around the world and that the U.S. is in a clear disadvantage. With cheap Chinese labor, abundant capital, the U.S. out of favor in most of the world, and the U.S. economy ever more dependent on foreign oil and gasoline supplies, the road ahead will prove to be quite formidable for the U.S.
TODAY'S MARKET
Stocks closed virtually unchanged from the open as the Federal Reserve decided to leave interest rates unchanged. The word 'elevated' was removed from the Fed wording on inflation, but it did say that "sustained moderation in inflation pressures has yet to be convincingly demonstrated." Consequently, nothing in the Fed's statements indicated the Fed was inclined to lower or raise the federal funds rate.
The Dow fell 5.45 points (-0.04%) to close at 13,422.28, while the S&P 500 fell 0.63 points (-0.04%) to close at 1505.71 and the NASDAQ closed at 2608.37, up 3.02 points (+0.12%).
The rally in the markets was mixed as five of the ten of the S&P 500 sectors were up on the day, with telecommunications leading the pack (+0.88%) followed by the materials sector (+0.16%). The weakest sectors on the day were energy (-0.34%) and utilities (-0.23%).
