The China Factor will Drive American Gas Prices Well Past $6 a Gallon this Decade

Wed, Feb 29, 2012 - 8:30am

Some people understand and some never will. Many politicians and media personalities such as Bill O’Reilly are screaming at the world wondering why U.S. gas prices are so high. From their prism, U.S. oil production is up and the U.S. market is flooded with crude oil. They ask, why is the price so high? What they don’t understand is that there happens to be an additional 7 billion or so people on the planet that we need to compete with for scarce resources such as crude oil.

Neither the U.S. consumer nor OPEC really determines global oil prices any longer. The Chinese market has been determining market prices for oil for several years now and going forward it will be this market that dominates the price determination of crude oil. After all, Saudi Arabia’s largest customer is no longer the United States but China. And China is just getting warmed up.

The factors driving U.S. gas prices higher can be categorized into supply factors, demand factors, and monetary factors. The monetary factors revolve around the price of the USD as endless dollars flood out into the global economy. The Fed money printing has been accompanied by globally coordinated Central Bank printing which has been driving all commodities higher. The supply constraints are also well documented in the supply side story of Peak Oil and these issues are becoming better understood.

The focus of this article is the demand factor or what you might just call “ The China Factor”. The China factor revolves around the key concept of the massive number of new cars sold and produced in China in the last decade.

In the year 2001, the total world demand for vehicles was only 56 million units. Since the year 2001, China has sold and produced over 100 million cars. Unlike U.S. production, these vehicles are not replacing scrapped vehicles. These vehicles represent new demand with new drivers who are buying their first gallon of gas.

The below chart represents Chinese and U.S. vehicle production as well as the average retail price of U.S. gas per gallon.

We can see in the above chart, despite U.S. vehicle production declining rapidly, the U.S. retail gas price continued to increase in the last decade. China started the year 2000 producing 1.8 million units in the car market and U.S. gas prices were only .11 a gallon. By the year 2011 China had produced 18.5 million vehicles per year and U.S. gas prices averaged .54 a gallon. The U.S. vehicle production crashed from 13 million units to less than 8 million units in the same time period. The U.S. vehicle market for sales was down from a peak of 17 million units early in the decade down to slightly over 12 million units in 2011. Despite this, U.S. gas prices still tripled.

In the below charts, we can see Chinese vehicle demand charted against the average U.S. retail gas prices.

Although the correlation is not perfect, the U.S. retail price of gas is much more closely correlated with vehicle demand in China than it is with vehicle demand in the United States.

China is now expected to produce 20 million vehicles in 2012 with double-digit growth rates to stabilize somewhere around 35 million units annually by 2020 or 2025. The dynamics of the market are still very bullish. In China, 90% of cars are purchased cash-up-front with very little vehicle financing involved. Vehicle ownership penetration rates are also still very low in China compared to “developed” countries. This contrasts sharply with the U.S. market where vehicle penetration is high and where 70% of all auto purchases involve a loan with 45% of purchases going to sub-prime borrowers.

If you want to gauge what the price will be at the pump, first check the going rate of RMB/Liter.

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