China: The 800 Pound Gorilla in the Energy Sector

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china's oil production and consumptionLast week Platts announced that China's crude oil demand reached record levels in December, rising 18% year over year to a record 9.6 million barrels per day (b/d) average.  Oil demand in December was up 7% from November's the previous record high – so it appears demand continues to ramp upward in a significant manner. The continued increase in demand has been labeled as ‘astounding’ by industry analysts.

For all of 2010, Platts reported that China's oil demand rose 11.4% year over year to a record 8.7 million b/d. Some analysts expect China's oil demand to increase to an average 9.5 million b/d in 2011 – an increase of 9% - as the Chinese economy continues to expand and the consumption of transportation fuels increases. "The last two months when China has hit oil demand records are proof in point of the country's apparent insatiable appetite for oil and transport fuel," noted Platts’ Tom Hogue, Asia news director. Chart courtesy Financial Times.

IEA Data

With slightly different methodology, the International Energy Agency’s data released last week also indicated that China has reached record demand levels. Due to coal import problems due to mine flooding in Australia they note much of China's oil-demand growth is accounted for by fuel substitution as large-scale diesel-powered generators are supplementing coal-fired units. In addition local governments have closed coal-fired power plants and rationed electricity to meet centrally imposed energy-saving targets, further stoking demand for diesel generation.

The IEA has forecast that global oil-demand growth will slow this year, with the world using 89.1 million barrels of oil a day, an increase of 1.4 million barrels a day. Demand grew by a whopping 2.7 million barrels a day last year, it said. Like last year, we expected continued increases in the IEA demand estimates for 2011—unless price increases begin to restrict demand. Even the current estimate of a gain of 1.4 million barrels per day in demand is substantial—and will account for a big chunk of the global spare productive excess capacity.

Economy Growing Strong

Other news on China, the world’s largest energy user, was released last week – almost all of which is bullish for the energy sector. Bloomberg reported that China’s economy grew at a rate of 9.8 percent in the fourth quarter from the same period a year earlier, above analyst expectations. Inflation eased only slightly last month. Food prices are a major concern, and are one of the main focus points for government officials.  Measures to cool the economy have had limited effect.

Forecasts are that China’s economy will expand 9.1 percent in 2011 according to Bloomberg. Gross domestic product grew 10.3 percent in 2010. An expanding economy will need more energy – coal, oil, and natural gas. The pace of growth in the last quarter of 2010 accelerated from the previous quarter. Both the quarterly and annual growth figures were significantly above what analysts had expected. And factory data also indicated the economy was in a solid expansionary mode.

Some experts claim China may face a diesel shortage in 2011 as refining capacity expansion lags behind the expected increase in consumption. Diesel demand may rise 6.2 percent in 2011 according to the experts, while oil refining capacity may climb 5 percent according to Bloomberg. Overall power generation climbed 13 percent in 2010 – and most of the increase was from coal-fired units. All bullish for coal and crude oil markets.

Acquisition of Exploration & Production Properties

Last, it was announced that China will spend an average of 500 million yuan each year on exploring and acquiring oil and gas resources over the next two decades. The effort is being undertaken to counter the country's growing dependence on imported energy. To get a feel for the magnitude of the increase note that the country invested roughly 50 million yuan per year on these activities from 1999 to 2010. So they expect to see a ten-fold increase in activity each year for twenty years – talk about a market niche with growth potential!

The increased activity apparently will include merger and acquisition deals in the energy sector – coal and crude oil being the focus - all focused abroad. Combined with merger and acquisition activity globally, this intensified interest should be a positive development for companies in the energy and mining sectors.

Investment Implications

The continuing increase in global demand for crude oil – from China as well as OCED countries – should keep prices and investor interest elevated in 2011. The merger and acquisition activity should add a spark to companies in the sector. We prefer small to mid-sized firms that focus on crude oil in North America, but all firms in the sector should benefit.

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About Joseph Dancy