NS4054
Fall Term 2015
China Scenarios
Background: Emerging Market Crisis I
• Experts disagree about whether China faces a hard
landing, but emerging markets pose a growing risk to the
global economy
• Global markets very jittery now
• August 11, 2015, Chinese currency devaluation rattled
global markets
• Since that time Chinese yuan has weakened – then
strengthened with government support
• Currency now just 2.5% lower than in August
• Global stock markets have had much bigger changes
• Dow Jones Industrial Average down 6.5%
• Shanghai Composite Index down 22%
2
Background: Emerging Market Crisis II
• Crisis reflects long-standing concerns over Chinese
economy including
• Overinvestment and excess capacity in manufacturing,
• Real estate and stock market bubbles fueled by easy money and
leverage and
• An incomplete reform process that failed to place hard budget
constraints on state enterprises
• The initial policy response by government was chaotic and
opaque
• So those predicting a hard land landing have some
support for their assessment
3
China: What Kind of Landing?
4
Background: Emerging Market Crisis III
China’s Growth Story
• IMF forecasts China’s growth rate at 6.8% (2015) and
6.3% for 2016 well below government's 7.0%
• This is well above many private forecasts
• High forecast based on several assumptions
• First, the nearly double digit growth in services and retail
sales will continue– confirming the rebalancing is
occurring
• Second, policy will be better coordinated and
communicated going forward
• Also monetary and fiscal stimulus will provide meaningful
support to activity later this year
• Third the sharp slowdown in manufacturing will not
cascade to the broader economy
5
Background: Emerging Market Crisis IV
• Most likely the truth in China lies somewhere between
hard landing and muddle through scenarios
• Other indicators of growth including sales, energy consumption
and international trade tell a mixed story
• Many forecasters have marked down their China
forecasts – but still room for optimism
• What happens in China will have a significant impact on
many commodity exporters
• Strong growth in Chinese services and a jobs supporting
government stimulus package will not help commodity exporters
• Slow-down already being felt in Australia, Brazil and Argentina
6
Background: Emerging Market Crisis V
• In countries where policies have been weak, markets
have been brutal
• In Brazil which is also experiencing a political crisis, currency
down 30% against the dollar since July
• Other countries such as South Africa and Indonesia also face
significant currency pressures
• Even greater risks come from financial contagion
• There has been a rapid buildup in corporate debt and warnings
of a banking crisis as a result of rapid credit growth in some
emerging markets.
• Nonbank corporate debt has increased 500% over past decade
to $23.7 trillion or around 90% of the GDP of these countries
7
Rising EM Debt Levels
8
Background: Emerging Market Crisis VI
• Corporate debt defaults weigh directly on economic
growth and can damage balance sheets of banks and the
countries that stand behind the banks
• Much of this debt is linked to trade with China and
• Falling profits as well as
• Losses that could result from added currency volatility which is
likely to dramatically add to burden of servicing this debt
• Could create financial distress throughout the emerging
world
• Could lead to deflationary pressures which in turn would
depress returns on investment
• Some worried that situation is similar to the collapse of
2008
9
Background: Emerging Market Crisis VII
• On top of these concerns the most striking change in the
IMF’s outlook is an increased concern over the
• Sharp downward revision to the long-term growth prospects for
emerging markets
• End of the commodity super-cycle and
• A reversal of capital inflows
• Signals a period of lower investment and weaker fiscal
positions
• Results in reduced capacity to support growth
• Many cases optimism that existed following 2008-09
recession that emerging countries would rapidly see
incomes converging with advanced industrial counties is
gone.
10
Background: Emerging Market Crisis VIII
• For the United States fragility in emerging markets is the
critical risk
• By itself, softer Chinese growth and the 2.5% decline in the yuan
since August 11 would only reduce growth by 0.1 or 0.2%
• However if other countries depreciate their own currencies
against the dollar in response to pressures the broad based
appreciation of the dollar could be significant
• Rough rule of thumb is that a 10% move in the traded weighted
dollar reduces U.S. GDP by around 0.5% after a year
• Risks appear to have been an important factor in the
Federal Reserve September decision to delay raising
interest rates from zero
• Situation not likely to change anytime soon
11
Currency Depreciation in Emerging Markets
12
EM Country Vulnearabilities
13
Policy Environment
14
China: Main Trends I
• Commission on Energy and Geopolitics, Oil Security
2025, Sub-Saharan Africa Scenarios
• China facts
• China already the world’s second largest oil consumer
• Even low to moderate levels of economic growth will spur
continued Chinese oil demand growth
• Will be underpinned by the transportation sector and
• Consumer mobility demand
• Between 2000 and 2009 the transportation sector
accounted for 60% of China’s oil demand growth
15
Changing Global Oil Demand
16
Forecast: Oil Demand 2035
17
China: Main Trends II
• Trend likely to increase as vehicle ownership increases
• In 2008 there were only 37 vehicles per 1,000 persons
compared to nearly 800 in the US
• By 2035 the Chinese vehicle ownership rate projected to
increase four-fold
• In 2010 China passed the US as the largest market for
passenger vehicles
• To counteract the growing oil demand and the possibility
of physical supply disruptions China has pushed to
increase oil production
• Production increased from 3.3 mbd in 2000 to 4.2mbd in 2012
• Increases have come largely from enhanced extraction and
recovery at mature fields.
• China not a top five oil producer behind Saudi Arabia, Russia
and the United States
18
China: Main Trends III
• Increases in domestic demand are expected to continue
vastly outpacing domestic supply
• Development of new resources both within and outside
China considered an important national priority
• Domestic possibilities are challenging
• China has proposed to produce in the East China Sea
• Contains an estimated 60 to 100 million barrels of oil, and
• One to two trillion cubic feet of natural gas
• Some of this territory also claimed by Japan
19
China: Main Trends IV
• The South China Sea is another potential source of new
oil
• Estimated to hold 11 billion barrels of oil and 190 trillion feet of
natural gas reserves
• Similarly claimed by several Southeast Asian countries
• Development of domestic shale resources
• Estimated at 32.2 billion barrels of undeveloped, technologically
available oil and 1,115 trillion cubic feet of gas
• Faces significant coat and logistical challenges
• Remains a longer prospect
• However have 1,2000 drilling rigs more than any country besides
the U.S.
20
China: Main Trends V
• Imports
• As a result of flattening oil production and booming
demand imports increasing rapidly
• Were more than 6 mbd by end of 2012,
• Accounted for 56% of consumption over the year
• By 2035 China could import more than 75% of its oil
• Political instability in the Middle East and Africa and
potential for supply disruption
• Prompted China to seek to diversify its sources of imports
• An additional 17% originated from Russia, and
• 15% from sub-Saharan Africa
21
China: Main Trends VI
• China also promotes exploration and development
through its NOCs
• Purchased equity stakes in energy companies in 31
countries – Middle East, North Africa, Latin America, subSaharan Africa and Asia.
• Investments in overseas oil and gas assets in 2011 topped $18
billion
• Overseas equity oil production reached 1.5 mbd.
• China also provided resource backed development loans
to major oil producing countries including
• Russia, Kazakhstan, Venezuela, Brazil and Angola
• Deals totaled about $100 billion since 2008
22
China: Main Trends VII
• Oil-for-loan deal between China and Venezuela
guaranteed $32 billion in exchange for 430,000 barrels
per day of oil
• Chinese access to Canadian oil sands assured by
• Recent $15 billion takeover of Canadian company Nexen
• Also smaller investments in Canadian oil resources
• China currently building up a strategic oil reserve
expected to hold 500 million barrels by 2020
• Country’s commercial stockpiles are
• between 170 and 300 million barrels of crude oil and
• 400 million barrels of refined products as of 2010
23
China: Main Trends VIII
• Other areas
• China has been greatest obstacle to efforts to increase
economic pressure on Iran over its nuclear activates
• Rising U.S. oil production providing China more supply
options to meet growing demand
• Nigeria and other oil exporters already turning east with
China and India most promising
• However due to new refining capacity brought online
since 2006, Chinese refiners currently prefer sweet,
medium, diesel rich crudes over the light types
commonly found in Africa
• A potential influx of U.S. shale technology and knowhow
could also aid China develop its own resurces in the
longer term
24
China: Main Trends IX
• Main Trends
• Trend I
• China’s demand for oil as well as other sources of energy
will continue to grow at a dramatic pace
• Solidifying the country’s recent role as the most
important demand-side factor globally
• China leads world demand growth
• By increasing by about 50% to 14.7 mbd (baseline) or
16.5 mbd (high)
• Increase should be around 40% of the increase in global
demand.
25
China: Main Trends X
• Trend 2
• China’s increasing demand for oil will far outstrip
domestic production leaving it much more reliant on
imports and strengthening the focus on
• Import diversification,
• Foreign engagement, and
• Investments in efficiency improvements and other fuels
• By 2015 China as well as India and Southeast Asia are
forecast to import more than 75% of their oil needs
• Increase from 60% in 2013
• China’s overseas efforts to secure oil supplies via longterm contracts, investments, and loan for oil deals will
only intensify
26
Scenario Assumptions
27
China: Scenarios I
• The Four Scenarios
• In each scenario, China is a major driver of global oil
demand growth.
• Although China will make efforts to
• further exploit domestic resources including shale, and
• diversify its sources of oil abroad
• Country will remain increasingly reliant on imports from
the Middle East
• Particularly true in the Flush and Hypergrowth scenarios when
the Middle East producers account for the majority of global
production growth.
• China’s reliance on imports will also damage its trade
balance creating tension as China must simultaneously
rely on exports revenue and shift to an economy more
focused on the domestic economy.
28
China: Scenarios I
• Scenario A Reference -- baseline demand/constraind
supply
• With slower Middle East oil production growth, China
sources more oil from Sub-Saharan Africa, South
America and other locations
• China’s constrained oil demand growth at a time of
relatively stagnant Western demand leads oil-exporting
nations to court China as a long-term customer
• China continues to encourage the adoption of alternative
transportation fuels and other policies to reduce oil
demand
29
China: Scenarios I
• Scenario B Flush– Baseline Demand, Abundant Supply
• Although China increases its consumption of Middle East
oil, the increases in supply provide it more flexibility to
source oil from other locations.
• Abundant oil supplies and lower oil prices allow China to
strike more favorable deals and improve import diversity
• China likely decreases purchases of Iranian oil if
international sanctions persist.
• Diminished urgency for China’s efforts to foster greater
energy efficiency in the transportation sector
• China’s trade balance is improved due to lower oil prices,
despite continued strong oil demand.
30
China: Scenarios II
• Scenario C Grind High demand/constrained supply
• With slower Middle East oil production growth, China
sources more oil from sum-Saharan Africa, South
America and other locations
• Despite improved prospects for development of shale,
the additional demand over the Reference Scenario
means even deeper reliance on imports
• Higher global prices increase competition for investment
opportunities abroad.
• China strongly incentivizes improvements in
transportation sector fuel efficiency and development
and use of alternative transportation fuels
• Higher oil prices and high levels of oil demand negatively
impact China’s trade balance
31
China: Scenarios III
• Scenario D hyper growth – abundant supply/high demand
• China’s reliance on Middle East oil increases
substantially
• Despite continued investments to diversify import
sources – due to higher domestic demand than in the
Flush Scenario
• The additional demand over the Flush Scenario results in
even deeper reliance on imports
• China’s role as the world’s largest importer and biggest
contributor to global oil demand growth make it a highly
sought after customer
• Lower oil pries result in less drag on the trade balance
than the Grind Scenario
32
China: Flashpoints I
Flashpoint I
• Increasingly vulnerable to oil supply disruptions, China
could grow more assertive as a global power
• China projected to become increasingly reliant on oil
imports
• So far China has pursued a “no strings attached” policy
• Minimal attempts to turn its foreign investments into influence
and
• Traditionally has only used its armed forces to defend its territory
and regional interests
• China is developing armed forces with more global reach
• China’s actions likely to be most assertive when their oil
demands are greatest
• The Grind Scenario (especially), and
• Hyper-growth Scenario
33
China: Flashpoints II
• Flashpoint II
• Chinese oil demand growth could falter as economic
growth fails to meet expectations
• China’s export and investment-oriented growth relies on
strong global demand and easy access to cheap capital,
labor and energy. Problems arise wiwth
• Spreading labor unrest
• Steady increase in labor costs, or
• A significant tightening of either the official or shadow banking
systems
• Could tip China’s economy closer to a “hard landing”
with growth rates in the low single digits.
34
China: Flashpoints II
• In addition to these factors, higher energy prices could
be an ingredient in any economic slowdown
• The economic and political problems of failing to
transition to a more domestic and consumption oriented
economy could lead
• To slower than expected growth in Chinese oil demand
• Which would lead to slow global oil demand
• Many implications for the global oil market’s major
participants
• Investment
• Prices
• Stability
35