The China Syndrome

In a recent post we highlighted the EIA’s revised energy supply forecast. The chart from that post shows a 1 million barrel per day reduction in current production volumes. Econbrowser is now publishing anlysis of the EIA’s energy demand forecast, focusing on the impact that China will have in the marketplace. 

Providing the market with adequate energy supplies would be a difficult issue on its own. Adding the unprecedented demand expected from China, provides a real opportunity for the innovative oil and gas producer. The author of the econbrowser article, Stephen Kopits notes an interesting characteristic of energy demand.

Oil demand does not grow linearly with GDP. Rather, the bulk of oil demand growth occurs in the two decades during which societies typically acquire motor vehicles, after which per capita oil demand flattens. For example, per capita oil consumption in the United States is today lower than it was in 1979, even though per capita income has increased substantially since.

That is not to say that the U.S. demand for energy has dropped. The focus on motor vehicles alone, which is what Kopits reviews, would therefore limit the potential demand from China to just that form of consumption. If we are to gain an understanding of the volume of potential demand from China, motor vehicles will be a portion of that demand, but not the sole source of the demand increase. Now the scary part of the analysis. Comparing the per capita increases in energy use of Japan (1960 - 1973) and Korea (1976 - 1996) and using either of those trajectories in China’s situation shows...

In any event, without delving deeper, we might expect China's steady state demand for oil could prove not less than that of more advanced Asian nations. Based on the experience of Korea and Japan, China's current population would be expected to consume approximately 55 mbpd at steady state (when per capita consumption plateaus), or nearly 2/3 of current global oil production, were the supply available.

One might argue that this is an unreasonable amount of energy consumption. It imputes systemic gridlock throughout China, and therefore would define the upper limit of what is possible. Nonetheless the volume of energy demand will be substantial. In this next quotation Kopits argues that the EIA’s forecast demand is similarly too low.

By contrast, the EIA sees China's oil consumption at only 10 mbpd for 2015, a growth rate of approximately 2.7% from current levels, and at only 16 mbpd by 2030. Is this consistent with a country whose vehicle sales are up 56% in the first five months of the year? Where sales of Audi's are up 77% and those of BMW have doubled compared to the first five months of last year? Is China truly going to be satisfied, as the EIA would have it, with less than 1/5th of the per capita oil consumption of Korea in 2030, even though they should be similar by that time?

and

The differences in views about China's oil demand outlook have enormous policy implications. If the EIA is right, and China will forget how to grow, then pressures on the oil supply will be modest. On the other hand, if China is to develop like other countries in Asia, the pressure on the oil supply will be crushing, with oil shocks, recessions, and war all conceivable outcomes. The energy--as well as the economic and security--policy differences between the two scenarios are like night and day.

I don’t think it has to be that way. Call me an optimist but I think that whatever China, the U.S. and all others need in terms of energy, it is possible to supply them at prices that reflect that demand. The costs associated with the exploration and production will be substantially higher then what they are today. The easy stuff is gone, that is something that we can all agree on. The prices and volumes of production are unknown at this time, with demand growth from China, the oil and gas business has moved into a different era of operations. We know that a commodity like oil or gas is affected by the demand from China no matter where the source of production is. 


Today’s oil and gas firms, particularly the large Independents and International Oil Companies are having difficulty generating value. The cost structures have caught up to the commodities prices and the performance of these bureaucratic firms is diminishing rapidly. If we look forward to 2030 we can assume that the way these firms are managed today will be history. No one would establish a firm today to operate in the fashion of the bureaucracy in 2030. 


What we do know about 2030 is that the industry will be using advanced systems to manage their operations. It is also reasonable to assume that the Joint Operating Committee (JOC) will be the key organizational construct of the innovative producer. The use of both the technology and the JOC will be decided upon today. Approaching issues that are as broad in scope as the supply and demand of energy, that present this level of opportunity, can not be approached in the same old bureaucratic fashion. We need to pursue a definitive course of action, by developing the Draft Specification of People, Ideas & Objects. 


Society is put in peril when world oil production declines. There is evidence that the world's oil production has declined. Therefore the world needs to have the energy industry expand its production. To do so requires that we reorganize to enhance the division of labor and specialization within the industry. As has been proven, this reorganization could achieve far greater oil and gas production. Management of the industry is conflicted in expanding the output of the industry. The less they do, the higher the oil and gas prices and the better they appear to perform. This managerial conflict must be addressed and the performance of the industry unleashed. To do so requires the current management of the industry to fund People, Ideas & Objects and build the systems as defined in the Draft Specification. Please join me here.

Technorati Tags: People's China Economics Energy IEA Leadership Organization Vision

McKinsey on Global Rebalancing

McKinsey have published an article that I think provides a good understanding of how our economy will be functioning in the near term. Entitled “Globalizations Critical Imbalances” it talks about the necessary adjustments in world trade and their implications. Coming from the point of view of the energy industry, I think this document shows the demand for energy will continue to increase substantially in the near term. Prices will be the means of allocating these finite energy resources and therefore the rewards to the innovative oil and gas producer will be substantial. McKinsey notes.

To some extent, the rebalancing of global economic activity from developed to emerging markets simply reflects economic laws of gravity. In a world where ideas can flow freely and countries are at different stages in adopting modern modes of production, communication, and distribution, less developed nations should grow more rapidly than their counterparts in the West as they catch up.

China, India, Brazil and others are providing substantial increases in the quality of life for their citizens. This naturally imputes greater volumes of energy will be consumed by these countries. Competition for energy resources will be extreme. How much of an increase in consumption and energy pricing is reflected in this next quotation.

The structural issue facing developed-world nations is that the amount of high-quality, high-productivity labor that will be mobilized over the next decade in Brazil, China, and India (not to mention Mexico, the Philippines, and Thailand) is likely to be measured in the hundreds of millions of people. By comparison, the entire US labor force comprises 150 million people. This is a wonderful trend for humankind and would be a boon for everyone in the world if emerging-market employment were directed largely toward production for domestic consumption. The challenge for developed-world governments and citizens seeking jobs, however, is that a significant fraction of this emerging-world labor displaces jobs that would otherwise be created in Europe, Japan, and the United States. This may be the underlying reason why unemployment in Europe, Japan, and the United States is becoming more structural rather than cyclical and may get worse over time no matter how much public stimulus is provided. Certainly, the job losses of the Great Recession look quite different from those of past recessions.

We are clearly not out of the woods in terms of the Great Recession. One of the best indicators of the world economies health has been the Baltic Dry Index. The costs to ship dry goods has fluctuated wildly during the last few years. Although the index has stabilized over the past few quarters, it remains substantially below the highs recorded prior to the beginning of the recession. (Note the recent decline in the index has been substantial.) McKinsey notes the difficult situation these global imbalances will cause various governments.

It is very difficult to say how these issues will play out. The global rebalancing that is needed is obvious: developed-world countries need to save more, consume less, become more fiscally disciplined, and run current-account surpluses (or at least be neutral). Emerging-world countries need to let their currencies rise until PPP rates are closer to financial-exchange rates. They need to consume more, save less, run current-account deficits (or at least be neutral), and continue investing, with some of the capital provided by outsiders. If major national governments work proactively together to rebalance and coordinate their fiscal, monetary, trade, and foreign-exchange policies, the adjustment process could be gradual.

The implications of this “rebalancing” may appear dire to those in the developed economies. I think the opportunities will be substantial and the challenges significant. Those that are able to innovate, and particularly the oil and gas producers, will realize many benefits. Realization that we are no longer in the “low cost” era of the energy industries past. Changing from this past mindset to one that can profit from these types of economic forces requires the changes that are contemplated in the Draft Specification.

The underlying global economic processes under way are very powerful, and the profit opportunities will be enormous as four billion people in emerging markets triple or quadruple their incomes and wealth over the next 20 years.

McKinsey are specific on how companies should position themselves for these changes. Oil and gas firms need to adopt these and other recommendations. It is foolhardy to think that these economic challenges and opportunities can be handled by the existing bureaucracies. Innovative oil and gas producers need to begin the process of addressing these opportunities by acquiring the software development capability of People, Ideas & Objects and begin the development of these software applications.

These suggestions represent specific applications of the more dynamic management approach I have urged companies to adopt in the past. The hallmarks of that approach—heightened awareness, greater resilience, more flexibility, and the timely alignment of leadership around needed adjustments—will be invaluable for companies as they navigate the choppy waters of global economic rebalancing. This process will continue and perhaps even accelerate in the years ahead, not despite, but because of the structural adjustments that are needed to put the global economy on a more sustainable trajectory.

Society is put in peril when world oil production declines. There is evidence that the world's oil production has declined. Therefore the world needs to have the energy industry expand its production. To do so requires that we reorganize to enhance the division of labor and specialization within the industry. As has been proven, this reorganization could achieve far greater oil and gas production. Management of the industry is conflicted in expanding the output of the industry. The less they do, the higher the oil and gas prices and the better they appear to perform. This managerial conflict must be addressed and the performance of the industry unleashed. To do so requires the current management of the industry to fund People, Ideas & Objects and build the systems as defined in the Draft Specification. Please join me here.

Technorati Tags: People's McKinsey Economics Change China Innovation Strategy

China Energy, A Guide for the Perplexed

From The Peterson Institute for International Economics

Written by Daniel H. Rosen, Visiting Fellow, Peterson Institute for International Economics, China Strategic Advisory
and
Trevor Houser, Visiting Fellow, Colin Powell Center for Policy Studies, China Strategic Advisory

This a comprehensive summary of the markets, pricing and use of energy in China. This document provides an insight into many of the anomalies of the Chinese market that provide an understanding about their future demands. I highly recommend downloading this file and keeping it handy for reference in the next few years. Anomalies such as;

• "What's Driving Demand"
  
• Just as the US' energy use is very efficient. "By 2000, Chinese economic activity required two thirds less energy per unit of output than in 1978."
• "Energy consumption grew four times faster than predicted, to over 15 percent of global demand in 2006. (nearly twice as large in absolute terms as forecast in most 2002 estimates.)"
• "Under this scenario (2030), China will account for 20 percent of global energy demand, more than Europe and Japan combined, and easily surpass the US as the largest energy consumer."
• It is assumed that consumption and transport are the big users of energy. "This is not correct. Consumption led energy demand will be the major driver in the future and is already significant in absolute terms, but the main source of today's growth is energy intensive heavy industry."
  
• "The number of passenger vehicles on the roads has doubled since 2002 to more than 25 million, with over 5 million new cars sold in 2006 alone."
• "While the vehicle fleet in China is still less than 20 percent as large as the United States, the gap is narrowing. Based on experience elsewhere, car sales in China are set to grow faster than GDP until income levels reach about $20,000 per capita." (Currently $2,000 / year.)
  
• "For a considerable period therefore we foresee consumption growth as additive to investment, rather than substituting for it."
• "And with several more decades to go before China reaches the urbanization level of Latin America, this secular driver is here to stay awhile."

• "China's Energy Supply Systems"
  
• "As a result, until the mid 1990's was not only able to produce enough energy to fuel its own development, but had enough for export."
• "A number of small bureaucrats try to plan supply while markets are determining more and more of the demand."
• "China's relatively meager proven reserves suggest that annual oil output is near peaking at the current 3.7 million barrels per day."
• "China will not be able to meet its medium term gas needs through LNG alone. A number of potential pipelines from Russia and Central Asia are under discussion, but both the economics and politics of these projects are challenging."
• "With limited reserves and relatively flat domestic production, China now relies on international markets for nearly half of the oil it consumes."
• "For the purposes of our discussion here, the point we wish to emphasize is that the domestic resource endowment and industry structure create a market incentive for Chinese oil companies to expand their upstream portfolios overseas."

• "Global Impacts"
• "China's energy markets and policies, as they exist today, are failing to reliably supply the country's explosive demand growth or adequately address its environmental consequences."
• "Blackouts resulting from poor planning and management in the domestic power sector send ripples through international oil markets."
• If these costs (environmental) right themselves in the years ahead, some heavy industry will no longer be viable in China and global metals and chemicals markets could be shaken up once again as excess Chinese capacity is subtracted."
• "Going from one of Asia's largest energy suppliers to one of the world's largest energy importers in little more than a decade, China is a major force at the margin in global oil, gas and coal trade flows."

• "Conclusion and Policy Recommendations"
• The authors draw four principle conclusion from our study of China's energy situation.
  
• The main energy challenge for China today is the shifting industrial structure of its economy, not factory inefficiency, new air-conditioners or more automobiles. These issues are systemic in nature and thus only China can effectively correct them.
  
• We do not expect China to adequately fix the root causes of its structural over allocation into energy intensive industry in the next decade.
  
• Structural adjustment is necessary but not sufficient to address China's energy issues.
  
• Regardless of how successful Beijing or others are in altering the country's energy trajectory, in 20 years China will likely be the world's largest energy consumer and polluter.
  

"A point of context should be kept in mind when contemplating these recommendations: China is an 800 pound gorilla on the world energy stage that cannot be ignored; but there is a 1,600 pound gorilla in this room too - the United States. Instead of treating that fact defensively, US policymakers might see it as an opportunity. The changes needed on China's behalf seem impossibly ambitious as unilateral adjustments, especially since China feels entitled to follow an industrial path that many OECD nations have trod. Even if progressive Chinese leaders recognize a self enlightened interest in unilateral reform, there exists a natural tendency to focus more on a rival getting off easier than they should than one's own best interest. The necessity for the United States to improve the sustainability of its own energy profile may be by far the most powerful lever it has for impelling change elsewhere: The opportunity for a grand bargain in energy and environment exists to give policymakers in both China and the United States political cover for painful choices."

I think that the energy industry needs to recognize the 800 pound gorilla in the room. I am a staunch believer that the energy challenges we face require the reorganization of the industry to meet these new global realities. China is in direct competition to our way of life. Are we to let the hierarchy whittle away the time that we do have?

Technorati Tags: Genesys, Environment, Energy, China