Professor of Strategy, U.S. Naval War College
China’s own official data suggest near term diesel fuel demand may have peaked in at least 13 provinces, which collectively account for nearly 60% of the country’s diesel fuel use. This development matters greatly because diesel accounted for nearly 1/3 of Chinese oil product consumption in 2015. Furthermore, China’s share of global diesel fuel consumption has increased from 9.6% in 2005 to 13.1% in 2015, and China accounted for nearly 36% of the global net increase in diesel fuel consumption, according to JODI data. Sinopec, China’s largest refiner, takes in approximately 3.27 barrels of crude oil for each barrel of diesel fuel produced. Because the vast majority of diesel fuel used in China is refined in the country, this ratio suggests that conservatively, each 100kbd of diesel consumed requires that refineries process at least 300 kbd of crude.
China’s national diesel consumption declined in both 2014 and 2015. Consecutive years of contraction, coupled with weakness in other physical indicators of industrial activity, increasingly suggests that China’s diesel demand architecture is structurally evolving. It remains somewhat premature to conclude that China’s diesel demand has “permanently” peaked. But the evidence increasingly suggests that for 1-to-4 year oil price path analysis purposes, the Middle Kingdom’s diesel demand is not coming back. Indeed, the IEA itself forecasts a continued decline in Chinese diesel consumption in 2016.
China’s tectonic diesel consumption shift has given pause to the global oil market. And it will continue to do so as producers, traders, and capital providers adjust to a new normal in which sustained massive oil demand growth from China can no longer be taken for granted. China’s diesel demand weakness also points to a potentially massive flaw in certain OPEC producers’ view that demand growth will quickly mop up the current crude supply overhang and resuscitate oil prices even if OPEC maintains current production rates.
The provinces where diesel demand appears to have peaked fall into three primary groups. First are the export-focused provinces/cities of Beijing, Fujian, Guangdong, Shanghai, and Zhejiang. These areas face stagnant demand abroad for many Chinese-made products and the rising wage and other costs that are undermining China’s historical export competitiveness.
Second are the rustbelt and coal belt provinces of Inner Mongolia, Liaoning, and Shandong, where overcapacity and slowing heavy industrial activity are crimping diesel fuel demand. Given that China has likely hit Peak Coal, it is difficult to imagine diesel demand recovering in these provinces in the next five years. Third are the Hinterland Provinces: Henan, Hubei, and Hunan. The massive economic stimulus efforts of 2008-2010 focused heavily on these areas. China’s stimulus created unsustainably high levels of fixed asset investment and construction activity in these three provinces and after several years of elevated activity, diesel demand began to decline.
China diesel bulls could disagree and say that the apparent provincial demand peaks are simply “local maxima” as opposed to being definitive structural inflection points. To pre-empt this potential criticism, the present analysis divides the peak diesel provinces into two main groups: (1) those which are “clearly in structural demand decline” and (2) those which remains “susceptible to stimulus.”
A stimulus package similar in magnitude to what China unleashed in 2008-2010 (4 trillion RMB) could potentially temporarily revive diesel demand in borderline provinces such as Jiangsu. Such a large infrastructure-oriented stimulus effort could very well temporarily prop up demand for diesel. But it would do so at high cost and introduce risks the Central leadership seeks to avoid. For one, a large stimulus package would increase systemic risk by further bloating the country’s balance sheet. It would also pressure existing real estate and infrastructure assets that are already seriously debt-laden and underutilized, while creating additional Ghost Cities and other “zombie” assets. Finally, it would seriously undermine Beijing’s policy goals of eliminating overcapacity, reducing pollution, and shifting China’s economy toward a more sustainable consumption-oriented structure.
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