25 October 2015

After China Slowdown what’s next?

What are the energy, environmental, and financial aspects of China's expected slowdown, was the topic a recent speech by Tom O’Sullivan of Mathyos Japan.

On a personal note, as an immigrant over 20 years ago, China was my first stop and almost my first plane ride, and I spent two years in Hong Kong before 1997 when the British handed it back to China.

Last week I also attended an international METI conference in Tokyo that John Holdren, President Obama’s Science advisor attended, Mohammad Yunus from Bangladesh the Nobel laureate, Amory Lovins of the Rocky Mountain Institute and Chairman Takao, of Asian Development Bank among others on energy and climate issues so I can also share with those of you who may not have attended some of the output from that event including the COP21 planning discussions that will commence in Paris on November 30th.

I wanted to start my short talk by looking back quickly over global economic activity over the last two decades. When I started in China around 20 years ago Global GDP was $28 trillion and is now $78 trillion so the world has added $50 trillion of GDP over the last 20 years, about 2.5 trillion per year (6 Swedens).

Chinese GDP was around $400bn (same as Sweden’s now) when I arrived. It is now in excess of $10 trillion an increase of 25x over 20 years.

A spectacular achievement that has reduced the poverty level in China by 60% over the last 35 years. China is now 20% of global population and 13% of global GDP and the world’s largest international trading country- $4 trillion per annum in imports and exports.

However, the growth story over the last two decades has been by no means confined to China. America alone also added $10 trillion of GDP over the last 20 years, that is almost equivalent to China’s current GDP. These represent substantial productivity gains for the United States alongside China’s o/s achievement.

In terms of energy consumption Chinese consumption has increased by a factor of 3.5 over the same period (1bn toe to 3.5 bn toe).

China now consumes 50% of the world’s coal, 60% of the world’s concrete, 50% of copper, 50% of aluminum, 50% of steel, 50% of nickel and12% of oil.

It is the world’s largest consumer of electricity with the largest power generation assets in the world. Its State Grid Company is now one of the most powerful companies on earth in terms of balance sheet and has brought 500 million Chinese onto the power grid over the last several decades.

China is also still a major producer of oil, gas, and coal with significant reserves something that it likes to remind Japan about which is not richly endowed with fossil resources!

China is currently importing 7 mbpd of oil and consuming about 10 mbpd up from 2mbpd in 1990. It is now the world’s largest oil importer, having only started importing oil in 1993.

It is consuming 5% of the global supply of natural gas.

Most importantly China consumes around 4 billion tons of coal 50% of global total up from 1 bn tons in 1990. Coal is where most of China’s energy comes from.

China’s industries consume around 60 to 70% of China’s primary energy consumption underling China’s role as factory of the world and the extent of the carbon leakage that has taken place over recent decades from the developed to the developing world.

China’s C02 emissions have increased by a factor of 5 over the last 20 years to 10 billion tons /annum, 1/3 of the global total.

The environmental consequences of China’s economic build-out over the last two decades, and in particular the coal burning, has had possibly disastrous global environmental impacts that we hope and pray will not be repeated by the other large emerging market, India.

What else happened over the last 20 years that has a bearing on what is going on in China today and that may shape China’s future engagement with the of the rest of the world and in particular the West.

• Disintegration of Soviet Union –China’s economy has significantly outperformed those of the x Soviet republics
• Japan’s economic slowdown- China will want to avoid this at all costs and may seek to exploit Japan’s weakness
• Kyoto protocol was signed and then ignored-China is now taking a leading role in Climate negotiations alongside EU and US
• Asian financial crisis in 1997-China will want to avoid significant currency depreciation
• Technology revolution-China has become a leading player in the manufacture of technology and ecommerce- Huahei, Alibaba and Bidu as examples etc.
• Emerging market economies have boomed but are now slowing down- China will want to diversify its economy-Russia, Azerbaijan Turkmenistan, Uzbekistan, and Tajikistan are all being impacted by over dependencies on commodity exports.
• Euro was launched-China would like to emulate and join IMF SDR basket
• China joined the World Trade Organization-it is proceeding with further bilateral trade agreements
• Invasions of Iran/Afghanistan: Afghanistan is a neighbor country of China and both wars showed the limits of US military hegemony, Syria is now doing the same. This may embolden the PLA Mathyos Japan 13 October 2015 4
• Shale oil and gas boom in the US from 2005- China is exploring its own shale revolution.
• 2008-oil hits $145 a barrel-accelerated China’s move toward indigenous cheaper and cleaner energy sources
• Global financial crisis/Lehman Bankruptcy-this may have slowed the Chinese reform program
• 2008 Beijing Olympics-China comes out to the world in the same way Japan did in 1964. Japan’s GDP peaked over 20 years after the Olympics so if we apply the same math to China we could expect a peak around 2030.

What has happened over the last 1.5 years?

• decline in oil prices caused by OPEC maintaining high production levels despite reduced demand
• and secondly as some commentators have referred to it the Great Fall of China-a mini collapse in the equity market capitalizations of Shanghai, Shenzhen and HK stock exchanges both phenomenon are regarded as linked. The onshore stock exchanges may still be black-boxes poorly understood by outside professional investors who mostly failed to predict the $ 5 trillion drop in valuations in Q3. Oil price volatility is expected to increase as OPEC has relinquished its role of stabilizer and is also prone to sudden external threats such as Syria or Katrina

The growth in China’s energy consumption is now declining, oil storage tanks in China may be full, it is sending back the LNG gas it has purchased trying to sell over supplies into the spot market.

The energy sector globally is worth around $7 trillion and is about 10% of global GDP so any large change in energy prices is pre-ordained to impact the global economy through declining CAPEX.

The decline in oil prices is significantly impacting the economies in the oil producing countries in the Middle East and further afield in emerging markets in Asia such as Malaysia and Indonesia and in developed Asia - Australia - where falling iron ore, coal and LNG prices due in part to falling Chinese demand and over supply and over production are negatively impacting Australia’s fiscal outlook.

Japan being a major fossil fuel importer is obviously benefiting from lower energy prices although the lower exchange rate over the last 2.5 years has reduced this impact.

We all now understand that a major transformation is underway in China as it transitions away from infrastructure development and Germantype export growth model toward a consumer-based economy.

100 million additional Chinese may migrate to urban centers over the next decade. Almost 23 million cars will be sold in China this year significantly more than the US and almost 5 times Japan auto sales, many of them VWs.

China needs to move away from what some commentators describe as an Irrational Construction boom that is debt-fueled. Estimates are that over $20 trillion of debt was added in China between 2007 and 2014 alone with 96% of the lending from public sector financial institutions. This may have taken aggregate Chinese debt to 300% of GDP.

Global public and private debt has also risen by a staggering $185 trillion over the same period.

How will the Chinese economy evolve, how will its energy consumption evolve, and what might the impact be on international trade ? What is the NEW NORMAL for China now and where might it be in 2030?

In other words What Comes next?

China needs to significantly reduce the fossil fuel energy intensity of its economy. Japan’s economy is around 250 % more energy efficient than China’s.

This should be an area that Japan can show significant regional and technological leadership.

Amory Lovins of the Rocky Mountain Institute who was here last week is working with the Chinese government on a Yr2050 plan that plans for GDP to increase to $50 trillion (5 x current GDP) by 2050 with only half its current energy consumption. Increasing the energy productivity of China by a factor of 10.

However, China will continue to need to focus on alleviation of energy poverty, its aspired energy security that was forfeited in 1993, and climate and environmental issues. Unlike Japan China has a Ministry of Energy and a State Energy Commission that sets and enforces energy policies.

However, China’s domestic oil and gas reserves are depleting. China is signing contracts with Russia and its central and south Asian neighbors including Myanmar. China is importing coal from Australia.

Perhaps later we can discuss what role the new sand castles/sand islands in the South China Sea may play in terms of delivering energy security to China.

China is at the end of its 12th 5-year plan and may adopt and publicize its 13th 5 year plan later this month covering the rest of this decade.

The energy and environmental focus of the 13th Plan is expected to dwell on cleaning the air of particulate matter in urban centers and the 14th and 15th plans that cover the 2020s will focus on CO2 reductions and coal peaking and coal replacement or upgrade to clean coal. China’s coal reserves may still represent around 40 years of current consumption.

China has committed to peak its C02 emissions and its coal usage by 2030. Reducing the footprint of the coal sector wmay be a huge challenge for China’s Political Establishment. 10s of million of Chinese may be employed in coal mining.

China is the world’s largest investor in clean energy and is the world’s leading producer of solar panels and wind turbines.

China currently has 25 or so Nuclear Power Plants and is building another 30 and expects to ultimately take NPPs to 150 units (US/100, Fr/50).

Japan is assisting with these efforts as Toshiba/Westinghouse are building 4 of those reactors.

In the most recent Xi-Obama summit China also committed to create a Cap and Trade emissions trading scheme by 2017.

Reverting to the economy if China is to transition over to a consumer based economy then $2trillion of additional domestic consumer demand needs to be created at minimum.

The question may be the extent to which China’s consumer incomes that are estimated at $5 trillion/annum can support further consumption? No income, no consumption… recent Chinese trade data is again disappointing.

To get to the global average GDP of $12,000/capita Chinese GDP also needs to double to $20 trillion.

All of this needs to take place in an environment in which the global economy is slowing.

We need to consider whether this is possible as it should require major reforms in labor mobility, land ownership, reform of capital and banking markets and interest rates and exchange rates, social security, reform of State Owned Enterprises, and the role of innovation.

What role will the new AIIB play? Will other post-Bretton Woods Asian focused multi-lateral institutions emerge?

Will China expand RMB bi-lateral currency trading arrangements beyond what it is currently doing with Russia, Argentina, and Venezuela? What about China’s Real Estate market that accounts for ¼ of GDP? Banking and insurance? 8 of the largest market capitalizations on China’s Stock Exchanges are banking or insurance, the other two being oil and mining.

We see some European countries particularly England and Germany keen to engage more actively with China. Both immediately joined AIIB unlike Japan. China will participate in Hinkley NPP construction and as quid pro quo the British government has guaranteed to give China mgt of a nuclear facility in Essex on the east coast, the first time an OECD country will grant a nuclear license to China.

China has also rolled out its One Belt-One-Road strategy that is expected to deepen economic integration with Central and South Asia, Shanghai to St Petersburg/Berlin axis.

The Trans Pacific Partnership was also signed last week with estimates that this could reduce Chinese growth rates by another 2%. Will China join? South Korea, Indonesia, Thailand, and Philippines are also outside TPP establishment.

Will this new exclusionary trading block push South Korea, Indonesia, and Thailand closer to China? How will Japan help to overcome these economic insecurities among its close allies?

On the security side China borders what many regard as the most challenged countries on earth, Pakistan, Afghanistan and North Korea. It then has territorial issues with Japan, Taiwan, Philippines, Vietnam and Malaysia.

We have no NATO in Asia. Should one be created? Can UN dispute mechanisms resolve these territorial issues peacefully?

What role might China play in the evolving situations in Iraq, Syria, Yemen, and Libya that may have a significant bearing on oil prices?

What about its domestic security challenges in the west in Xinjiang and Tibet ?

Xi Jinping is likely to be in power until 2022 half way through a 2nd term of the next president of the US so there is expected to be political stability over the next 6/7 years.

One might also expect democratic reforms to evolve in China over the coming two decades. However, is that possible?

China will also assume presidency of the G20 group of countries in 2016.

And back to HK where I started. As you know when Britain returned its colony to China in 1984 it insisted on a one-country two-systems one 50 years. When Thatcher visited in Beijing in 1984 she asked Deng why he agreed to that and he said it would take 50 years to bring the Chinese economy up to a level similar to the west. 50 years expires in 2047.

I would like to end by saying that I believe Japan can and should play a major role in resolving some of the challenges that I have outlined above.

I would like to close there and thank you for your kind attention.

Tom O’Sullivan
Mathyos Energy
13 October 2015
Tags: china, china slowdown, mathyos

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