 "Dr Mosongo Moukwa")
Last August, China devalued its currency. This shocked the market as analysts interpreted this move as a means to stimulate China’s exports and its economy. The Chinese Yuan has been on an upward track for a decade when the country grew to become the second largest economy in the world. As the government is growing concerned about slow growth, it decided to cut the value of its currency by 2 percent.
Technically, the People’s Bank of China (PBOC) has revised the way China sets a midpoint for the value of the Yuan against the US dollar. Daily trading and previous day closing price will now determine the exchange. This devaluation was the most significant exchange value drop to the Yuan since 2005 when China reformed its currency system to have a strict tie with the US dollar and in favour of a looser tracking policy. Chinese authorities stated that this devaluation would help drive the Yuan toward more market driven movements. Economists have predicted that China’s currency would continue to slide against the US dollar until the end of 2015.
China also recently launched its own oil benchmark, similar to Brent and WTI (West Texas Intermediate), striving for a more important role in establishing crude prices. In the new oil benchmark, the Chinese contracts will be in the Yuan, not in the US dollar. China is seeking to gain more control over the pricing of its main source of energy. At the same time, it is loosening its grip on the physical sector by granting quotas for imported crude to privately owned refiners for the first time. This provides more favorable market conditions for the launch of crude oil futures.
So what difference will it make to the rest of the world?
The role of China in the energy market
According to BP Statistical Review, oil demand in China has risen 4.5 mbd since 2004, most of which from imports. China now accounts for one barrel in every eight traded internationally. China’s coal consumption is up by almost 80 per cent over the last 10 years and the country now burns more than half of all the coal used worldwide each day. Twenty-three percent of the world’s primary energy consumption is now accounted for by China. The country’s total energy consumption has risen by more than 90 per cent in the last decade.
Impact on oil prices
A cheaper Yuan makes Chinese exports less expensive, boosting exports that have been the main drivers of growth over the past two decades. If China’s devaluation deepens, pressure to weaken currencies could become particularly intense in other Asian nations that export large amounts to China or compete with Beijing in other markets. Many Asian nations have cut rates this year and could be forced to take further action.
China’s insatiable thirst for natural resources has been a key factor supporting the price of oil in recent years. Fears that China’s economy is in trouble tend to undermine oil prices, coupled with other factors such as strong oil production in the US. The Yuan devaluation did not do much for oil prices. However, what is certain is that the improvement in the domestic market is what will fuel most of oil needs.
A slowdown in the Chinese economy would have a significant impact on the global economy. Indeed, China has driven the global growth, which has averaged around 3 percent since 2008. According to The Organization for Economic Cooperation and Development (OECD), a 2 percent decrease in the Chinese domestic demand for two years would decrease the world GDP by 0.3 percentage points a year.
Impact on the energy market
The prospect of several years of low growth in China will have implications on the global energy market. Import growth will be minimal for the next two to three years. This in turn will compound and extend the existing surplus of supply over demand. Foreign investments in the energy sector, including nuclear and liquefied natural gas (LNG), will be cancelled or postponed. Projects outside China by Chinese investors would be put on hold. With the Yuan now tied to market movements, Chinese manufactures have also lost the predictability they once had when planning investments. As China’s economy is slowing down, the focus would most likely be on domestic demand and investments.
China still remains a dominant player in the world energy markets. The country does not have much choice but import energy in order to meet its needs. But, the ground has shifted in many ways. The Japan’s Institute of Energy Economics simulated that if GDP performance is 1.5 percentage points below expectations through 2040, it will cut oil demand by seven million barrels a day from forecast levels. As China seeks to boost non-fossil fuel energy, including nuclear, to 15 per cent by 2020 and 20 per cent by 2030, the reliance on oil and gas is being chipped away. The current picture is a reminder that prices in all energy markets are set by the balance of supply and demand. China is the most important country on the demand side.
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Dr Mosongo Moukwa is director of technology at PolyOne, USA, and was recently an independent consultant based in Chapel Hill, USA, and vice president - technology at Asian Paints Ltd, Mumbai, India. He is a member of the American Chemical Society and Product Development Management Association.
Email: mosongo@mosongomoukwa.com
