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Marcuard's Market update by GaveKal Research
A recent report in the People’s Daily that Beijing city will eliminate all large scale coal boilers within the city center by 2015 is another sign of the shifting winds in global commodity and asset markets. The move is certainly a self-interested one on the part of China’s new leaders, who breathe the same filthy air as the proletariat when they leave the carefully filtered confines of their private compound in Zhongnanhai.
But the broader message is clear. As we argued in a previous comment on Commodities: This is Structural, the age of coal-powered and heavy industrial led growth in China is over. Slower, less electricity intensive, and cleaner growth is bad news for bulk commodity producers and shipping stocks. But the winners will also be many. China continues to forge ahead with its ambitious nuclear agenda, import rising quantities of natural gas, and struggle to unlock its own substantial shale gas reserves. Its energy transition will be as transformative on the demand side as the unconventional energy revolution in the US is proving to be for the global energy supply— although it will take time to unfold.
What exactly do we mean by saying that coal-powered growth is over? Clearly, China remains massively dependent on coal for its energy needs—the black stuff still supplies 70% of all energy and accounts for 80% of electricity production. When Chinese power demand growth was galloping along at 10-20% annually and the energy intensity of the economy was actually rising as it was in the mid 2000s, the nation naturally turned to the cheapest and most abundant energy source on earth, which China also happens to be liberally endowed with. But the forces which pushed China into a tight embrace of the dirtiest fuels over the past decade are now abating.
First, growth is lower. Chinese electricity demand growth has slowed decisively along with the construction-led industrial complex. As we argued last year: Metals, the industrial economy has already began to shift away from energy intensive metals and cement led growth, although the shift remains fitful. When power demand is growing at 7% and 30% of an increasingly scarce industrial water supply is being sucked up by coal power, the logic for coal is far less compelling.
Second, the rising outrage of the Chinese urban middle class over horrific air pollution is becoming a major concern for the leadership. In the 2000s as China was rapidly transitioning from a poor rural to a middle income urban society, the nation’s leaders could safety focus on building cities and moving people into them, without worrying overly much about things like quality of life, which richer citizens tend to value. But as we have highlighted in recent work many Chinese have now reached a critical mass where they are able, and very willing, to spend money on items that would have been considered luxuries a decade ago. This includes clean air. Middle class urbanites, who have been a critical piece of the Communist Party’s support since reform and opening began, have already begun to demand a quality of life more comparable to citizens of other middle income nations.
China’s leaders will be forced to respond—and indeed they already have. New sulfur and nitrogen oxide emissions requirements are raising capital costs for generators. And December 2012’s coal power price reform ensures that should coal prices recover down the line, the power grid will no longer be artificially insulated from higher prices—a major reason that wind and natural gas power have not gained higher market share in China. Coal power retains the dominant share of power supply in China, but in 2012 saw its share drop almost -3% to 78.5%, the lowest in a decade.
In sum, coal’s dominance in China will continue to erode, even in an environment of lower prices — which in Asia at least largely reflect weaker Chinese power growth on the demand side anyway. The winners will naturally be the purveyors of credible alternatives and their enabling technologies. Chinese demand for natural gas will help ameliorate (although not eliminate) a likely coming glut of LNG supply in the Pacific in the second half of the decade, and support uranium and nuclear technology providers in an environment of weak OECD demand.
Most importantly, whoever can help China unlock its own massive shale gas reserves at the right price will hold something of a golden ticket, if they can protect the technology once they have it. China’s shale reserves are apparently massive—larger than the US’s—but deeper and in water-scarce areas of an already water-scarce country. Chinese policymakers have thrown their support behind shale gas development, but progress has been slow. The oil service firm which can solve these technological problems and market them to the Chinese oil majors would find itself in an enviable position indeed.
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