May 27, 2015
China oil demand for the first four months in 2015 has been stronger than expected and decoupled from weak industrial production growth. Lower oil prices have helped stimulate SUV sales which are in turn pushing up demand for gasoline. As demand proves more elastic to price than many expect, we anticipate further positive revisions to demand, which will be positive for oil price and oil linked equities in the near term.
• China has surpassed US as the largest oil importer of crude oil as lower prices have led to stronger apparent demand growth and increased stockpiling.
- Chinese oil imports reached an all-time high of 7.4MMbls/d (+9% y-o-y, +0.6MMbls/d) in April, exceeding US crude oil imports for the same month (7.2MMbls/d).
- Stripping out crude purchases for the strategic petroleum reserve and commercial inventories, underlying apparent demand increased by 6% y-o-y.
- While industrial output growth has been a good proxy for oil demand in the past, there are clear signs of decoupling, as oil demand becomes increasingly a function of demand for transports than industrial activity.
• China oil demand is being driven by exceptionally strong gasoline sales, which reflects stronger underlying demand for transportation fuels.
- Apparent gasoline demand increased by 20% y-o-y in April to 10MMT per month (2.8MMbls/d), which was an all-time high and double the level from 2008.
- While jet fuel (kerosene) demand was also strong, diesel demand remains relatively sluggish on weak industrial growth in China. Further loosening of monetary conditions could help boost demand near term.
• Stronger gasoline demand has in turn been driven by stronger SUV sales which we partially attribute to the 30% decline in gasoline prices in 1Q15.
- SUV sales have been growing at 50% y-o-y in China and now represent over 25% of passenger vehicle sales in mainland China
- While increasing SUV sales has been a long term trend, the acceleration in SUV sales coincides with gasoline prices were almost 30% lower y-o-y in 1Q15. Despite lower fuel efficiency, the fall in gasoline prices has meant that SUV’s today have comparable fuel costs to Sedan’s a year ago.
• We expect further positive revisions to global oil demand estimates as demand proves to be far more elastic to oil demand.
- With China oil imports growing at 9% (year to date) and apparent demand growing at
6% (year to date), IEA demand estimates of 300mbd growth (3%) for China are too low.
- More broadly, we expect that that oil demand will prove to be far more elastic to oil prices than currently assumed (as was seen during the 1980’s). While demand estimates have been raised from 0.7MMbls/d to 1.1MMbs/d, this does not go far enough in our view. We expect further positive revisions from the IEA throughout 2015
• We continue to believe that markets will tighten in the near term pushing up oil prices, which will be positive for oil linked equities.
- Oil markets are rebalancing and we expect demand growth to significantly outpace non-OPEC supply growth as we go into the second half of the year, with a supply deficit of 1.5MMbls/d in 4Q15.
- While inventories are high, spare capacity is extremely low at 2.5MMbls. Any unplanned supply disruption or surprise on the upside for demand will support prices.
A controversy for oil markets is how elastic demand will be to lower prices. While the perception is that demand is inelastic to price, we expect that demand will prove more elastic to price than many expect.
Recent data from China support this view. Oil imports in China continue to grow at close to double digit rates. Not only is China now the largest importer of crude but apparent oil demand (stripping out commercial and strategic stockpiling) has increased year to date by 6% year-on-year, primarily on stronger gasoline demand. In turn, the growth in gasoline demand appears to be a result of SUV sales which are growing at 50% year-on-year, (partly) in response to the fall in gasoline price. We expect positive revisions to current global demand estimates of 1.1MMbls/d which will further help to rebalance the market as non-OPEC supply growth slows. This will be positive for oil and oil linked equities in the near term. Our top picks in the region are CNOOC, Oil Search, Inpex and InterOil.
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