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On AsiaJune 2004 Over a Barrel?By Andrew T. Foster, Head of Research As prices hover around $40 per barrel, investors are assessing the risks that oil poses for their portfolios. Observers in financial markets often single out Asia Pacific1 as a region that is particularly susceptible to price hikes; oil is perceived to be the region’s Achilles heel. Asia Pacific’s Energy Profile
(1) One “metric ton of oil equivalent” provides the same energy as 7.33 barrels of crude oil.
(4) Based on average market prices of $17.97 and $28.50 per bbl in 1989 and 2003, respectively.
Sources: U.S. Department of Energy, World Resources Institute, Goldman Sachs, Bloomberg, Matthews International Capital Management, LLC There is some truth to this idea. Asia Pacific utilizes a great deal of oil: at present, the region consumes 1.1 billion metric tons each year, which is about 11% more than the U.S. does.2 Moreover, the demand for oil continues to rise, outpacing the growth of the region’s various economies. Oil demand is up 102% since 1989, whereas the regional economy has risen 87% during the same period. Unlike the U.S., which has shifted away from heavy industries towards service sectors, Asia Pacific has a growing manufacturing base with expanding petroleum needs. The region requires about 22.3 million barrels of oil per day to keep its transportation systems running and its factories humming. This thirst for oil presents a significant challenge for the region, because like the U.S., domestic production is not large enough to keep up with demand. Despite steadily growing capacity, the region produced just 7.7 million barrels per day during 2003, which is enough to meet only one third of its needs. (By comparison, U.S. production satisfies approximately 45% of domestic demand.) This shortfall forces the region to either draw on its minimal reserves of oil, or turn to imports to make up the difference. Production shortfalls are more acute in some countries than others—Korea and Japan are notably oil deficient-but the majority of the region is at least partially dependent on imported petroleum. Despite a clear dependence on oil, it may be too simple to conclude that high prices will necessarily dull the region’s growth. One argument to the contrary is that oil is still not the region’s most important source of fuel. Even after recent increases in oil consumption, petroleum accounts for only 34% of Asia Pacific’s aggregate fuel demand. Historically, coal has been a more important energy source for the region (it is used to fire up China’s plants and electric generators); for the moment, it remains the region’s leading fuel. Demand for natural gas has seen sharp increases in recent years, and may quickly rival petroleum as a source of energy. Alternative energies are also employed across the region, whether it be nuclear power in Japan, hydropower in China, or wood products in India. However, regardless of whether the region balances its fuel consumption by utilizing non-oil energies, the future likely entails rising petroleum demand. Yet, increased oil usage will not necessarily impede growth. Instead, much of the region’s marginal oil demand is the direct product of rising domestic consumption, which may beget even more growth. Consumers are beginning to spend in earnest again for the first time since the 1997 regional financial crisis. China, in particular, has discovered the automobile; car sales have spiked over 60% for the last two years - and the country still has only about 9 cars per 1,000 capita, versus 475 in the U.S. A great deal of growth in China’s auto market may yet materialize, and with it, increased mobility, freedom and consumer spending. From this perspective, Asia Pacific’s reliance on oil is symptomatic of a robust outlook rather than a permanent structural weakness. Even so, the region may suffer if prices rise too far, too fast; the oil-induced recession of the early 1980s is illustrative of how an extreme price shock can choke off growth. Although oil is currently trading near record prices, it still has not reached the heights achieved during that era, as measured in inflation-adjusted terms. Oil’s relative “cheapness” can be observed via the ratio of oil demand relative to the size of the overall economy. At the height of the 1980 crisis, oil demand represented roughly 7% of global GDP - effectively, for every dollar earned, seven cents were spent on oil. The current oil bill is substantially lower, even accounting for recent price hikes. During 2003, Asia Pacific’s oil demand comprised 2.7% of regional GDP, based on an average price of $28.50 per barrel. With prices now near $38.50 per barrel, demand represents about 3.7% of Asia Pacific’s GDP. The region also has one key advantage that may help blunt the impact of rising oil costs: its currencies. Central banks around the region have suppressed their currencies relative to the U.S. dollar in order to remain competitive on a trade basis. In the process, Asia Pacific has accumulated an enormous store of foreign reserves, roughly $2 trillion in U.S. government-backed securities. Should Asia Pacific’s governments decide that maintaining domestic demand via oil consumption is paramount, they could easily unwind a portion of these dollar reserves via oil purchases, rather than continuing to hold U.S. bonds. Effectively, Asia Pacific has saved up enough to weather a very “rainy day” in the global oil market. In the end, rising prices may not be the region’s greatest threat, but rather the risk of an interruption in supply - but that is a risk that Asia Pacific does not face alone. |
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