Why Investing in Oil is Investing in China

 he title is obvious: China is one big reason to invest in Oil. No need to go into a list of emerging countries, China by itself is sufficient to justify this investment because it is increasingly becoming a heavyweight player in the supply and demand game.

China‘s Thirst for Oil

China’s growth has been stellar with high GDP numbers reported yearly. On one hand, China is producer – its net export of goods and services has been rising steadily. On the other hand, its high production rate has also given rise to a thirst for resources.

In 2009, Chinese crude oil imports accounted for 52% of the country’s total oil consumption, up from 45% in 2006. Importing more than 50% is recognized as an energy security alert. By 2020, analysts believe that 65% of the oil consumed in China will have to be imported. Not that long ago, China was an oil exporter in 1992.

In June of 2010, China posted record crude oil imports of 5.4 million barrels per day. So far this year, China’s crude oil imports are running at an average 4.77 million barrels per day, up a massive 30.2 per cent year over year. The United States is still the leading oil consumer, at 19 million barrels a day against China’s second-place 9.2 million.

China’s oil production is not able to match domestic demand and currently sits at a flat 4 million bbl/d as of 2009.  China is becoming increasingly reliant on oil imports. In order to continue its growth it requires access to cheap energy which is why it is currently scrambling to secure by acquiring oil and gas assets worldwide. The EIA reported that China’s major national companies’ overseas investments reached 29$billion between January 2009 and April 2010.

According to the International Energy Agency, China’s oil demand is expected to double by 2030 to over 16 million barrels per day as more people rise from poverty, move out of villages and buy more cars. What does buying cars have to do with oil demand? Globally, transportation of people and freight currently accounts for at least 60% of oil consumed. Ask anybody about uses of oil and the first thing that comes to mind is fuel for transportation.

China‘s New Love for Cars

China dethroned the United States as the world’s largest auto market in 2009 with 13.6 million vehicles sold, up from just 326,000 in 1995. If you look at the following graph, you will realize that car sales rose 500% in less than a decade. For 2010, vehicle sales in China are set to hit at least 16M units. Even if the US auto market recovers the no.1 spot following a strong economic recovery, it will only be temporary until the Chinese recapture this position within the next decade for good.

A UBS report entitled “What if everyone in Chindia had a car?” says that just 4% of Chinese over 14 and 1% of Indians have cars. In South Korea it’s 26%,  in the U.S. it’s 44% and in Japan, 46%. If China was to reach South Korea’s ownership level, it implies a 5.7 times growth potential. There is a huge growth potential left for car sales in China and India directly impacting daily global oil consumption. Since I am focusing on China with an oil investment time frame of 10 years, let’s drop India from the equation and work with more conservative numbers.

Let’s assume that Chinese car sales settle at 15 million vehicles per year for the next 10 years. That means a 0% growth rate for the next decade, which is unlikely, since estimates for 2021 are China will be selling close to 25 million units. Following our assumption, by 2020, 150 million cars would have been added. The current fleet is about 50-60 million vehicles which implies a growth of about 400%.

The conservative scenario above could generate annual oil demand growth of at least 400,000 bpd* ((2L/car/day * 15M cars)/75L of gasoline per barrel of oil), and we can also add in increasing Chinese trucking, petrochemical and aviation consumption. For 2011, the IEA estimates that global crude oil demand will grow by 1.30 million barrels per day (mbpd) next year to a record 87.84 mbpd. China will be driving over 25% of that demand growth.

It is likely that demand will push inflation up. According to the fisher equation, that should mean interest rates will be up too. For investors calculating yield to worst, this is great news – it would make companies calling their bonds less likely.

Final Thoughts

In our scenario, China would not even meet South Korean car ownership levels. It is clear that the impact on global oil consumption by 1 country is significant because of the size of its population. China with its car market alone will be fueling demand for oil on a yearly basis. We have not discussed other countries such as India or Brazil which recently surpassed the German car market.

For the tree huggers amongst you, don’t bet on the electric car so soon; it will take many years before it dents global oil consumption. Many factors have not been taken into consideration here such as the uniformity of growth in China. We have only reviewed the vehicle component of Chinese growth; should per capita demand for oil in China follow the historical path of those in the U.S., S. Korea, or Japan, oil imports to China will soar. Is this only the beginning of prosperity in China?

Finally, investing in oil is not only investing in China, investing in oil is investing in all of the emerging economies; it’s investing in the world economy. The beauty of it, especially for us North Americans, is we can get this exposure by investing using our own currency and in our own domestic producers.