What China's 'Small City-ization' Does For Energy Demand?

What China's 'Small City-ization' Does For Energy Demand?
G. Allen Brooks takes an extensive look at China's new urbanization program and how it might impact the country's growth in energy consumption.

Global economists, Wall Street investors and politicians worldwide are growing concerned about the pace of growth of China’s economy.

Absent a robust U.S. economy, trapped on a slow-growth path by structural and government policy challenges, and saddled with political sclerosis in Western Europe, the world economy is searching for the next driving force for growth. That force is supposed to be the developing Chinese economy, which had been growing at double-digit rates for the past several decades. Lately, China’s economic growth has slowed to high single digits rates but now appears to be slowing more. Recently, the World Bank cut its 2013 growth forecast to 7.7% from its prior 8.4% estimate. Other financial institutions have issued new Chinese economic forecasts that call for even slower growth this year and barely any increase next. The latest economic data from China appears to be confirming the slowing and highlighting the challenge the government faces in boosting the growth rate.

The problem for China is that its economy’s rapid growth in the past was due to it becoming the low-cost manufacturing center for the global economy. China’s economic growth came via expansion of its export sector. To handle that new role, which resulted from China’s large pool of unskilled, thus cheap, labor, the country invested in plants and infrastructure to foster export growth. That expansion also meant significant increases in consumption of raw materials and energy. To feed its low-cost labor pool, the country encouraged migration of rural residents to manufacturing centers located near large cities in the coastal provinces. There are estimates that 17% of China’s population currently living in its cities does not have official urban status allowing them to register for schools and social benefits. These migration trends and growth policies have contributed to the major pollution problems that impact the livability of major Chinese cities. Estimates are that every year China experiences 400,000 premature deaths from respiratory diseases due to air pollution.

As a possible way to reorient China’s economy and boost its sustainable growth, the government is engaging in a kind of populist urbanization, which is really focused more on “small city-ization” rather than traditional “urbanization.” This policy is meant to focus on developing emerging cities rather than expanding large existing ones. The policy is being implemented by bulldozing farms and villages and moving the people into newly constructed cities with high-rise residential towers. By 2025, China is expected to have over 200 cities with populations of more than one million people. What lies behind this new strategy? According to Chinese Premier Li Keqiang, city residents spend more than rural residents on services such as schools, healthcare, leisure and financial advice. This spending would help boost the country’s services sector and reduce the economy’s dependence on exports. Premier Li also cited the reality that the services sector is “capable of absorbing the largest number of new employees and is an important driving force behind scientific and technological innovation.” In a nutshell, the plan is to bring rural citizens to where their children can obtain better educations, health care and training that will make the future Chinese labor force more skilled and productive, able to compete on an international scale rather than to be limited to competing only based on low cost labor and manufacturing capacity.

According to China’s 2010 census, 51.3% of the country’s population resided in rural areas, down from 63.9% in 2000, when a different counting system was employed. In 1970, the rural population represented 70% of all citizens in China, down from 95% in 1920. Projections call for China’s rural population to represent less than 40% by 2030. To understand the scale of this government urbanization effort, there are about 800 million rural peasants and migrant workers. Of that total, 500 million are farmers and 300-400 million are excess unskilled rural laborers. The government’s target is to move 250 million rural residents to these newly constructed cities. The big impact of this urbanization program will be to boost average annual family incomes and spending, and change spending patterns. Studies show that migrant rural workers tend to maintain their historical spending patterns and send most of their money home. Their new urban domicile is just a place to sleep and eat according to Nielsen Greater China.

Musings: What China's 'Small City-ization' Does For Energy Demand?

Urban household income is significantly higher than rural incomes, which helps support the increased spending on services, but also boosts spending on appliances and gadgets, all of which will have an impact on China’s future energy needs. Studies show that every 100 households in rural areas own on average 89 color televisions, 22 refrigerators and 62 cell phones. The same number of urban households own 137 color televisions, 92 refrigerators and 153 cell phones.

The growth in household incomes and the disparity between rural and urban incomes is a long standing issue, which the government attempted to address in the past. An article from China Daily in 2010 cited income statistics from China’s National Bureau of Statistics showing that in 2009 annual urban household disposable income was 17,175 yuan ($2,515) versus rural incomes of only 5,153 yuan ($758), or a ratio of 3.31:1. In 1978, China introduced the household contract responsibility system in rural areas. As a result, the then urban to rural household income ratio of 2.56:1 declined to 1.82:1 by 1983, its narrowest ratio in modern times. The income gap widened starting in 1985 as the focus of the reform shifted to cities. A projection from McKinsey & Company shows that if the government’s urbanization measures go as planned, by 2022, 75% of urban Chinese will have annual household disposable income between 60,000 yuan and 229,000 yuan ($9,000-$34,000) a year. A key aspect of the government’s new plan is that when relocating rural citizens, they will be provided new apartments cost-free plus the state will pay the farmers for their land, or provide a monthly stipend or dividend stream from the payment for the land taken.

Land reform, such as now, has been a key aspect of past economic and political programs. During the 1950s, the Communist Party gave small plots of land with the encouragement for people to farm. A few years later those same farms were collectivized by the Party, but the peasants’ rights to use land were restored at the start of the reform era. Now, the government is trying to obliterate small landholders to help re-orient China’s economy and growth prospects. By boosting the percentage of urban residents, China hopes to lift per capita income.

Musings: What China's 'Small City-ization' Does For Energy Demand?

So what does all this mean for China’s future energy consumption, and especially for its use of oil? Given the country’s huge population (1.354 billion people) and its rapid economic growth over the past 47 years, China’s consumption of crude oil and refined petroleum products has demonstrated a steadily rising trend. Expectations are the trend will continue.

Musings: What China's 'Small City-ization' Does For Energy Demand?

The belief is that as China’s economy, currently ranked second in the world, grows and eventually surpasses the United States as the world’s largest economy, its need for increased energy, and especially oil, will grow. There are many stories about how China is building a new electric power plant every week and how its use of coal, the fuel source of choice at the present time, is growing rapidly. For the past decade, the world has marveled at the efforts of Chinese state energy companies to secure ownership of and access to fuel resources and energy technologies around the world. In fact, the efforts of some of these companies to buy western energy and raw material producers has provoked high profile intellectual (political) struggles over free markets versus national security issues in the host countries. It is also instructive, after considering the historical growth of China’s oil use, seeing where the country ranks among other leading economies in terms of per capita energy consumption. Data from the World Bank in Exhibit 9 shows per capita energy consumption, based on kilograms of oil equivalent per capita. The measure is calculated based on taking a country’s indigenous production plus imports and stock changes minus exports and fuels supplied to ships and aircraft engaged in international transport.

As shown, China’s per capita use of energy has grown, but still remains well below that of other wealthy and developed economies in Asia, Europe and, of course, the United States. The country listing shows that China’s energy consumption is more equivalent to that of countries such as Brazil and Mexico, but three times the consumption of residents of India. China’s energy use is about a quarter of that of Canada and the U.S., 45% of Japan’s use and a little under half the use in Germany and France. As China’s middle class expands, its desire for a life style that mirrors that of western countries will likely boost its energy use. The Chinese automobile industry is now producing vehicles at a 22 million units per year rate, 50% more than the U.S. and nearly twice the new car sales in Europe. Importantly, a third of China’s new cars are less fuelefficient SUVs. Although Chinese are buying many small and fuelefficient vehicles, there is also a large luxury car market, meaning fuel consumption will grow. The Asian Development Bank predicts that the number of cars in China could increase by 15 times the present level by 2035, producing three times the carbon dioxide emissions.

Musings: What China's 'Small City-ization' Does For Energy Demand?

To examine the relationship between China’s economic growth and its oil consumption, production and imports, we plotted figures from BP’s statistical database. We measured China’s economic growth as calculated in purchasing power parity terms. Until 1993, China was a net producer of crude oil, but as consumption began accelerating the country was forced to begin importing oil. That demand acceleration came as the economy’s growth ramped up from 8% to 14% between 1993 and 2000. The growth was surprising given the Asian currency crisis of the late 1990s, but demonstrated how the technology boom of that decade was powered by manufacturing in China. The tech implosion and 9/11 created a global economic contraction that was felt by China as its economic growth slumped to 4% before rebounding back to doubledigit growth. With the exception of a brief slump to 9% growth in 2006, China has enjoyed double-digit growth until the global financial crisis exploded in 2008. Despite slowing growth, China’s oil consumption has accelerated – both due to infrastructure investment and the start of a huge strategic oil storage program.

Musings: What China's 'Small City-ization' Does For Energy Demand?

Taking a closer look at China’s oil demand and economic growth, we can see how the country’s demand has slowed along with the economy. The chart in Exhibit 11 (below) shows that the three smallest yearly oil demand increases coincided with years of serious economic downturns. However, when we look at the oil demand growth projections for 2013 and 2014 from the U.S. Energy Information Administration’s (EIA) Short Term Outlook, they will rank among the lowest annual increases in the last 17 years. The key question is do the small yearly increases suggest significantly slower Chinese economic growth or does it reflect a shift in oil use?

Musings: What China's 'Small City-ization' Does For Energy Demand?

When we consider the Chinese government’s efforts to stimulate its services sector through its small city-ization program, we have to wonder what impact that could have on oil consumption. A Brookings Institute study in 2008 showed that U.S. cities had 14% lower energy footprints than the average for the country, meaning that cities are more energy-efficient. That conclusion was supported by a broader study from the International Institute for Environment and Development (IIED) of 11 cities around the world. They identified lower energy consumption as a result of denser housing and increased use of public transit. The IIED study also measured carbon dioxide emissions and found that in 2004, London’s citizens emitted 6.2 tons of CO2 each annually versus 11.19 tons on average for each citizen of the UK. The comparison of city dwellers to average citizens was even more dramatic in the United States where citizens of New York City emitted 7.1 tons each per year versus a national average of 23.92 tons. Lower emissions equals lower energy consumption.

Musings: What China's 'Small City-ization' Does For Energy Demand?

We would make two observations from the chart of CO2 emissions of the various cities included in the study in Exhibit 12. First, Tokyo’s per capita emissions are below those of both Shanghai and Beijing suggesting that greater prosperity of a city’s residents doesn’t have to mean greater pollution. Second, the official explanation for Washington, D.C.’s high per capita emissions figure is its small population size. The author of the study suggests it might be more appropriate to measure the emissions for the metropolitan area rather than the city. We wonder if the high figure is due to all those government vehicle caravans hauling politicians and visiting dignitaries around Washington, or maybe there is something to all the “hot air” talk there.

At this point we don’t know whether there will be a permanent downshift in oil use as China’s economy grows, especially in response to the government’s urbanization efforts. A 2007 study in The Nation by Elizabeth Economy, the C.V. Starr Fellow and Director of Asia Studies at the Council on Foreign Relations, stated that city residents in China use 250% more power than their rural counterparts. The report attributed the poor power relationship to the sorry state of China’s construction industry. Ms. Economy says that China’s buildings use 250% more energy than buildings in countries with comparable climates. The problem with many of these energy efficiency studies is that they are using older data and China’s economy is growing and evolving rapidly. The rapid increase in new cities built to more exacting energy efficiency standards will also skew old energy/population relationships.

The big push to urbanize the population to boost the service sector may be in some trouble, though, as a recent report says government officials have halted a plan to spend $6.5 trillion of investment for roads, homes, social welfare benefits and other public services. The most likely reason for the suspension is concern about the level of local government debt and volatility of the property market.

Musings: What China's 'Small City-ization' Does For Energy Demand?

The latest HSBC Holdings plc preliminary purchasing managers’ index for China’s services industry registered its second-lowest reading since August 2011 and sequential decline from the prior month. The latest Manpower Group Inc. survey of 4,241 employers in China showed service sector employers reporting their lowest hiring expectations since 2010. So if this urbanization program doesn’t work, China’s shift away from an export-based economy may not be achieved, making the economy increasingly subject to global economic trends and increasing cheap-labor competition from other Asian and Latin American countries. Without this economic shift, China’s demographic challenges of a rapidly aging population along with a shrinking work force will significantly alter the country’s existing energy consumption pace. At the moment there is no clear answer to how it may change, but energy markets are growing increasingly nervous.

G. Allen Brooks is Managing Director of Houston-based investment banking firm Parks Paton Hoepfl & Brown. This article originally appeared in the June 25, 2013, issue of PPHB's newsletter "Musings from the Oil Patch."




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G. Allen Brooks works as the Managing Director at PPHB LP. Reprinted with permission of PPHB.


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