Treasury’s very long China boom

By Leith van Onselen

The Australian Treasury yesterday released an interesting paper (below) as part of its Economic Round-up series, entitled China’s emergence in global commodity markets, which analyses the history of China’s demand for commodities and the potential path of future demand.

As readers are probably aware, the rapid growth of commodity demand from China since the early-2000s is the key driver of Australia’s surging terms-of-trade, which recently touched 140-year highs (see below chart).

Because of this commodity demand, China has grown to become Australia’s largest export destination, accounting for around 30% of total merchandise exports (see below chart).

With a large share of this export growth coming from the sale of iron ore and coal exports (see below chart).

The Treasury paper provides some interesting background and data on China’s influence on global coal and iron ore markets, which are obviously of key significance to Australia:

A direct consequence of China’s rapid economic rise has been its rising demand for energy, which has had a significant impact on global markets for energy commodities. China’s share of global primary energy consumption has risen from 8 per cent in 1990 to 20 per cent in 2010 (Chart 4). In particular, oil and coal demand has increased rapidly over the past two decades, and accelerated since 2000, reflecting China’s rapid GDP growth and the structural shift in its economy towards energy-intensive heavy industry and infrastructure investment.

Notwithstanding the potential for energy prices to remain high and pressure to meet environmental goals, prospects for future Chinese energy demand growth remain strong, given that China’s per capita consumption of energy remains at only one-third of the average of Organisation for Economic Co-operation and Development (OECD) members. The International Energy Agency (2011) estimates that China’s primary energy demand will rise by 2 per cent per annum to 2035, at which point China will account for 23 per cent of global energy demand. While gas and non-fossil fuels are expected to take on a greater share of China’s energy mix in future decades, the transition in the fuel mix will occur slowly due to long asset lifetimes for existing energy infrastructure.

Looking ahead, China is expected to consume nearly 70 per cent more energy than the United States in 2035, be the largest oil consumer and oil importer, and will continue to consume nearly half of world coal production (IEA, 2011)…

China’s share of global iron ore consumption has more than doubled since the beginning of the 2000s to reach 52 per cent in 2010 (Liu and Grafton, 2011). Chinese iron ore production has been unable to keep pace with sharply rising demand as a result of transportation bottlenecks, low-quality ores and high marginal costs of production. Despite being the world’s fourth largest iron ore producer (producing 15 per cent of global supply), China dominates global iron ore markets and accounted for around 70 per cent of global imports in 2009 (Christie, Mitchell, Orsmond and van Zyl, 2011).18 Around 40 per cent of its iron ore imports are sourced from Australia (amounting to an annual trade of around 280 million tonnes, or A$40 billion, in 2010-11)…

China is likely to remain dependent on imports for a number of key intermediate inputs to metals production…

Looking ahead, the underlying sources of Chinese metals demand are expected to remain strong, with construction, infrastructure, machinery and motor vehicle production projected to grow robustly for some time…

These per capita studies are all very impressive and perhaps right. But there has been a recent global debate led by investment banks around an alternative way of viewing the historic progression in China’s metals consumption. Citibank and Nomura have both recently argued that it is not consumption measures per capita or GDP unit that matters but the “value in use” that matters. From Zarathustra:

…while commodity consumption per capita-type of analysis shows that China’s metal consumption does not look very stretched, this type of analysis is understating the true usage. Citi argues that the value in use (i.e. taking the prices of those metal into account) analysis shows that China has overtaken most of the developed world in terms of metal consumption, while Nomura points out that the amounts of various metals used per USD1 million of GDP for China are basically outliers and outrageously high:

It would be nice to see Treasury argue why it sees consumption and GDP per capita is the appropriate benchmark.

The Treasury paper then concludes that the long-term outlook for Chinese commodity demand remains robust due to strong underlying drivers. :

China’s rapid economic rise has had a significant impact on global commodity markets in recent years, and will be a key influence on future market developments. China has emerged as the leading consumer of a broad range of commodities — especially energy and industrial metals —and is a significant player in most major commodities markets, including agricultural commodities.

Strong economic growth, underpinned by commodity-intensive investment has sustained global commodities demand since the global financial crisis. With weak growth among advanced economies, China has taken an increasingly large share of global commodities consumption growth over the past five years. Although there will be short-term fluctuations around China’s growth, and China faces significant medium-term reform challenges, the long term outlook for Chinese commodity demand remains strong as the process of urbanisation and industrialisation, and a growing middle-income class are set to continue for some time. Per capita consumption of key commodities, like per capita income, is still well below that of major advanced economies.

Economic rebalancing in China could have significant effects on future Chinese commodity demand, with significant implications for global markets. A more rapid shift from investment- to consumption- driven growth could slow the pace of metals and energy demand, although many consumption goods, such as automobiles, are still comparatively commodity intensive. Future Chinese commodity demand may be constrained by its already dominant position in some global commodity markets and the rate of growth of commodity supply…

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Australian Treasury – China Commodity Demand