The Beginning of Demand Destruction?

China_suvEarlier today, we looked at the decrease in miles driven in the US (Chart of the Day: US Miles Driven). Let’s put that into some context,  and consider a few goings on in China.

SUV sales may be falling off the cliff in the US, but in China, they are red hot. Sales of the large vehicles in China rose by 40% in the first four months of this year. That is twice the growth rate for the Chinese passenger car market.

Its no surprise why: The costs of petrol and diesel in China is as much as 40% cheaper than US levels (which are nearly half of European prices).

China, the second-biggest fuel consumer after the U.S, has been encouraging SUV purchases via subsidized fuel.

That now appears to be changing: The Chinese givernment  will
"increase gasoline and diesel prices by 1,000 yuan ($145.50) a
ton, the National Development and Reform Commission said," according to a Bloomberg report. This
represents a 17% price increase for gasoline and 18% for diesel. China is also scheduled to raise jet-fuel prices by 1,500 yuan a ton (~25%).

The response in Crude futures was immediate: Crude Oil fell almost $5, spurring gains in the broad averages.

Demand Destruction is now clearly upon us. Its a cliche, but its true: The best cure for high prices are high prices.


SUVs still roaring up China’s sales charts   
Geoff Dyer in Beijing
FT, June 17 2008 17:50

Oil Falls More Than $4 as China Announces Fuel Price Increase
Mark Shenk
Bloomberg, June 19  2008


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What's been said:

Discussions found on the web:
  1. Chief Tomahawk commented on Jun 19

    “The best cure for high prices are high prices.”

    Provided we all survive the ‘cure’.

  2. Feeling Stupid commented on Jun 19

    Stupid question time….How much is a ton in China? I know 2000 pounds, but is this a large enough increase to justify the oil markets dropping back 3 bucks or is this a shallow increase?

  3. SecondLook commented on Jun 19

    Yes, clearly there has been, and is, ongoing demand destruction. However, it’s also clear that demand for oil is relatively inelastic, that is, the decline in demand has been extremely modest in the face of dramatic prices increases over the past few years.
    There are a number of concurrent explanations as to why demand is so inelastic: the ratio between GDP (and household income) to the price; the high level of “fixed” consumption in the US – the minimum amount of fuel needed by consumers, the comparative lack of viable alternative energy resources, etc.
    It’s possible that we have now past a tipping point in price/demand; that demand will decline at a greater rate as prices remain and/or climb from these levels. That is the ah, big picture, question that will only be answered over the coming years. There is no certainty, it’s quite possible that most of the higher oil prices will simply cause a reduction in demand of other goods and services instead, especially the non-critical ones – a reallocation of capital on a household and business level.

  4. Bob A commented on Jun 19

    …might be a little premature to say the price hike will slow gas consumption in China. and if it doesn’t?

  5. DL commented on Jun 19

    “The best cure for high prices are high prices”

    Is that true in Zimbabwe…?

  6. Space Cowboy commented on Jun 19

    At 60 degrees Fahrenheit:
    a gallon of pure water weighs 8.34 lbs
    a gallon of Gasoline weighs about 6.15 lbs.
    a gallon of Diesel weights about 7.1 lbs.

    Ton of Gasoline = 325 gallons
    Ton of Diesel = 287.7 gallons

    China is adding .44 cents a gallon of Gas
    and .50 cents to a gallon of Diesel,
    .75 cents addition per gallon for JetA
    (which will not impact air travel ops costs)

    I’d venture not enough (uptick in price) to curb Chinese demand given pent-up desires to drive.

    They (too) desire to ‘ride in style’!

    Your mileage may vary!

  7. Sinomania! commented on Jun 19

    Another reason for SUV demand in China is that they are status symbols, they convey wealth and authority. Most SUVs in China come with completely tinted windows. I’ve seen them drive to the front a long merge line at toll roads and cops just waive them in, never know if there’s a party member inside. Notice that the number 2 category is mini cars like the QQ.

    But it’s not just China – car demand is up all over the place, in the Ukraine sales up over 60% in the 1Q, in even poorer parts of Latin America such as Ecuador sales are wasy up, all over the middle East, etc. America may still be the biggest single market buts sales are shrinking now and not much higher than levels of the late 70s.

  8. Brendan commented on Jun 19

    This may be a bit misleading, being that last year only about 5% of vehicles sold were trucks and SUVs, since there is still reluctance to buy a “gasoline powered rickshaw.” Body on frame vehicles haven’t sold well because of their utilitarian look. Perhaps the changing style of SUVs toward a “softer” look is the culprit. Or perhaps this shows that that sentiment is changing. But a 40% increase of 5% of the market is still relitively few cars. On top of that, as of last year, the sales of MVPs (minivans) was increasing at about half the rate as the average vehicle, showing a shift away from MVPs and toward SUVs, with only a slight overall change toward larger vehicles. See here:

    Oh, and a Chineese ton is the same as a ton just about everywhere in the world… except the US: 1000KG – or about 2205 lbs.

  9. jz commented on Jun 19

    It’s just like the oil nuts to say this increase in price means nothing. GDP per capita in China is $5300 versus $46,000 in China. The average person in China can afford an increase in gasoline a lot less than the average American.

    And China was the last big country to cut their subsidy. Malaysia, an oil exporter, cut their subsidies as did Indonesia, and in a move that got much less press, India cut theirs as well. All these cuts have been in the last month.

    And while Iran has not cut the price of its 56 cents gas, they are rationing how much cheap gasoline you can buy per month.

    Only Venezuela, Nigeria, and Saudi Arabia are now selling gas for less than $1. Mexico has not cut subsidies on their $2.45 gas yet, but it is only a matter of time IMO.

    Nonetheless, subsidies sure explain a lot. The reason third world oil demand increased so much was not just growth but that many third world consumers were shielded from the rise in price. Well, they aren’t now.

    And enough already about oil supply and demand being inelastic, who needs to drive a 10 MPG hummer over a scooter that gets 100 MPG most of the time? Oil is way more of a luxury item that the oil nuts want to admit.

  10. jz commented on Jun 19

    I meant $46,000 for the U.S. GDP per capita for China is $5300.

  11. noone commented on Jun 19

    When you say “The best cure for high prices are high prices” does this mean you are expecting higher inflation and possibly higher interest rates?

  12. Larry commented on Jun 19

    This is going to hurt the average Chinese and not only because of the income levels. China has also been under investing in mass transit, tearing out bike lanes, banning electric bikes, etc. Wouldn’t be surprised to hear of scooter bans either. Bad policies including subsidized gasoline painted Beijing into a corner.

    Or maybe they’ve has gotten that desperate to reduce smog before the Olympics.

  13. leftback commented on Jun 19

    Yes that was an interesting day’s trade. Maybe a hint of anxiety late in the day among our long oil friends? I would expect the usual knee-jerk bounce in crude tomorrow, but Monday’s action will be revealing in setting the trend for the near-term future.

    Whether this is really THE top depends a lot on the Fed’s resolve in holding interest rate policy for the rest of the year, and on control of the money supply. Clearly many forces are being brought to bear on the oil price now, and we may see a migration to gold as an alternative inflation hedge. Of course the consequences for the SPX are not favorable – the oil and commodity sectors have been leading and are now vulnerable.

    I agree with jz that we will see demand destruction in China on a large scale due to lower income levels and the fact that for many Chinese driving is “new” and not an ingrained habit in communities that are largely compact – exurban development is limited in China.

  14. Sinomania! commented on Jun 19

    China “under investing in mass transit”?

    There are currently underground mass transit (subway) systems under construction in cities all over China at enormous cost: brand new systems in Xi’An, Wuhan, Nanjing, Dalian, ShenZhen, existing systems in Beijing, Tianjin, Shanghai, monorail sytem in ChongQing. This does not include new light rail and high speed bullet trains. All of these mass transit systems are using the latest technology. This type of investment is not being made anywhere in the US right now.

  15. Bob A commented on Jun 19

    Yes, the ‘city of the future’ is indeed being built in China today…
    let’s hope the evil communists are able to keep the Cheney wannabee’s among them in check.

  16. Neil commented on Jun 19

    A contrarian view from Reuters…

    China fuel price rise may bolster consumption
    Thu Jun 19, 2008 7:21pm BST Email | Print | Share| Single Page| Recommend (0) [-] Text [+]
    1 of 1Full SizeBy Emma Graham-Harrison – Analysis

    BEIJING (Reuters) – Beijing’s surprise increase in diesel prices will make truckers grumble, but for the first time in weeks they may be able to fill up without rationing or queues, and the easier supply of oil will likely bolster consumption.

    The government said on Thursday it would raise low state-set caps on fuel pump prices by around 1,000 yuan a tonne, or nearly 20 percent, the first rise for nearly eight months and the steepest one-off hike ever.

    Oil markets fell on the news as traders bet it might help curb soaring demand, as Chinese drivers already squeezed by high inflation looked to cut back on spending.

    But they may be underestimating the appetites of the newly rich middle-classes, government plans to protect the poorest with direct subsidies, and most of all the role of state-owned refiners who carry much of the burden of current policy.

    “Perhaps somewhat counter-intuitively, it’s not bearish,” said Kevin Norrish at Barclays Capital in London.

    “At the margin it may help to support demand growth for diesel and gasoline as it alleviates shortages,” he added.

    China’s oil majors PetroChina (PTR.N: Quote, Profile, Research) and Sinopec (SNP.N: Quote, Profile, Research) are obliged to sell fuel at often unprofitable state-set levels and get only ad-hoc subsidies to help balance their books.

    Fuel prices had been unchanged since last November even as crude climbed by around $40 a barrel, so plants faced feedstock prices far above break-even levels. Many cut output as they plunged into the red, causing widespread shortages.

    Before the increase there were queues and dry pumps across the capital, and a tour bus driver was spotted begging assistants at one service station, rumored to offer supplies at illegally high prices, to let her buy at whatever cost.

    By restoring refiners to financial health, the increase will encourage them to ramp up production, and the new supplies of fuel will unleash suppressed consumption growth.

    “This price increase gets the refiners pretty close to profitability, and throughput should increase in the months ahead,” said Trevor Houser, analyst at Rhodium Group in New York.

    “Don’t expect much demand destruction…certainly not enough to outweigh the increase in output from improved economics.”


    Beijing has pledged subsidies for the most vulnerable users, including farmers and fishermen, which should support their consumption. Economists say this is a better way to spend government money than handing cash to refiners.

    “The low prices benefit everyone, including rich people that can afford high prices,” the World Bank said in a report released before the increase, advocating a rapid raise to support energy efficiency policies.

    But there is a second group of fuel users whose demand will likely also be undented — the newly rich.

    The fondness for powerful but inefficient sports utility vehicles (SUVs) now appears to be on the wane in the West as crude spirals towards $140 a barrel, and the credit crunch bites.

    But China’s middle classes are taking to its already crowded roads with a vengeance, and those who can afford to are in SUVs.

    Sales of the gas guzzlers rose more than twice as fast as car purchases last year, up 50 percent to 357,400 units, compared with a 22 percent rise in car sales to 6.3 million units.

    Even the surprise hike is unlikely to coax the nouveaux riche to take their new toys off the road.

    The speed of economic expansion outweighs much of the rise in oil prices, and depreciation on cars also means that once bought, owners like to drive them even if fuel is pricey.

    “I don’t think too much about oil prices, the main thing is the car’s performance,” said Mr Chao, a 52-year-old businessman shopping for a second car in an upmarket Landrover showroom.

    “A good car can upgrade your quality of life, reflect the excitement of being alive.”

    ($1=6.882 Yuan)

    (editing by James Jukwey)

  17. mh497 commented on Jun 19

    That last article makes a very good point. There are shortages of fuel in China, partly because refiners were losing so much money it didn’t make sense to produce. Now that refiners can make more money, they should be encouraged to produce more fuel, alleviating the shortages. So it’s possible China consumption goes up.


  18. Kurt commented on Jun 19

    Even with a GDP per capita of $5,300, how many folks will hanker for something like the $2,500 car that Tata Motors is producing in India? How many millions of people do you think want to have their 1st car, for many probably the 1st in the history of their family?

  19. Kurt commented on Jun 19

    “In the U.S., there are an average of 2.9 people per car. In India, there are 137.2 people per car. The research firm A.T. Kearney predicts that Indians will buy 300 million under-$3,000 cars by 2020. (There are 900 million cars in the world today.) Similar demand will explode across China, Southeast Asia, and Africa: all markets to which Tata plans to export the one-lakh car. If the big carmakers aren’t a part of that growth, they’ll be as vulnerable as mainframe-makers were at the dawn of the PC era—churning out elegant, high-end machines for an increasingly narrow market segment.”

  20. reader commented on Jun 19

    many don’t understand that all levels of government, military and police are major buyers of SUVs in China. do you think fuel costs will influence their purchase decisions?

  21. Adam Butler commented on Jun 19

    Unfortunately, the ‘Contrarian View from Reuters’ is not actually contrarian. Xinhua reported that the objective of the price hike was to “… ensure supplies by reducing the gap between soaring international crude prices and state-set domestic oil prices…”

    It is important to remember that the only consumers of crude oil are refineries. State controlled prices for petroleum products in China has saddle Chinese refiners Sinopec, PetroChina and others with massive losses per barrel of throughput. These companies have very large economic disincentives to import crude oil, and so they have minimized the amount of crude they purchase and process, leaving many regions in China short of gasoline and diesel fuel. Many stations can not get gasoline or diesel fuel for love nor money.

    The increase in petroleum products is effective ‘at the gate’ of refineries, such that the extra profit from the price increase accrues 100% to refineries’ bottom line. The purpose is to incentivize refineries to import more crude for processing, and to therefore provide more products to the domestic market.

    Make no mistake – this will NOT cause a decrease in crude consumption, a view supported by the IEA in this comment today: IEA: Won’t Trim China Oil Use Outlook On Price Hike

    Lastly, it is less relevant to discuss the consumption of cars and SUVs in China in the context of GDP per capita. This is because the income disparities are so large between rural and urban dwellers. Purchases of automobiles in China are overwhelmingly driven by the growth in the urban middle class and the even faster growing elite class. Incomes in these classes is growing incredibly fast, and the number of people that join these income brackets is also increasing rapidly. That is why we see 40% growth in SUV sales YEAR-TO-DATE. In China, no one that buys a new SUV is concerned about being able to afford to fill it up with gasoline.

  22. Douglas Watts commented on Jun 19

    “The best cure for high prices is high prices.”

    Tell that to an old widow in Mattawamkeag, Maine who cannot pay her oil bill and it is 30 degrees below zero and her pipes are frozen.

    There is no social safety net for fuel oil anymore. It has completely fallen apart.

    But who cares !!!

  23. Space Cowboy commented on Jun 20

    Attn: JZ (“It’s just like the Oil Nuts say this increase in price means nothing.”) will not have any impact on demand destruction for China. Period.

    So, JZ, do think GS is short this game?

    As always, your mileage may vary….according to local conditions

    Goldman Sachs on Chinese Price Increases
    Chinese price hike unlikely to significantly slow demand growth

    On the contrary, in the near term, the announced hike will likely incentivize higher refinery demand for crude oil, alleviating domestic shortages of refined products.

    Chinese domestic oil prices to increase by 18%

    The announced increase in Chinese prices will not, in our opinion, depress Chinese demand growth to any significant degree. On the contrary, historical evidence suggests that in the near term it will likely help alleviate the shortages of refined products that are plaguing the country, supporting near-term crude demand from refineries. This is due to the higher incentive for refineries to bring more products to the market. In the medium term, we believe that the negative impact of the price hike on demand will be very limited – less than 0.3% of current Chinese demand or 6% of our estimated Chinese demand growth for 2008.

    Despite the initial reaction from the market, which sold off by $4.75/bbl at the close today (June 19), the announced increase in Chinese prices will not, in our opinion, depress Chinese demand growth to any significant degree. On the contrary, in the near term, it will likely help alleviate the shortages of refined products that are plaguing the country, supporting near-term crude demand from refineries. This is due to the higher incentive for refineries to bring more products to the market. In the medium term, we believe that the negative impact of the price hike on demand will be very limited – less than 0.3% of current Chinese demand or 6% of our estimated Chinese demand growth for 2008.

    Chinese authorities announced an increase in gasoline and diesel prices for the first time since November 2007. The increase of 1000 CNY per tonne amounts to $0.41/gal for gasoline and $0.45/gal for diesel and will bring average domestic prices to $2.84/gal and $2.97/gal, respectively. The price increase does not come as a surprise since, as mentioned in our June 3, 2008 Energy Weekly, historical data on Chinese fuel prices show that prices are periodically readjusted closer to market prices (see Exhibits 1 and 2). Authorities are typically pressured to increase prices when the disconnect between international oil prices and domestic prices causes refinery margins to turn negative, leading to refinery production cuts and domestic petroleum product shortages.

    While large refineries and oil companies can mute the impact of the low or negative refining margins on their profits thanks to government subsidies, marginal “teapot” refineries are forced to shut-down. As these marginal independent refineries account for almost 15% of the domestic refining system, the result is typically a significant decline in the quantity of oil products supplied to the market and, therefore, demand rationing. These shortages can only be partially offset by an increase in product imports. Recent reports from China confirmed that domestic product shortages were becoming increasingly severe, as usually occurs right before a price increase. In the near term, the announced price hike will likely alleviate the current shortages and boost crude oil demand, as it should improve domestic refinery margins and incentivize increased refinery runs. In fact, after end-user price hikes, Chinese crude oil imports have typically increased (see Exhibit 3). In November 2007, the 10% increase in prices enforced by the Chinese authorities was followed by an approximately 500 thousand b/d increase in crude oil imports, similar to what happened after previous fuel price hikes.

    In the medium-term, the impact of the price hike on demand will likely be very limited, as has typically occurred after previous hikes. Based on our estimates of price-elasticity of demand, we believe that the impact of the price increase will be below 25 thousand b/d. This would represent less than 0.3% of total Chinese demand and less than 6% of our estimated 400 thousand b/d demand growth for 2008. Even considering recently announced price increases in various countries, the overall impact on oil demand will likely not surpass 65 thousand b/d (see Exhibit 4). Further, the likely impact on oil demand of the recent natural calamities in China could largely overshadow the effects of the price hike.

    Net, we maintain our constructive outlook for Chinese demand growth and continue to expect oil prices to reach $149/bbl by the end of the year.

  24. I, Hans. commented on Jun 20

    Barry is always full with surprising news.

    The Big Picture | The Beginning of Demand Destruction?: Its no surprise why: The costs of petrol and diesel in China is as much as 40% cheaper than US levels (which are nearly half of European prices). China, the second-biggest

  25. David commented on Jun 20

    I drive a decent amount of hwy miles each week. I have noticed that the flow of traffic on the hwy has slowed considerably. A couple of years ago traffic flow would be +10mph over posted speed limit for the normal drivers and you would see the flow of faster drivers everywhere. Now when I drive it appears to me that the average speed is the posted limit and there are many less speeders.

    I practice the safer aspects of hypermiling in my vehicle(none of this crap about shutting the motor off while coasting). The results have been very good.

    prior to hypermiling 15 city, 19 hwy
    with hypermiling city 21.5, hwy 26.5

  26. jz commented on Jun 20

    I’m not taking GS at gospel, but if China is like the U.S. in 1973, and there is pent up demand for more supply than I could see how higher prices could lead to more demand.

    Of course, just a few months ago, the oil nuts were saying gas lines in China meant world oil supply was in peril.

  27. Larry commented on Jun 23


    I still stand by my statement of underinvestment. Going back over ten years, the mass transit infrastructure spending is busy playing catchup, compared to road and highway building.

    Case in point: How many subway lines did Beijing have before the current Olympic build up? Three lines. And the third one was opened only a few years ago. The bus system is a mess in between the overcrowding and the traffic. And good luck enforcing those new bus only lanes.

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