Energy

Liam Denning is a Bloomberg Gadfly columnist covering energy, mining and commodities. He previously was the editor of the Wall Street Journal's "Heard on the Street" column. Before that, he wrote for the Financial Times' Lex column. He has also worked as an investment banker and consultant.

Remember China? You know: big place, fair-sized population, rising geopolitical behemoth and all that. In oil circles, it used to be all anyone talked about. Just recently, though, it has gotten a little sidelined by other topics such as a rumored supply freeze or a jump in U.S. gasoline demand.

But we need to talk about China. It is still indispensable to a real recovery in oil prices. Even with a slowdown in economic growth now established, China is forecast to account for a third of the projected increase in global oil consumption by 2021. Its demand for other commodities is also vital to sustaining many of the other developing economies expected to suck up more oil.

Essential for Oil
Projected annual growth in oil demand by region
Source: International Energy Agency

All of which makes the latest results from China Petroleum & Chemical Corp. -- better known as Sinopec -- troubling.

Sinopec's earnings, released on Tuesday, beat forecasts, mainly because lower oil prices benefited the company's refining operations even as they hammered its exploration and production business.

What they also confirmed was that China's two domestic oil giants, Sinopec and PetroChina, hit a wall in 2015 when it comes to selling fuel to the country's masses.

Back in October, I highlighted the slowdown in sales of gasoline, diesel and jet-fuel by Sinopec and PetroChina in their home market, raising the possibility that 2015 might see an outright decline. Well, that happened, albeit only slightly: Sales were down just 0.1 percent. The trend hardly looks healthy, though:

Slow Burn
Change in Sinopec's and PetroChina's combined domestic fuel sales, year over year
Source: Company reports

In absolute terms, the picture of plateauing sales is unmistakable:

Even Flow
Sinopec's and PetroChina's domestic fuel sales, trailing four quarters
Source: Company reports

These are necessarily lagging indicators. Given the difficulty of gauging actual demand in the world's single-biggest growth market for oil, though, they matter. The two companies report fuel sales in tonnes, but using a rough conversion factor of 7.5 barrels per tonne -- it differs for each fuel -- their sales last year amounted to about 6.8 million barrels a day, or 60 percent of China's estimated oil consumption.

While sales of gasoline increased as more Chinese bought first, or bigger, cars, it hasn't been enough to offset the decline in diesel. This captures perfectly the challenge Beijing faces in shifting away from a reliance on industry and fixed investment toward a consumer economy, while maintaining relatively fast expansion overall. This drags on oil and most other industrial commodities, such as liquefied natural gas, iron ore and copper, where producers invested billions in new capacity in the expectation that China would simply consume whatever was supplied.

It wasn't just foreign miners and oil majors losing their heads, either; China's own national champions did the same. This is where the slowdown in Sinopec's and PetroChina's domestic fuel sales add further pressure on oil prices.

The two companies figure large in a growing, if somewhat less obvious, excess of global oil refining capacity, something I wrote about here. One way of looking at a refinery is as a huge, complex system of distillation units, pipes and tanks. Another way is as a huge sunk cost that you ought to keep switched on as much as possible, whatever the economic weather.

Similar to what has happened in the global steel market, when China's capacity to produce fuel outpaces its willingness to consume it, more of the stuff ends up on the global market -- as Miranda Wang at Bloomberg Intelligence laid out in a recent report.

Good News for Tankers Anyway
China's net exports of refined oil products, trailing 12 months
Source: Bloomberg Intelligence

China may yet end up pulling off its economic pivot (indeed, Bloomberg economists Tom Orlik and Fielding Chen just published a paper on how Beijing might go about it). The challenge is enormous, though, and oil bulls shouldn't take Chinese demand growth projections for granted. Maybe it really is best to just keep chatting about that supply-freeze thing instead.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Liam Denning in San Francisco at ldenning1@bloomberg.net

To contact the editor responsible for this story:
Mark Gongloff at mgongloff1@bloomberg.net