What's behind China's oil demand dip making waves in global energy

If there is one figure Gulf economic policymakers should watch as carefully as the oil price, Dubai property prices, or US interest rates, it’s probably Chinese oil demand. The world's second largest economy has a huge hunger for petroleum that has been the mainstay of the market since the early 2000s. Now it seems to be ebbing – and whether this is cyclical or structural, temporary or permanent, is crucial.

Chinese economic performance and lacklustre oil demand has weighed on oil prices all year. Implied demand for the first seven months of this year is nearly 2 per cent down from the same period last year. As domestic production has gained modestly, that translates to a 3.1 per cent fall in oil imports. When those imports reflect more than a tenth of all global oil production, even a modest drop causes major ripples.

This lower import share has to be parcelled out among competing suppliers. Remarkably, Iran, under the guise of “Malaysia”, has become China’s largest seaborne supplier. Russia is the biggest provider overall, including its exports by pipeline, and has gained market share since early 2022 by diverting the supplies that formerly went to Europe.

But Russia’s sales to China last month were still the lowest since early last year, and Iraq’s were the least since January. Saudi Arabia did not benefit much, its sales were basically flat. Of China’s other top suppliers, the UAE, Kuwait, the US and Kazakhstan all saw their volumes drop. Only Oman and Angola of the other major providers registered a gain this year.

In this month’s report, Opec for the first time downgraded its global demand estimates for this year, while the International Energy Agency also cut its already bearish forecast. There is still a huge gap between them, amounting to 1.22 million barrels per day, or more than half the amount of Opec+ voluntary cuts intended to be eliminated from October onwards.

Both said weak Chinese demand was a key reason for the cuts. But with apparent Chinese crude demand down, the last few months of the year will have to be strong to register any growth. The outlook for next year is cloudy, too, despite the two agencies concurring on roughly 300,000 barrels per day of growth.

Rather than exporting more refined products, China has cut back refinery runs, which at least gives some relief to the industry elsewhere. The famous independent “teapot” refineries are operating at less than half of capacity.

So why is Chinese oil demand weak – and is it going to recover? There are three reasons, one cyclical, one structural and one technological.

Part of the explanation is in the post-Covid recovery, which led to strong growth last year, jumping to 15 to 16.6 million barrels per day, but which is now mostly exhausted. Jet fuel demand is the one bright spot, with foreign passenger flights still not back to 2019 levels.

General economic weakness is another key contributor. This is a mix of cyclical and at least semi-permanent features. Growth of 4.7 per cent in the second quarter was below target, with the puncturing of the real estate bubble and more barriers to exports. A prominent adviser to the central bank, Yiping Huang, said that the economy was once “easy to heat, difficult to cool”, but was now “easy to cool, difficult to heat”.

Slowing construction and goods transport cuts diesel demand, even though the manufacturing sector still hums along. The country’s working-age population peaked around 2014-2015, and on current trends, the total population will be less than half current levels by 2100 – within the lifetime of those born today.

But increasingly the dominant factor is technological: a shift away from oil in the economy. About 25 per cent of Chinese petroleum consumption is diesel, used in construction, industries, trains, buses and lorries. 24 per cent is petrol for cars. And 19 per cent is petrochemical feedstocks. The first two of these are under major pressure.

Liquefied natural gas is replacing diesel in heavy goods vehicles, saving 220,000 barrels per day last year. An expected global glut of LNG from around 2026-2027 will further encourage this substitution. As renewables replace coal, diesel demand for mines, lorries, goods trains and barges will also drop.

More than half of passenger cars sold last month were electric or hybrid. This will grow further with financial incentives to scrap older petrol or diesel vehicles, and continuing improvements and falls in sales prices of battery cars. The share of electric vehicles in the total fleet has reached 11.5 per cent, up from 7.7 per cent a year ago, which should therefore have cut petrol demand by nearly 4 per cent, or about 150,000 barrels per day.

The leading state oil company, PetroChina, itself says that national oil consumption in transport will peak next year at the latest. BP sees the overall peak in 2030 on current trends, but only 400,000 barrels per day above current figures. Yet Opec forecasts 4 million barrels per day of Chinese demand growth by 2045.

Beijing has strong economic and strategic reasons to continue this shift. Oil imports are a major vulnerability, particularly in the event of disputes or outright conflict with the US. Purchases from Iran, Venezuela and Russia are hampered by US sanctions. And most petroleum imports come from the US itself, or through maritime passageways in the Middle East and South-East Asia that could easily be blocked by the US Navy.

Whether powered by coal, nuclear power or renewables, battery cars boost domestic energy self-sufficiency. And they are less environmentally damaging in carbon dioxide emissions – particularly as China’s grid cleans up – as well as in local air pollution.

Chinese electric vehicles have quickly moved to dominate not just the domestic market, but exports, too. In the last quarter, BYD passed Honda and Nissan to become the world’s seventh-biggest car maker – of all types. China only became a net exporter of cars in October 2021. Now, it has overtaken Japan as the world’s biggest automotive exporter.

It has built a complex, integrated supply chain with a high level of self-sufficiency in everything from raw materials to batteries. Now it needs to sell more electric cars both at home and abroad to absorb fast-growing output. The challenge to oil exporters is not just that China’s own prodigious oil hunger is now waning – but that it will export that loss of appetite to the rest of the world.

Robin M Mills is CEO of Qamar Energy, and author of The Myth of the Oil Crisis