Last year, for the first time ever, the developing world consumed more energy than the developed. Size matters. A growing middle class with high savings rates will provide an increasing demand for energy now and into the future, with developed world demand likely dragging behind. The common theme of change in the world has again shifted away from the developed markets and towards the emerging markets (“EM”)… in this case in the important area of energy economics.
True, the global economic downturn has put a hold on overall energy demand, as this particular sector attempts to recover. But, as the economy teeters towards the end of the recession, demand from the growing EM is on the rise. Increased auto sales in Q1 2009 out of China compared to the US, are a further indication of an increase in energy consumption. While the main problem in the global economy is the lack of credit and access to lending, the nations with high savings rates will emerge strong. This results in these participants leading the way in the continued demand and search for natural resources.
In 2009, for the very first time, EM will account for more than 50% of the global GDP. One of the factors for this growth is the demographic story of the rapidly growing middle class. EM now account for 75% of the world's population, led by the BRICs. Furthermore, EM will, in relative terms, accelerate ahead as they continue to carefully liberalize their financial systems. Investors realize that measures applied since the financial crisis of the late 1990’s have provided the necessary reforms to establish a stable foundation for capital markets in the EM. Why is this important when considering global energy economics? As the energy sector consolidates, the improvements in capital markets within EM will allow for greater activity among these countries as well as their interaction with companies from the developed world. Suffice it to say, there are many energy behemoths from the emerging markets. With financial might comes the power for acquisition. If energy is a limited resource, and the EM need it badly then increased collaboration and alliances should be expected.
China is the best-known example of fiscal “shock and awe”, as it used its $2 trillion of foreign reserves to expand its reach in south-south trade. The game has changed. As the BRICs take a bigger allocation in the global GDP pool, their influence in the commodity sector will increase. We can see evidence of this from high correlation between GDP growth and oil prices. In recent news, China allocated $10 billion into Brazil’s state-run oil company Petrobras and is one of several examples validating the decoupling story and with it an increased interest in EM energy.
If you believe in the long term EM story it is easy to conclude that the commodity supercycle is far from over. Recent reports from the IMF and World Bank confirm that despite trade flows and global capital falling in the past 12 months, stronger emerging markets gained momentum. Their diversified economies and large domestic consumer pools provided support when foreign markets failed. This growing demand from EM is leading to consumption, generating what looks like a “spending splurge on steroids.” It is interesting how this simple concept affects the supply and demand equilibrium of crude oil. As the developed world is healing its wounds from the financial calamity, the IEA estimates overall energy cap-ex will drop by 15-20% this year, while the number of drilling rigs in use around the world fell by 32% in the year to April. Furthermore, the International Energy Agency (IEA) estimates that the output from mature fields outside OPEC will drop by about 11% a year and continue to fall. The question then is how long will cheap crude last? Mr. Al-Naimi, the Saudi oil minister, argued that a low oil price always sows the seeds of a future price increases since it often leads to underinvestment. Experts agree that much of the world’s easy to access oil has already been extracted. The reality is that shale, tar sands and deep offshore rigging are not easy or low cost alternatives. Therefore, as the global economy resurges, increased demand of crude will put pressure on prices.
Jeff Currie of Goldman Sachs noted that oil closed above $60 a barrel for the first time in more than six months at the end of May. This is an incredible rise (4th biggest on record) of more than 75% since mid February when it was below $34. Despite some recent choppiness, oil today is even higher, currently hovering around $70. The current fall in investments within the energy industry will only compound the price of oil until supply catches up with the new levels in demand.
Despite the news that expenditures from energy companies has decreased, we continue to find conflicting news from large producers in EM. According to the May 21st issue of The Economist, Petrobras plans to increase its investment by 55%, to $174 billion over the next five years. According to the report from McKinsey Global Institute in June 2009, lower oil prices and overall demand for energy due to the economic downturn are a temporary blessing that should not lull policy makers and businesses into a false sense of complacency. Consider who seems to be working hard to deal with energy demand/supply issues. It is those from the developing world that are leading the way.
The statements expressed herein are informed opinions, are as of the date noted, and are subject to change at any time based on market or other conditions. They reflect the view of an individual and may not reflect the view of Emerging Global Advisors. This publication is intended merely to highlight issues and not to be comprehensive or to provide advice.