Report

Wheezing China Gut Punches Global Oil Market

The Chinese economy is growing at its slowest pace since the financial crisis. That could be bad news for oil producers who gambled on China's unquenchable thirst for oil.

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China’s disappointing economic growth isn’t just worrisome for Beijing — it’s also potentially very bad news for places as far apart as Texas, Alaska, and Scotland.

China reported an official third-quarter GDP growth of 6.9 percent, just below the government’s target figure of 7 percent and the lowest figure since the depths of the global financial crisis. But China’s economic picture could be even bleaker: Economists and analysts are torn over how much credence to give to official Chinese data, which are habitually massaged and finessed for political purposes and which appear to contradict other economic indicators, such as falling energy consumption, which point to significantly less economic activity than the government’s headline figures suggest. Some experts figure China may only be growing half as fast as official figures claim.

And that is spooking oil markets. Crude oil prices fell on Monday by 2.5 percent in New York to about $46 a barrel and by 3.5 percent in London to about $49 a barrel.

The global oil market is currently oversupplied, with producers in the United States, Russia, and OPEC pumping at near-record levels. Many analysts figure global oil demand will pick up next year, led by emerging markets such as China (the second-biggest oil consumer in the world), which would help balance supply and demand and push oil prices slowly back up. But China’s economic stumbles are starting to raise doubts about those expectations.

It depends on how serious China’s slowdown really is. If the economy really is only growing half as fast as the Chinese government says, then, over the next year, China’s thirst for oil could well flatline, and there is no other single oil consumer in the world who could pick up the slack. Even if government figures are correct, a slower-growing China would likely require less additional oil than it has needed in recent years. Either way, the future development of the Chinese economy and how much oil it will require is a trillion-dollar question for roughnecks and oil executives all over the globe.

Chinese consumption of oil in September fell slightly compared with the same month last year, and even though oil consumption has increased overall through the first nine months of the year, it has not risen as much as analysts expected. And it’s hard to overstate the importance of Chinese demand growth for the global oil market as a whole: Just since 2010, China has gobbled up one out of every three new barrels of oil produced in the world.

Cheap oil used to be good for oil-consuming developed economies like the United States and Europe and in many ways is still a plus, at least for consumers there. That’s because cheaper transport costs trickle through the whole economy, making everything from groceries to air travel less expensive, not to mention prices at the pump. Nationwide gasoline prices average just $2.26 a gallon, almost a dollar cheaper than one year ago, and new research suggests that U.S. consumers immediately spent most of that unexpected windfall, which essentially amounted to a giant $100 billion stimulus.

But now that the United States is again a major oil producer, and not just a consumer, lower prices promise plenty of pain, too. That’s particularly true because the U.S. shale revolution requires higher prices than traditional oil fields in the Middle East because it costs more to blast open subterranean rock to get at crude than it does to siphon oil out of massive reservoirs. U.S. shale producers weathered the plunge in crude prices over the past year and, thanks to gains in efficiency, were able to keep pumping profitably. But many producers appear to have reached a breaking point: Bankruptcies are starting to litter the U.S. oil patch, debt defaults in cash-strapped energy firms are growing, and big companies that thrive on a healthy oil sector, like Halliburton, are posting multimillion-dollar losses.

“There’s pain in the oil patch now. If we were to get weak demand, then the oil market doesn’t rebalance in the second half of 2016, and prices won’t elevate,” said Skip York, an oil market expert at Wood Mackenzie, a commodities consultancy. “And if the oil price doesn’t start drifting up, then there could be a quote-unquote ‘day of reckoning.'”

The pain is especially acute in places like Texas, Oklahoma, and North Dakota, which benefited the most from the recent oil boom. Now, though, Texas is struggling to make up an estimated $4.7 billion budget hole, thanks to lower tax revenues. In North Dakota, where thousands of workers flocked to take part in a modern-day gold rush, small towns spent millions of dollars to build new housing and lay new water and sewer connections; today, the crash in oil prices has left many of those developments ghost towns and has many municipal budgets in tatters.

Alaska, too, is reeling or will be soon: Lower oil prices have shot a $3.5 billion hole in the state budget, yet the cash payout to Alaskan residents who share in the state’s oil bounty reached a record level this year of $2,072 per person. Alaska Gov. Bill Walker called it “unsustainable.”

Pain in the oil patch is especially problematic because energy was one of the bright spots during the recent economic recovery. Now, though, the wider U.S. economic recovery appears to be running out of steam; job creation last month was dismal. Regional economies in places like Midland, Texas, and western North Dakota are already seeing signs of economic contraction.

But the ripple effects from China’s slowdown aren’t just limited to the U.S. oil sector. Producers in places like Canada, Mexico, and Britain also need higher prices to keep pumping oil in the future.

Lower oil prices helped tip Canada into recession earlier this year, and the province of Alberta is grappling with vanishing jobs and rising budget deficits. Oil sands producers, who’ve sunk billions of dollars into long-term projects, aren’t turning off the spigots, but they are shelving future projects that don’t make economic sense with cheap oil. Since Canada’s oil sands projects take years to develop, that could make it harder for Canada to jump back on the bandwagon and boost production if and when oil prices do go back up.

Britain’s North Sea oil industry, which just a year ago was cast as the economic savior of a would-be independent Scotland, is now facing the prospect of a collapse thanks to cheap oil. Even flush Norway has been staggered by the plunge in oil prices: Unemployment has jumped even higher than it was during the worst of the financial crisis. Mexico, for its part, was counting on the historic opening of its energy sector to attract deep-pocketed foreign investors and kick-start a wheezing oil industry, but that’s a whole lot harder to do with cheap oil.

“If oil prices stay between $45 and $50 a barrel, it’s not only an issue for the U.S. oil patch, it’s an issue for virtually every non-OPEC oil patch in the world,” Wood Mac’s York said.

Photo credit: ChinaFotoPress/Getty

Keith Johnson is Foreign Policy’s global geoeconomics correspondent. @KFJ_FP

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