Asian Energy Fundamentals

Dr. Marc Faber recently made a presentation for U.S. Global Investors titled "Investing in a world of rapidly changing geopolitical and economic trends". The audio version of the presentation is available online along with a few dozen slides, and highlights are included in this article at FN Arena.

This is an excellent use of forty-five minutes of anyone's time. It provides a view of how Asia sees the world regarding energy, U.S. hegemony, and a range of other topics - largely foreign concepts to many here in the U.S. in more than just the physical sense of the word.

A big fan of Dr. Faber since reading his 2002 book Tomorrow's Gold: Asia's Age of Discovery (which still fetches a hefty $35 at Amazon.com and has little to do with precious metals), it was good to once again hear the good doctor's global view and his unique accent.

During Dr. Faber's introduction, the host at U.S. Global Investors noted that Tomorrow's Gold is required reading for all new associates at their firm, something that makes a great deal of sense given the sort of funds in which the company specializes - emerging markets, natural resources, and precious metals.

This presentation was mostly about China, oil, and U.S. dollars.

The US is the world's largest consumer of oil, with China second. As the US is 40% self-sufficient in oil production, China is actually the world's largest net consumer.

Japan has no oil. 75% of Japanese oil imports come from the Middle East (compared to the US with 20%). The Middle East also supplies the bulk of Chinese oil imports. Tankers which leave the Persian Gulf en route to China and Japan sail through the Straits of Malacca, between Malaysia and Indonesia, and up through the South China Sea – right past Taiwan.

Says Faber: Who controls Taiwan controls Chinese/Japanese oil.

China and the US create a fragile dichotomy. While once clear enemies on an ideological basis, China's capitalist evolution has meant relationships have become more co-operative, but not particularly less strained. While China has become the factory for the manufacture of US goods, it has also become the largest foreign investor in US financial assets. While US businesses are happy to invest in China, US Congressmen are calling for protectionist policies.

The US is bordered by two friendly nations – Canada and Mexico. Both are significant suppliers of oil and other commodities to their neighbour. China is bordered by 14 nations of various levels of influence and ideology. They include Russia, India and North Korea.

China enjoys a friendly relationship with Russia. They have formed an alliance with each other known as the Shanghai Co-operation Organization (SCO), which includes members Uzbekistan, Kirgizstan, Tajikistan, and oil and uranium-rich Kazakhstan. Aside from these members, the SCO includes "observing members", being Mongolia, India, Pakistan and Iran. If these countries became full members, the SCO would represent 45% of the world's population.
Faber notes it is US foreign policy that has pushed China closer to Russia. The SCO has set a timetable for the US to withdraw its central Asian military bases.

Central Asia boasts significant amounts of oil and gas. Under its alliances, China can contemplate direct overland access through to Iran, which currently supplies 15% of Chinese oil imports. Already India is building an oil pipeline from Iran, through Pakistan (with Pakistan's co-operation).

What do they say? He who controls the oil controls the world, or the global economy, or something like that. It appears that China and their neighbors have been busy building strategic energy alliances and Russia, rich in natural resources, stands to benefit from increasing demand to the south. They recently completed a pipeline south from Siberia that could serve either Japan or China - if memory serves, the spigot empties in China at the moment.

It must be annoying for these governments to have to convert their currencies into U.S. dollars to conduct trade. At some point in the future, that will no longer be necessary, something that will greatly diminish the role of the dollar - part of the long, slow process that is the rise of Asia onto the world stage.

The statistics for automobile production and purchase are telling - the implication of some simple math on world oil consumption is clear.

Production and investment have shifted away from the US, to China and other developing nations. While China may have exported its deflation to the rest of the world, it has also promoted deflation at home. Faber notes it wasn't long ago that the Chinese were buying their first locally-produced car for US$20,000 in real terms. Today the equivalent car (everyday sedan not dissimilar to those which GM produces) costs US$3,700.

At US$20,000, roughly one million Chinese could contemplate owning a car. At US$3,700 this figure rises to 50 million. China is now the second largest car market in the world behind the US. In the US, first-time car buyers represent 1% of the market. In China that figure is 84%.

Similar price deflation has occurred for other items the West takes for granted, such as TV sets and mobile phones. While the US boasts the largest economy in the world, Faber suggests the Chinese economy is actually far bigger than anyone realises.

Officially, the current size of the US economy is US$12 trillion and China's US$2 trillion. But if you measure not in monetary terms, but in volume of goods produced, then China represents 60% of the global economy. And the Chinese economy is growing at the rate of 13-15% per annum in industrial production and 20% in capital spending.

China is now the biggest consumer of the world's commodities. Yet Chinese per capita consumption of commodities is much lower than the West's. India's is much lower still. Faber notes India is still probably twenty years behind China.

The history of oil consumption provides a revealing example. Prior to industrialisation, the US consumed one barrel of oil per capita. Today it consumes 27 barrels. Japanese industrialisation in the 1950s took its consumption from one barrel to 17 barrels today. China's current consumption is 1.7 barrels per capita. India's is 0.8.

Today all of Asia (including Japan) consumes 22 million barrels of oil per day. This is consumed by 3.6 billion people. The US also consumes 22 million barrels of oil per day, with a population of 300 million people.

Asian oil consumption will double at some point in the future. Can current oil production (84 million barrels per day) be sufficiently increased to meet that demand? Says Faber: oil prices simply must keep going up.

Commodity prices in general in the 1990s were at their lowest level, in real terms, in the history of capitalism. Commodities price cycles can last 45-60 years, notes Faber. We are only at the beginning of the bull market.

This does not mean there cannot be, and won't be, major price corrections along the way – even in the order of 50%. The price of copper, for example, has risen from US30c/lb to US$4/lb. Faber would not be surprised to see the price of copper reaching US$2/lb in the current correction. Or oil reaching US$50/bbl. History is littered with major corrections in ongoing bull markets.

The price of gold moved from US$30/oz in 1970 to US$175/oz by 1974. In 1976 it fell to US$103/oz before hitting US$850/oz by 1980.

In 1987 the Dow Jones index fell 40%. It is now seven times higher. In 1987 the Hang Seng index fell 50%. It is now ten times higher.

Those who think that recent movements in commodity markets signal a return to the cheap energy days of the 1980s and 1990s are going to be surprised. Energy consumption and economic growth go hand in hand - just wait until a Chinese consumer psychology takes hold and the banking system starts extending credit to individuals on a scale that is even a fraction of that in the west.

[Thanks to chubbyray for posting a link to this over the weekend]