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Economics Economics – Markets – Strategy The rise in Asian demand is a structural one. It is not going to go away anytime soon And the numbers are compelling. Take the data point for this year, 2008, which reads 93 cents. That says that for every dollar of domestic demand generated by the US, Asia will generate 93 cents of the same. What’s the arithmetic? Simple. Assume that US domestic demand is 1 dollar in size. It grows by 3% on a clear day, thus generating 3 cents of new demand. Now turn to Asia. If the US is 1 dollar in size, Asia’s is 40 cents in size. On a clear day, it grows by 7%, generating 2.8 cents of fresh demand. That’s 2.8 cents for every 3 cents from the US, or 93 cents on the dollar. What is key is how this ratio has changed over time. Back in 1990, the US generated more than twice as much new demand each year as Asia did. No wonder Asia went up and down whenever the US did. No wonder everybody said, when the US sneezes, Asia catches a cold. No wonder all those two-fer rules came about. All those rules, all those sayings were pretty much on the mark. Twenty years ago. Today, the US no longer generates twice as much demand each year as Asia. Today it generates 7% more. And that’s on a clear day. On a bad day, like today, Asia already generates more demand than the US does (American demand growth has been zero for the past two quarters). But we haven’t shown the sick days in this chart because we want to stress that this change is a structural one – it has been occurring for the past 20 years and will continue for the next 20. Bottom line? It is this structural change, more than anything else, that explains how Asia managed to accelerate for three years while the US slowed. Asia is no longer too small to matter. Asian demand is driving Asia’s growth more than ever before and will, in another year or two, be a bigger driver of global growth than the US. Plainly, it is the growth in Asia’s aggregate demand that underlies its growth in demand for oil, to which we now turn. Higher oil prices – demand-driven Take a look at the differences in the two charts below. Both plot the global supply of crude oil (in red, quantity terms) against the price (in grey, measured in avg USD, EUR/ECU and JPY terms, adjusted for inflation). The picture on the left shows supply and price during the second oil crisis of 1979-84. Global supply falls by 15% thanks a drop in OPEC output of 55% between 1979 and 1983. The price of oil triples in 13 months. Contrast that with the picture on the right – which shows oil supply and price over the past six years. Oil output expands steadily as the price triples over a four year period of time (annual average figures). Global oil production and price – 1979-84 bil bbls/yr avg USD, EUR, JPY terms, CPI def, 79=100 25 225 Global oil production and price – 2000-08 bil bbls/yr avg USD, EUR, JPY terms, CPI def, 98=100 32 300 24 23 real G3 ccy price (RHS) 200 175 150 31 30 29 supply (LHS) 250 200 22 21 supply (LHS) 125 100 28 27 real G3 avg crude price (RHS) 150 100 20 77 78 79 80 81 82 83 84 75 26 00 01 02 03 04 05 06 07 08 50 10
Economics – Markets – Strategy Economics What’s the difference in terms of economics? Any textbook would say that the first picture, 1979-84, is one of prices being driven by a contraction in supply. And it would say that the other picture, from 2002 to 2008, shows prices being driven north by an expansion in demand. And what would one expect for the direction of industrial output in these two situations? That a contraction in oil supply would bring a sharp contraction in industrial output along with the surge in prices. Plainly, that’s what happened in the oil crises of 1973-75 and 1979-83. In 1973, oil prices rose by a factor of nearly four in six months and G3 industrial output dropped by 12% in very short order. In some countries, like Japan, industrial production fell by 20%. In the second oil crisis, prices tripled in the 12 months ending Nov79 and were subsequently maintained there for the next three years. G3 industrial production fell for three years, by a total of 8%. G3 – industrial production and crude oil, 1973-75 Nov73=100, sa wt avg ccy unit/bbl, Nov73=100, Brent G3 – industrial production and crude oil , 1979-84 Jan80=100, sa avg ccy unit/bbl, Jan78=100, Brent 100 98 96 Oil price (RHS) 400 350 300 102 100 98 Oil price 300 275 250 225 94 92 90 88 IP (LHS) 250 200 150 100 96 94 92 Oil price triples in one year IP falls 10% over 3 years IP (LHS) 200 175 150 125 100 86 Jan-72 Jan-73 Jan-74 Jan-75 Jan-76 Jan-77 50 90 Jan-78 Jan-80 Jan-82 Jan-84 75 By contrast, when higher oil prices are driven by demand, one would expect to see a more gradual rise in price along side an uninterrupted rise in output – precisely the picture seen in the global economy since it last hit bottom in Dec01. One such picture (for the G4 overall) was shown on page 8. Two additional pictures of Asia – with and without China/India – are shown below. Asia 10 – industrial production and crude price Jan02=100, sa wt avg ccy price, Jan02=100, Brent Asia 8 – industrial production and crude price Jan02=100, sa wt avg ccy price, Jan02=100, Brent 200 600 180 600 175 150 IP (LHS) 500 400 160 140 IP (LHS) 500 400 300 300 125 100 Oil price (RHS) 200 100 120 100 Oil price (RHS) 200 100 75 02 03 04 05 06 07 08 09 0 80 02 03 04 05 06 07 08 09 0 11
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Economics - Markets - Strategy 3Q 2
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