China Holds the Key to Global Energy Demand

Global energy prices hinge on China’s economic recovery. China’s reopening will boost oil and gas demand this year, especially if the government succeeds in stimulating investment in construction and real estate. Stronger industrial activity should increase China’s natural gas imports, and a rebound in mobility will boost gasoline, diesel, and jet fuel demand. Still, there are lingering questions about weak consumer sentiment and high debt levels. The strength of the recovery will dictate how China adjusts crude oil import quotas and refined product export quotas—and the latter could prove critical as the oil market adjusts to a price cap on Russian products.

Last year China confronted the rising toll of its policy to contain the spread of Covid-19, a more volatile international environment, and a change in the party leadership. The country’s 3 percent reported growth for 2022 was the lowest since the mid-1970s. It was the first time in 40 years that China’s economy grew below the international average.

While structural issues will continue to be a drag on the economy in the long term, 2023 is likely to see stronger growth thanks to the reversal of zero-Covid policies. After two and a half years, in early December, the government abandoned the pandemic control system based on strict quarantine and rolling lockdowns. Infections swept through the country, affecting millions between December 2022 and January 2023. However, the economic outlook has improved since Chinese people are now allowed to travel more freely and businesses no longer fear sudden lockdowns. The government has also signaled that it will pursue economic growth more actively, stimulating demand through infrastructure projects and looking for ways to boost consumer spending, even though long-term structural reforms are still lagging. The International Monetary Fund forecasts GDP growth of 5.2 percent in China this year, but expects the country to stay below the 4 percent growth mark after 2024.

Figure 1

A few factors could alter the trajectory of China’s recovery. First, and perhaps most important, is consumer spending. Consumers in China have experienced a slowing economy, declining real estate values, rising unemployment, strict lockdowns, and observed regulatory changes that have affected entire industries, including private tutoring and technology. It is not surprising that the People’s Bank of China (PBOC) quarterly survey reported that over 60 percent of households intended to save (as opposed to consume or invest)—the highest level seen yet. As a result, consumption has been timid through 2022. All of this may change as the economy reopens and the government relaxes restrictions on real estate investment. However, much will ultimately depend on consumer confidence. For example, while Chinese auto sales have rebounded since 2020, reaching 26.8 million in 2022, they were still well below 2017 levels (28.8 million).

Figure 2

Related, and just as important, is the performance of the real estate sector. A significant portion of household assets are tied up in real estate, so the ongoing slump is contributing to Chinese families’ sense of uncertainty. The construction sector has also been a driver of growth in China for years, accounting for as much as 30 percent of the economy, according to some estimates. Government policies to loosen restrictions on real estate developers and boost sales are expected to lead to some recovery in 2023 but are unlikely to be a panacea in the medium to long term.

Finally, Covid-19 continues to be a wild card. It seems that the virus swept through much of the country in December and January after restrictions were removed. The economic effects are hard to measure in part due to a lack of official data, but public health could slow the pace of recovery, especially in the first half of the year.

In short, 2023 is likely to bring an increase in economic activity and boost demand in China. But broader challenges including high levels of debt, an unsustainable real estate sector, high levels of youth unemployment, inequality, and demographic pressure mean that the country is unlikely to return to high levels of growth after 2023.

The World’s Key Growth Market Stalls Out

China’s zero-Covid policies produced a steep drop in energy demand last year. Chinese oil demand fell by 390,000 barrels per day (b/d)—the first decline in oil demand since 1990. In the first 10 months of 2022, Chinese refineries produced about 600,000 b/d of jet fuel and other kerosene, down from 1.1 million b/d in 2019.

Figure 3

Transport demand was especially weak last year. China's frequent lockdowns cut traffic in major cities and reduced passenger flights, which cut gasoline and jet fuel consumption. Ridership on all modes of transport was down 67 percent in the first 10 months of 2022 compared to the same period in 2019. Covid-19 cases in December and January dampened air travel, but domestic flights picked up substantially over the Lunar New Year.

Outbreaks and restrictions in China also dragged down industrial output and investment. The manufacturing purchasing managers index (PMI) and non-manufacturing PMI fell in December 2022 to their lowest point since early 2020. China’s residential sector downturn, with declining home prices and a sharp decline in new property investment, had negative knock-on effects. And China’s manufacturing sector suffered from weak external demand for Chinese exports.

Figure 4

The silver lining for the global energy market was that China’s downturn freed up supplies in a turbulent year following Russia’s attacks on Ukraine. Last year, overall natural gas demand fell by 1.4 percent from demand of 369 billion cubic meters (bcm) in 2021. In the liquefied natural gas (LNG) industry, weak Chinese demand, along with expanding domestic coal and gas production, freed up volumes for Europe. More than 4 million tons of LNG destined for China were resold to Europe in the first half of 2022, equivalent to about 7 percent of Europe’s LNG imports.

Expect a Fairly Strong Recovery, though China’s Reopening Could Disappoint Bulls

Many bullish market forecasts last year centered on China’s economic rebound, and the same is true in 2023. If there is a sharp recovery this year, the oil and LNG markets will tighten, reviving energy security concerns in Europe and elsewhere. The International Energy Agency estimates that China’s oil demand will rise by nearly 850,000 b/d in 2023, making up about half of global demand growth.

Figure 5

An economic rebound would naturally have big oil market implications. Last year, the drop in Chinese refined product exports contributed to a tight global diesel market, increasing the cost of shipping and trucking goods and fueling worldwide inflation. The government recently increased its first batch of export quotas for gasoline, gasoil, and jet fuel this year by 46 percent compared with the same period in 2022 and raised fuel oil export quotas by 23 percent year-over-year. The prevailing view in the oil market is that China is poised to import more crude oil, but its role in the product export market is more uncertain. Stronger domestic demand means that clean product exports could be smaller than expected in February and beyond. That could limit China’s capacity to alleviate pressures created by the price caps on Russian petroleum product exports, especially diesel.

On the other hand, the reopening could prove disappointing. The construction sector looks especially weak, with declining investment in real estate after a massive overbuild in the past decade. The government may try to stimulate the economy through infrastructure investments, but it faces fiscal constraints. And while the economic outlook in Europe and the United States is improving, there is always the risk that slower growth could constrain demand for manufactured goods from China. Much depends on personal consumption—but China typically focuses on supply-side investment incentives rather than consumer stimulus.     

A slow recovery in China would remove one of the key sources of support for global commodities this year—but would also have big implications in the years to come. Since the 2000s, China has been the world’s most reliable engine of demand growth. Its infrastructure expansion as well as a massive boom in construction and real estate fueled strong demand for commodities of all types. A slowdown from the heady days of the 2000s (when GDP growth averaged 10.3 percent per annum) and 2010s (average growth of 7.7 percent) was inevitable. Gone are the days when insatiable demand in China fueled a commodity super-cycle.

After a disruptive few years—due to Covid-19, strict lockdowns, rapid increases in electric vehicle sales, and evolving external demand for Chinese exports—the “new normal” for Chinese oil and gas demand is uncertain. A big rebound is quite possible, but the market cannot take strong energy demand growth for granted.

Ben Cahill is a senior fellow in the Energy Security and Climate Change Program at the Center for Strategic and International Studies (CSIS). Ilaria Mazzocco is a senior fellow with the Trustee Chair for Chinese Business and Economics at CSIS. Chen Huang is former intern with the CSIS Energy Security and Climate Change program.

Qin (Maya) Mei, research associate with the CSIS Trustee Chair for Chinese Business and Economics, also contributed to this commentary.

Ben Cahill
Senior Fellow, Energy Security and Climate Change Program
Senior Fellow, Trustee Chair in Chinese Business and Economics

Chen Huang

Former Intern, Energy Security and Climate Change program