For the third year in a row, Indian fuel consumption has eclipsed China’s. In fact, it grew by 10.7% in 2016, the highest growth rate in 16 years, according to the Indian Oil Ministry. This should be a cause for cheer; as one of the main reasons that crude prices collapsed in 2015 was due to China's economic slow down. With India now apparently taking China’s place as the motor of oil growth in Asia and the world, how long can this hold?
Indian growth in 2016 was down to cheap oil, an advantage that is being erased as crude oil prices climb on OPEC’s decision to enforce a supply freeze. Higher crude means higher oil product prices; so the transport boom in gasoline and aviation fuel sales might peter out. LPG penetration was also a major factor in expanding demand, but this will also begin to slow down. The surge in automotive ownership following two years of low oil prices led gasoline and diesel sales to leap by 12.2% and 5.6%, while LPG grew by 11.3%. This sort of growth figures might not be able to continue. It should be noted, however, that these statistics are based on the Oil Ministry’s fuel consumption statistics, which is generally higher than official oil demand figures as it excludes oil for non-fuel use but indicates trends.
The annual figures, however, mask developments that occurred at the end of 2016. A demonetisation drive to crackdown on tax dodgers and counterfeiters by removing the 500 and 1,000-rupee notes from circulation has dented consumption; fuel consumption spiked in November as consumers rushed to stock up, and grew by only 4.3% in December. Across India, there is a slowdown in consumption, affecting all products from coconut oil to diesel to scooters, as consumers hold back on purchases to monitor the ongoing demonetisation (even though old notes are still valid for buying automobile fuel and cooking oil). This has affected the rural population in particular, heavily cash dependent. Alarmists are saying that that demand growth could slow by as much as 80%. That would be a worst-case scenario. The more likely outlook is that growth will fall to the 6-8% range instead. Because oil demand is resilient, the population will adapt to the new monetary rules and the cash crunch will abate, leading to stronger growth in the second half of 2017 offsetting a slower first half.
And even the first half has bright spots. This is an election year for India, and the political arena will see the main parties stage huge rallies across the vast country, requiring gasoil for generator and heavy transport, as well as gasoline. The size of the country, including its large rural population, also means voters will have to travel great distances to reach a ballot box, with political parties and the government again stepping in to ferry people to cast their vote.
Looking forward, the government’s "Make In India" initiative to boost local manufacturing and a slew of new petrochemical projects onstream should ensure a stable basis for growth over the next 3 - 5 years. Higher fuel prices might choke off some momentum, but India is ready to inherit the crown of the world’s oil demand driver from China. Take note that, India’s economy is very different from China’s centrally-planned one, India's economy is more dependent on private entreprise and complex political factors. Though this should provide a broader base for fuel growth, but will probably not reach the dizzying heights of double-digit growth that China did. But grow it will, and the oil world will be banking on that.
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Supply chains are currently in crisis. They have been for a long time now, ever since the start of the Covid-19 pandemic reshaped the way the world works. Stressed shipping networks and operational blockages – coupled with China’s insistence on a Covid-zero policy – means that cargo tanker rates are at an all-time high and that there just aren’t enough of them. McDonalds and KFCs in Asia are running out of French fries to sell, not because there aren’t enough potatoes in Idaho, but because there aren’t enough ships to deliver them to Japan or to Singapore from Los Angeles. The war in Ukraine has placed a particular emphasis on food supply chains by disrupting global wheat and sunflower oil supply chains and kicking off distressingly high levels of food price inflation across North Africa, the Middle East and Asia. It was against this backdrop that Indonesia announced a complete ban on palm oil exports. That nuclear option shocked the markets, set off a potential new supply chain crisis and has particular implications on future of crude oil pricing and biofuels in Asia.
A brief recap. Like most of Asia, Indonesia has been grappling with food price inflation as consequence of Covid-19. Like most of Asia, Indonesia has been attempting to control this through a combination of shielding its most vulnerable citizens through continued subsidies while attempting to optimise supply chains. Like most of Asia, Indonesia hasn’t been to control the market at all, because uncoordinated attempts across a wide spectrum of countries to achieve a similar level of individual protectionism is self-defeating.
Cooking oil is a major product of sensitive importance in Indonesia, and one that it is self-sufficient in as a result of its status as the world’s largest palm oil producer. So large is Indonesia in that regard that its excess palm oil production has been directed to increasingly higher biodiesel mandates, with a B40 mandate – diesel containing 40% of palm material – originally schedule for full implementation this year. But as palm oil prices started rising to all-time highs at the beginning of January, cooking oil started becoming scarcer in Indonesia. The government blamed hoarding and – wary of the Ramadan period and domestic unrest – implemented a Domestic Market Obligation on palm oil refineries, directing them to devote 20% of projected exports for domestic use. Increasingly stricter terms for the DMO continued over February and March, only for an abrupt U-turn in mid-March that removed the DMO completely. But as the war in Ukraine drove prices even further, Indonesia shocked the market by announcing an total ban on palm oil exports in late April. Chaotically, the ban was first clarified to be palm olein only (straight refining cooking oil), but then flip-flopped into a total ban of crude palm oil as well. Markets went haywire, prices jumped to historical highs and Indonesia’s trading partners reacted with alarm.
Joko Widodo has said that the ban will be indefinite until domestic cooking oil prices ‘moderate’. With the global situation as it is, ‘moderate’ is unlikely to be achieved until the end of 2022 at least, if ‘moderate’ is taken to be the previous level of palm oil prices – roughly half of current pricing. Logistically, Indonesia cannot hold out on the ban for more than two months. Only a third of Indonesia’s monthly palm oil production is consumed domestically; the rest is exported. An indefinite ban means that not only fill storage tanks up beyond capacity and estates forced to let fruit rot, but Indonesia will be missing out on crucial revenue from its crude palm oil export tax. Which is used to fund its biodiesel subsidies.
And that’s where the implications on oil come in. Indonesia’s ham-fisted attempt at protectionism has dire implications on biofuels policies in Asia. Palm oil prices within Indonesia might sink as long as surplus volumes can’t make it beyond the borders, but international palm oil prices will remain high as consuming countries pivot to producers like Malaysia, Thailand, Papua New Guinea, West Africa and Latin America. That in turn, threatens the biodiesel mandates in Thailand and Malaysia. The Thai government has already expressed concern over palm-led food price inflation and associated pressure on its (subsidised) biodiesel programme, launching efforts to mitigate the worst effects. Malaysia – which has a more direct approach to subsidised fuels – is also feeling the pinch. Thailand’s move to B10 and Malaysia’s move to B20 is now in jeopardy; in fact, Thailand has regressed its national mandate from B7 to B5. And the reason is that the differential between the bio- and the diesel portion of the biodiesel is now so disparate that subsidy regimes break down. It would be far cheaper – for the government, the tax-payers and consumers – to use straight diesel instead of biodiesel, as evidenced by Thailand’s reversal in mandates.
That, in turn, has implications on crude pricing. While OPEC+ is stubbornly sticking to its gentle approach to managing global crude supply, the stunning rebound in Asian demand has already kept the consumption side tight to match that supply. Crude prices above US$100/b are a recipe for demand destruction, and Asian economies have been preparing for this by looking at alternatives; biofuels for example. In the past four years, Indonesia has converted some of its oil refineries into biodiesel plants; in China, stricter crude import quotas are paving the way for China to clamp down on its status of a fuels exporter in favour of self-sustainability. But what happens when crude prices are high, but the prices of alternatives are higher? That is the case for palm oil now, where the gasoil-palm spread is now triple the previous average.
Part of this situation is due to market dynamics. Part of it is due to geopolitical effects. But part of it is also due to Indonesia’s knee-jerk reaction. Supply disruption at the level of a blanket ban is always seismic and kicks off a chain of unintended consequences; see the OPEC oil shocks of the 70s. Indonesia’s palm oil export ban is almost at that level. ‘Indefinite’ is a vague term and offers no consolation to markets looking for direction. Damage will be done, even if the ban lasts a month. But the longer it lasts – Indonesian general elections are due in February 2024 – the more serious the consequences could be. And the more the oil and refining industry in Asia will have to think about their preconceived notions of the future of oil in the region.
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