One of the ways that resource investors can achieve success is by focusing on the long term outlook for economic growth and what that might mean for commodity demand. As investors have become fearful of the direction that many emerging economies are going in (populism, etc.) and the potential for more limited gains in their equity markets its worth considering whether now is an opportune time to bet on renewed demand growth from many of the emerging economies.
Since 2000, commodity investors has been fixated on China as the main source of demand growth. Over the following 18 years, China’s oil demand grew by nearly 10 million b/d, representing 40% of total global demand growth.
Economies’ demand for commodities typically tends to follow an S-curve. This is where consumption rises at an increasing rate before eventually stabilising at much higher levels. As economies develop, high income elasticity of commodity demand means that the quantity of commodities demanded rises substantially in response to an increase in income per capita. However, as economies develop further the income elasticity gradually declines resulting in smaller increases in commodity demand for a corresponding rise in income.
Recent research published by Goehring & Rozencwajg looks to where the next opportunity for growth could come from. And it has the potential to be a large consumer of commodities – India.
India today is only just reaching the same level of real per capita GDP growth that China reached in 2001, when China first crossed its “S-Curve Tipping Point.” Over the last decade, Indian per capita oil demand has grown by 0.03 barrels per year – the same rate as China between 1991-2001. In 2016, India’s real per capita GDP averaged $1,900 while its oil demand was 1.2 barrels per person per year. These levels are both very similar to China in 2001 when China’s real GDP per capita averaged $1,900 and oil demand was 1.4 barrels per person per year.
If India is in fact in the process of crossing its “S-Curve tipping point,” what should we expect to see?
If India has indeed crossed its tipping point and, using China as a guide, then we should expect to see India grow its per capita oil demand by nearly 2 barrels per person per year over the next 15 years. This equates to 7 mm b/d of total oil demand growth over the decade or ~500,000 mm b/d per year
One of the most important drivers of a country’s commodity demand growth is the rate at which its population urbanises. As a population moves from the countryside into cities, there is a dramatic increase in demand for both materials to construct infrastructure and buildings and energy to power them.
Today, India sits exactly where South Korea and China did in 1970 and 2000, respectively. With $1,900 of per capita income, 33% of its population is urban and total per capita primary energy consumption averages 0.35 tonnes of oil equivalent. Projections from the UN estimate that India could add 300 mm urban residents over the next 15 years which, assuming India’s population continues to grow at 1.2%, would equate to a ~50% urbanization rate by 2030. In turn, this would suggest that total primary energy consumption will need to grow by between 160% and 270% (depending on whether India follows the South Korea Model or China model).
A key driver of oil demand growth in China has been the sharp increase in total vehicle sales for both personal and industrial use. Major contributors to accelerating vehicle sales have been an increase in Chinese real GDP per capita, an increase in the urbanization rate, and the final point we turn to – a massive increase in the number of expressways across the country.
Amazingly, India has 1.5 million citizens per mile of expressway (ten times the amount as China in 2000 with a comparable level of real GDP per capita). There are 31,000 vehicles in India per mile of expressway (32 times China’s level in 2005).
But the Indian government appears to recognise the problem and is planning on large scale investment.
In response to these staggering statistics, the Indian government has announced a massive expressway building program of its own. In the next five years alone, India plans on increasing its expressway system by a staggering 14 fold (albeit off of a very low base). By 2022, there are expected to be 13,000 miles of expressways in operation. While this is a step in the right direction, there will still be 100,000 Indian citizens per mile of expressway (twice the level of China in 2005).
In the short term a drop in the exchange rate of any country that imports a lot of commodities (and oil in particular) is going to present a headwind for growth. Since oil and other commodities are priced in US dollars the recent selloff in emerging market currencies will mean that imported commodities become more expensive. India’s currency has not been spared the carnage, falling to a record low against the US dollar in recent weeks as investors focused on the country’s widening trade deficit.
However, the picture presented in this article is that the longer term potential for growth remains. A short term curve ball shouldn’t overcome the long term ‘S’ curve.