Some great economists and academics, along with Wall Street luminaries, have been debating the prospects for growth and bubbles in China. My first post of three touches on several subjects, as the demographic shifts in China are enormous. Today, I am chipping away at energy because of the size and concentration of the industry.
All fast growing economies have boom and bust cycles. Generally speaking, these economies rise more than they fall over moderate time periods (5-10 years). This occurs until its economy matures and China is a long way off from a mature economy. GDP growth was a whopping 13% in 2007 and slowed only to 9% during the financial crisis of 2008 and has not fallen.
Even so, by many measures, China is one of the poorest countries in the world. For instance, with the world’s largest population (1.3 billion, India 1.1 billion and then the US at ~300 million) when looking at GDP purchasing parity, China ranks 130th versus the US, which is ranked 11th (the source for all of the above data is the CIA). Although blessed with many advantages, the country, through its exponential rise to economic power, has had many unintended consequences.
One expected demographic shift has been mass urbanization and suburbanization, which requires careful management. As the population increases its income, consumption patterns will change, as will imports and exports. In essence, as I have written about in other countries, you cannot fight demographics.
Energy prices are carefully controlled by the government. A recent Reuters article discusses a rare occurrence in China, a public discussion of what the central government prefers versus what the provinces are planning to do.
Alarmed by the vaulting ambitions of many Chinese provinces to grow at all costs, China’s top economic chief is pleading with officials to calm down and spare a thought for the environment.
Zhang Ping, who heads China’s National Development and Reform Commission, the central economic planning agency, said only five or six of China’s 30 provinces are targeting annual economic growth of 8 or 9 percent.
The remaining provinces are aiming for growth rates of more than 10 percent this year, with some even wanting to double economic output in the coming five years.
This presents an array of issues for China in which to contend. Energy is one of the larger issues, with pollution also becoming an issue openly discussed as health and animal health issues are outweighing the old growth at any cost attitude.
“China has a planned energy supply of about 4 billion cubic tonnes of coal equivalent for the next five years, and this is not enough to meet demands for economic growth to double,” he was quoted as saying on the news portal Sina.com.
Beijing is increasingly exasperated by the ambitions of Chinese provinces across the country to chase high-octane growth despite the central government’s pleas for a more moderate and sustainable pace of expansion.
Years of break-neck growth have taken a toll on China’s environment, with Beijing trying to undo some of the damage now. It has an annual growth target of 7 percent for the next five years, well down from last year’s 10 percent.
Zhang said Beijing has asked local governments to take into account the supply of “energy, environment, water and land” to set more reasonable growth targets.
This presents opportunity. There may be a bubble growing in land values in parts of China. The population occupies around 46% of its land and that is projected to decrease as more people migrate to cities and their immediate outlying regions. It may take days, months, years or even a decade for that bubble to burst.
We seek more concrete investments through public companies, and in the energy sector there are several in which to select. China continues to build coal plants, but is also seeing major growth in cleaner and less expensive natural gas, which is currently >5% of energy use. Many of the largest integrated multinationals are not exposed enough directly to China to increase its P/E multiple. Some firms are recasting their positions in mature markets and repositioning growth expectations from mature economies toward faster growing regions and countries.
In China, many of these large firms are kept on the outskirts of the market by domestic players. One reason is direct access. China directly imports the bulk of its oil from Saudi Arabia, Iran and Angloa followed by Russia and Sudan. Some domestic players trade here, such as oil and gas exploration firm CNOOC (NYSE: CEO), and refiner SINOPEC Shangai Petrochemical (NYSE: SHI). There is also China’s largest energy source (nearly 70%), which is coal. You can also find oil and natural gas deals, and you will find Royal Dutch Shell (NYSE: RDS.A), with its domestic partnership with PetroChina (NYSE: PTR) and Chevron (NYSE: CVX), with major activity in Australia and South East Asia, where both firms supply energy to Japan and South Korea. These are both high dividend stocks with betas less than the market, CEO, SHI and many other firms in the energy sector, making them attractive.
From another Reuters article back in September.
Anping County, in Hebei Province, cut electricity to homes, factories and public buildings for 22 hours every three days in a radical move that has highlighted both the serious last-minute effort that China is making to achieve environmental goals and the immense long-term difficulty of shifting away from a dirty, wasteful model of economic growth.
There are less than four months left until the end of China’s current five-year plan, during which the economy is supposed to have become 20% more energy efficient. That target (which measures energy use relative to GDP growth) is crucial for a nation that wants to move up the economic value chain and prove to the world that it is making a significant contribution toward tackling greenhouse gas emissions.
The government is serious about control, but the wheels of this bus, factory and new air conditioners and refrigerators have already left the station.
Coal is another large play and Australia is again a good place to look for pure plays, as well as which larger firms are benefiting. A sample pure play is New Hope Corporation Limited (ASX code: NHC).
Investors beware and traders watch your hedges. Whenever seeking investments outside the US, the dollar plays an important role as currency fluctuations amplify gains and losses. ADRs, ETFs and common stock are all currency influenced. Trims and adds are more important as is watching for government as well as market influences. For a more diversified play (including mining) on Australia, one can look at iShares MSCI Australia Index Fund (NYSEArca: EWA).
I will post two more times (I am back from my writing break) with some clear and local selects to play other demographic shifts in China. Today, in the energy sector, we are with two large megacap multinationals not based in the region. With OPEC keeping its $90 price target for oil, a growing economic recovery in the US and expansion in growing markets such as China, playing companies with the desire to expand and financial strength to make it happen seems prudent.
Disclosure: Mr. Corn is Chief Investment Officer of E5A Funds LLC. Through various strategies under his supervision he is currently long CVX and RDS-A.