China commodities: Falling demand in a sea of expanding global supply.

China's voracious appetite for raw materials from the rest of the world is in flux.  The economy’s inevitable slowdown to a more sustainable rate of growth has been one of the most widely anticipated global economic events in recent times; the quandary has been just how slow and how extreme the drop will be.  Gauging China’s demand for commodities will depend not only on figuring out how slow China's economy will eventually grow, but what sectors are slowing.  

There are three important things to note about China’s commodity demand.  First, industry and construction, the main sources of raw material usage, have declined much faster than the overall economy.  This trend will continue in 2016 as Beijing lowers its growth target again, keeping downward pressure on major commodity demand.  Second, price declines have exaggerated China’s commodity import drop.   Recently, most major commodities have seen weaker imports, but not the collapse suggested by headline numbers.  Import volumes have held up much better than in the last economic downturn (see the charts below).  And third, demand for various commodities will be highly divergent going forward, with coal demand for example, dropping for the foreseeable future, and agricultural imports rising.

China's slowdown is disproportionately hurting commodity demand, and supply growth globally has overwhelmed weaker demand.

For years Beijing has told us two things: They are going to restructure to quality growth (services and consumption playing a bigger role), and policymakers want to move growth to a lower sustainable trend rate.  The only way to achieve those two goals is by letting industry and fixed investment drop (which is what we have seen in recent years) while maintaining rapid growth in services and consumption.  Heavy industry has dropped like a bag of hammers, and services and consumption have remained strong.  That has made growth highly uneven on its way down to a lower more sustainable long-term rate.  A commodity exporter gets little benefit from a soft landing in overall GDP in such a bifurcated growth scenario.  Online retail sales are growing at almost 50% a year, while steel production is down almost 5% from last year.  Compounding the uneven slowdown effects, much of the world's commodity capacity was built for China's "miracle growth" of the 2000s.  Supply, especially from mainland China producers, will take some time to adjust to a weaker China.  For many commodity exporters in markets where supply has charged forward unabated, China's uneven slowdown has felt like a hard landing.

Expect weak demand for many commodities to continue into 2016 as Beijing will probably reduce the growth target another 0.50%.  

A reduced growth target will lead to reduced fiscal and monetary stimulus, which will disproportionately weigh on investment and heavy industry, the main sources of demand for raw materials.  We may see a short-term boost in demand from the property market rebound this year and late '15 fiscal spending, but demand may slow further in 2016 for most major commodities.

Demand has weakened for most commodities, but we are not witnessing a complete collapse of all commodity demand.  

In fact, as seen from the charts below, the volume of imports is weak, but not falling dramatically.  It is the combination of both weak demand and commodity producers increasing output that has lead to the massive price drops, and the dramatic drop in the value of China's imports.  Iron ore, copper, oil, and aluminum suppliers in particular have pushed greater output despite weaker demand in recent years.  The result has been a tidal wave of supply overwhelming demand and crushing prices.  China's suppliers in particular have kept production robust in the face of weaker demand.

Domestic suppliers are still pushing down prices.

China mining firms are not subject to the same profit maximizer behavior as more market-oriented firms globally.  Local mines will keep pumping out production regardless of the price as local leaders are incentivized to keep mines and smelters open in order to maintain stable employment.  China produces 47% of the world's aluminum and over 40% of its iron ore, and miners seem to be keeping the foot on the production “gas pedal" regardless of prices. Therefore, excess supply in local commodities - aluminum and iron ore in particular - may persist for some time, even as prices drop.  China only produces 9% of global copper output, meaning supply is primarily based outside of China and will come offline much quicker than other base metals as prices fall.  

Here are some details on selected commodities in China:


China accounts for 13% of global economic growth, but 47% of the world’s coal consumption.  almost 70% of China’s electricity production comes from coal burning, causing the deadliest pollution in the world.  A recent study by Berkeley Earth concluded that 1.6 million deaths in China each year can be attributed to air pollution.  Coal has powered China’s economic "miracle growth", and now is the source of much pain.

After the 2013 “airpocalypse” events in China, pollution became the main source of civil unrest.  Beijing countered by announcing the “war on pollution”.  Since then, coal demand has plummeted.  Coal mining investment to August 2015 is down 14% from last year.  Beijing is trying to rapidly reduce coal burning as it adds massive amounts of renewable energy capacity.

The bottom line is, coal demand will face the double whammy of slowing industry and the “war on pollution”.  Coal demand of all types will continue a rapid decline for the foreseeable future; bad news for Mongolian and Australian exporters.


Copper demand has remained very weak, which for many analysts seems to be a surprise given the potential state-directed boost expected this year.  China is working to upgrade its cross-country electricity transmission in order to send electricity instead of coal from resource rich regions to wealthy coastal cities beset with deadly air pollution.  Grid upgrades, renewable energy investments, and vast long distance ultra-high voltage power line investment was supposed to boost copper demand this year.  Grid investment alone was supposed to increase 24% in 2015, as announced early in the year.  As recent as September 1, officials announced new spending of $315 billion from 2015 to 2020 for grid infrastructure improvements.  

However, improved demand for copper has yet to materialize.  Recent estimates for 2015 demand by Antiake are for a 6% consumption growth in 2015, down from a 9% increase forecasted at the beginning of the year.  China copper imports by volume are down 8% so far this year vs. 2014. 

Most research firms have grown more negative on copper over the last few months as uncertainty over Beijing’s ability to keep the economy on track grows.  Goldman Sachs sees copper demand continuing to decline on property weakness, arguing that potential improvements in grid-related demand are overstated.  Societe Generale recently cut its forecast for 2015 global copper demand nearly in half, to 2.5%, primarily driven by uncertainty in China.  Supply on the other hand is expected to increase 3% for the year.

Demand improvement depends on whether or not you think China’s infrastructure and grid spending surge will ever materialize.  I expect it will, and imports will have to increase as inventories have dwindled.


There are two offsetting factors in China’s oil demand prospects.  First, demand from the real economy has weakened.  Car sales have slowed to around 2.5% so far this year from a 10 year average annual growth rate of 21%.  Freight traffic will moderate with the industry slowdown.  Pollution controls will force changes to automobile efficiency.  Crude oil imports on a volume basis have grown 10.5% on average for the last ten years.  But going forward, the demand from the real economy will certainly be weaker than the last ten years.  As of August, the IEA’s latest forecast for Chinese demand growth is 3.2% for 2015.  China imports almost two-thirds of its oil consumed, and production is up only 3% this year.  So, import growth from underlying demand will be weaker than in the past, running at a third of the trend growth rate potentially.

On the other hand, China is building massive strategic petroleum reserves, and is not finished yet.  According to the International Energy Agency China has accumulated about 200 million barrels of crude in its reserve so far and aims to have 500 million by 2020.  300 million barrels represents about 13% of China’s total 2014 crude imports.  When and if all this storage is added is in the hands of policymakers.

The end result of these two opposing factors is a robust 10% growth in imports for the year so far.  But going forward, the problem with oil demand is similar to other commodities; structural underlying demand growth is certainly growing weaker relative to previous years, but the prospects for a boost in demand are in the hands of policymakers building reserves, and therefore remains an uncertainty.


Argicultural commodity demand in China is widely expected to fare much better than metals and energy.  Rising incomes, changing preferences, a structural rebalance to consumption, and recent price declines have pushed commodity imports higher this year.  By volume, some commodity shipments have surged dramatically (see chart below).

The USDA expects continued growth for years to come, with soybeans dominating imports.  The US supplies half of China’s soybean and cotton imports, so the trend is a positive for US exporters.

Year to Date Imports % Change from Last Year to Aug '15

Source: National Bureau of Statistics of China

Iron Ore

With the expectation of another target growth reduction next year, infrastructure growth is likely to continue its deceleration.  Iron ore demand will suffer from lower infrastructure investment than most other commodities.  About a third of iron ore goes to infrastructure building, with another third to property, and the last third to “other”.  Beijing’s infrastructure investment in the pipeline this year will probably add to demand a bit, but with the lower growth target comes less infrastructure spending.  So, on the demand side, the property market rebound will improve demand, but a lower growth target in 2016 will potentially negate the property market rebound.  Demand will weaken further, but not collapse.

On the supply side, many expect China ore producers to drop out when prices fall below $45/t, but iron ore production is a political issue.  Local policy bias to keep folks employed often outweighs profitability.  Supporting mines could get quite costly eventually.  China’s mines are high cost, with estimated break-even prices as high as $80.  That compares to BHP at $28/t, Rio around $30/t, Vale at $39, and Fortescue roughly $42/t.  If China were to support all of its iron ore producers down to $50/t, it would cost the government potentially 0.40% of GDP at a time when more pressing fiscal needs are abundant.

Credit Suisse expects iron ore prices to stay flat for the rest of the year, declining to $50/t in early 2016.