with Xizhou Zhou, Director, Gas & Power; Head of China Energy, IHS Cera China
Mr. Zhou, in 2009, you were a principal contributor to a study labeled “Feeding the Dragon: China’s Energy Future.” The study envisioned three possible scenarios for the Chinese economy and its energy demand dynamics, called ‘Tangram,’ ‘Compass,’ and ‘Tiaozhan.’ Can you briefly explicate the implications of each of these scenarios, and how they have been updated with the benefit of hindsight?
Since 2009, we have updated these scenarios by integrating a number of additional knowledge bases that the company has assimilated through recent acquisitions—for example, in the automotive, chemical, and macroeconomic fields. We have changed the names of the scenarios, but the narratives for China are somewhat similar to what we had previously envisioned.
Tiaozhan is a ‘challenge’ scenario wherein economic growth in China remains very swift, and this fact poses a significant challenge for the Chinese energy sector as the country looks to secure the energy supply needed to keep up with growing demand. Today, we have a similar scenario called ‘Global Redesign,’ which predicts collaborative efforts—including smooth trading relationships and effective global partnerships among international companies—that will ensure the continuation of robust economic growth.
The second scenario, Tangram, is called ‘Vortex’ under current global conditions. The idea behind this scenario is that the global market will enter into sharp decline. Here, we foresee huge recessions across the world. We actually began to first design our scenarios in 2005, when IHS initially entered the realm of scenario planning. At the time, global growth rates were very strong, and the environment appeared wholly positive. Tiaozhan envisioned that the trend would endure; Tangram—now Vortex—envisioned that this state of affairs would collapse.
The final scenario, Compass, is one of oil price hikes. It is now called ‘Metamorphosis.’ It predicts that the barrel will reach a very steep price, and, consequently, energy security will become a very important driver. In response, countries will start more actively migrating toward non-fossil fuels—for example renewables, nuclear energy, etc.
In 2008, oil prices reached between $140-$150. The year after, the world economy collapsed and went into the Great Recession. Looking back, each of our three scenarios have been realized within five years—despite the fact that the scenarios were intended as a 10-20 year planning tool. This is a true measure of how quickly the world now changes.
Returning to today, Global Redesign predicts a high growth rate after the redesign of players across the public and private sectors. These players would come together to reshape the global landscape itself, in a fashion that is conducive to high economic growth.
The second scenario, Vortex, would entail a double-dip recession this year and next year; it would entail a major crisis in the Eurozone, and the death of the Euro; a recession would spread to the U.S. and also negatively impact China’s growth rate to 4-5%—which would effectively denote a recession in China as well. Vortex is a frightening world, with strong implications in the energy sector.
Under Metamorphosis, oil prices drive governments around the world to increase emphasis on alternative energies and new technologies, and causes a fundamental change in how the energy industry evolves.
Based on these three scenarios, we develop rigorous quantitative models to provide detailed outlooks for the global economy and energy sector development. These models cover over 100 countries and many unified regions. They are detailed descriptions of the possible future for the oil, gas, and electricity markets. They also describe factors such as automotive sales and petrochemical projects, etc.
In the energy sector—which is the most capital-intensive sector in the world—whenever an investment decision is made, it usually has a 30-40 year time frame. However, it is very difficult to forecast project returns. If, for example, an organization builds a coal-fired power plant today, it most likely will be in operation 30 years from now. To estimate project returns, one needs to understand things like how coal prices will develop over the long term, and how these prices will compare against natural gas price—because, in the end, one competes with other fuels. If a natural gas power plant produces electricity at a lower price point, a coal-based operation will lose business to that facility.
Having a long-term forecast is very important—and if this forecast is but a one-line forecast, the chances are immense that it will be wrong. In today’s world, even if we try to forecast oil prices two days from now, we may well be incorrect. The idea is to plan within a range of possibilities: what we call ‘equally plausible scenarios.’ Thereby, we capture a range of futures that could potentially come about, and our clients are able to plan their strategies such that, when unexpected challenges occur, they have a robust strategic response.
To provide an example: IHS had a client that subscribed to our services in 2005-2006. One of their staff looked at our scenarios, and remarked that they had not made any plans for a state of affairs wherein they would no longer have access to financing the complete a major project. The client had a project that was under construction, and its development would continue for the subsequent five years. They needed continued capital support. Most capital support comes from banks; in 2006, there were no indicators that the financial institutions would not have sufficient liquidity. However, looking at our scenarios, our client realized that there was a potential scenario wherein a major recession would cause their line of financing to falter. In order to anticipate this scenario, they set aside capital to ensure that they would have sufficient resources.
When the recession indeed struck, bank financing started to dry up, yet our client was able to complete their ongoing project with the capital they had set aside. Once their project comes online, they were one of the few suppliers that continued to meet demand in their niche.
This is an instance of how companies use scenario planning. Across the board today, major energy companies all have internal scenario planning as well, and they use IHS scenarios to compare against their own analyses to ensure robustness.
What kind of scenario do you believe is envisioned by China’s 12th 5-Year Plan?
5-Year Plans in China are actually notorious for not being very predictive when it comes to the actual numerical targets. If we look back across three decades of five-year planning, even some of the most basic elements have been missed. For example, the government never reached the GDP targets it had set for itself. The actual figure has typically been higher—in some cases, by as much as three percentage points.
During 2011-15, the authorities are planning for 7% GDP growth per annum. This will likely not happen: 8-9% is more probable, based on our macroeconomic forecasts.
Government officials are aware that they have missed their specific targets. However, the importance of the Five-Year Plan is more in the policy direction that it sets for industry and for the economy. It will have an impact on how policies are developed. For example, by planning for 7% GDP growth, the government is delivering a very clear message that they do not wish to see excessively high, unsustainable expansion. They prefer to have slower, ‘high-quality’ growth that does not damage the environment or overstrain resources. By setting a 7% target, the central authorities are communicating to regional administrators that quick growth is no longer the nation’s priority. Rather, very aggressive environmental control standards are being put forward: for example, how much sulfur or NOx should be reduced by 2015. Again, by setting such targets, even if they are not fully met, the key conceptual message is delivered to the regions.
Mr. Schoentgen of GDF Suez has called the 12th 5-Year Plan a ‘re-balancing.’ Indeed, the principal themes on the energy side seem to be that China aims to shift from growth to green growth, and from an energy consumer to an energy producer. Do you believe that China will be able to overcome the challenges inherent in realizing these goals?
It depends on the target in question. The country will want to produce more energy; however, if we look at the history, China became a net importer for oil in 1994. A few years later, it began to import natural gas; gas-importing projects really began in earnest in 2006, and China became a clear net importer for that resource, as well. In coal, many people believed that the country would remain self-sufficient for decades ahead. Then, in 2009, this view was entirely shattered, as the country became a net importer for coal. Coal is now coming from Australia, South Africa, Colombia, Indonesia, etc.
Hence, if the question is posed: “Will China become self-sufficient?” The answer, in my view, is unequivocally “no.” Importation trends will continue as demand for these commodities continues.
The question at hand is how the government can balance the economy, on the demand side, towards consumption and the service sector instead of industrial growth—because heavy industries are consuming the major part of China’s energy resources. If we look at electricity demand, over 70% of the electricity consumed in this country goes toward the industrial sector. In Western Europe or the U.S., that share is approximately 25%. If China can reduce the share of heavy industry in its overall economy, and produce less goods—not act as the ‘world’s factory’ anymore—then it could see its energy demand growth slow significantly.
The government would like to realize this scenario. However, the government is also quite recognizant of the fact that the economy needs to create tens of millions of new jobs every year to keep people employed. If a certain GDP growth rate is not maintained—a rate that can spur industry and commercial outlets—these jobs will not be created. There is always a need to balance one’s grand vision with one’s near-term preoccupation with social stability and providing work opportunities for the nation’s people.
Furthermore, the government pays careful attention to the social situation in places like the Middle East, Greece, or North Africa, and notes that if people are not given jobs, they will protest and they may seek to topple the regime. Today, although China seeks to slow its economy, too much deceleration too quickly would prove dangerous—and yet there are signs that overly rapid deceleration is indeed occurring.
Any decision that is made on the economic front will have an impact on energy demand. The government has a slew of goals. For example, in 2005, an energy intensity target— the amount of energy used to produce each unit of GDP—was set for 2010. Officials wanted to see the figure decline by 20% over five years’ time. For the first three years, targets were met—until the market went into recession. During the recession, the authorities injected capital into the economy at a scale never seen before in history anywhere in the world, and that money all went into industry: real estate construction, etc. This entailed the production of cement, steel, and other heavy industry products.
Because of this string of events, China’s energy intensity went up in 2009 and 2010 as officials sought to save the economy. By the end of 2010, the prime minister gathered his cabinet together and tried to do produce a solution: provincial officials started simply cutting power to people in order to meet the target. Ultimately, the target was missed anyway.
This illustration indicates that on one hand, the government is very determined to achieve its goals; on the other hand, when faced with an economic crisis, there is a challenging struggle between long-term objectives and near-term priorities. This struggle will continue to mark China’s national reality for the foreseeable future.
What does China’s balancing act, and its inherent troubles, portend for the global scenario?
There are three principal engines in the world: Europe, North America, and China. If Europe collapses due to the sovereign debt crisis, and the U.S. heads into recession, and China’s growth slows, there will be great difficulties ahead. For example, China is the destination for a majority of South East Asian exports—if China fails, this avenue will vanish. Hence, South East Asia will begin to decelerate as well. Similarly, if commodity demand slackens in China, robust economies like Australia will not achieve the kind of growth rate they hope for.
We are speaking of a doomsday scenario. If we extrapolate using Vortex, the world remains in this scenario for a decade to come. I believe that, unfortunately, this kind of environment is becoming increasingly likely. Much of the future hinges on what politicians will do. The German prime minister recently met with China’s top officials to try to secure capital to help rescue Europe—because if Europe deteriorates, the situation will spill over to the U.S., and if the U.S. has another recession, China is next. That is the chain reaction.
Incidentally, our economists believe that if we have another double-dip recession, it will not be an economic cycle problem—it will be a pure policy mistake. There is a policy mistake potential in the U.S., in Europe, and in China.
Let’s turn to IHS CERA. You mentioned an instance of how your data and insights are used: a client in the midst of the construction of a new facility was able to survive a recession they did not expect, by setting aside money after considering the possibilities of your recession scenario. Can you tell our readers a bit more about how IHS CERA advises its clients given the realities that exist in China, and the suite of services you offer?
The IHS organization is able to span from areas like upstream data services—for example, geological oil & gas databases that cater to technical teams in various companies—to the CERA level, where we aggregate much of the information and data we have, and perform very high-level analyses. We try to go in depth into what this data could reveal. In this way, we elevate the data to the strategic level. The audience of CERA services is at a strategic level in client companies.
For example, our client could be making a decision about whether to enter the Chinese shale gas space. Because of our full range of services, we can then: begin by looking at the geology of shale gas in China—are there enough resources? How easy is it to exploit those resources? How does the resource base here compare to North American shale? On the production side, we can estimate how much it would likely cost to produce shale gas: our production engineers, who often come from within the industry, can assess economics based on the geology. They may ask, for instance, how many rigs and wells would be required in the U.S. given identical rock conditions. Thereby we derive the cost of development.
Once we know the cost of gas at the wellhead, our market analysts can make note of this cost, make note of where the reservoir is, and make note of the volume, then compare it against the other gas sources available—such as conventional gas, pipeline gas from Turkminestan, potential pipeline gas from Russia, and LNG coming in from Qatar and Australia. We know how much these other sources cost because we have teams based in each of those countries. Say all of these sources arrive in China at the Shanghai city gate for gas supply. How do price levels look? Can shale gas be competitive?
By making these analyses, we can advise clients regarding whether shale gas is truly commercially viable in this country. We furthermore will explicate regulatory hurdles: are there restrictions for foreign companies? Does the company have the operational knowhow to enter the market? If the company does get the gas, what is its ability going to be to sell the gas to the market, and receive a rate of return that is desirable?
This is an example of our full range of services. However, we of course work with both companies that are looking to enter the market, and those that are already here. Some of our clients have been here for decades, and have a lot of experience in China. When we speak with them, we obviously do so at a different level.
More and more, we also cater to Chinese companies. The region is so large, and so dynamic, that they increasingly want to have fundamental analysis on the domestic market. Chinese companies are also going abroad, and they seek our services overseas, as well. For instance, if a national oil company in China is looking at a potential acquisition in Brazil, we can liaise and help the Chinese speak with our colleagues in Rio De Janeiro.
Let’s consider the validity of these data. You have previously worked with IHS CERA in Boston. Conversely, how would you characterize the challenge of conducting accurate market analysis in China, a country with a famous culture of secrecy, which puts enormous resources into disguising its demand for commodities? Can you really claim to be accurate?
No, you cannot. There is generally a perception of Chinese authorities intentionally “disguising” data—it still exists indeed in many cases—but the main challenge for us and our clients are really the quality of the data. For a wide range of data, the Chinese government may not even know the real picture itself simply because data collection process was often difficult.
There are other instances of a simple lack of data. For example, in the coal segment, the market has been liberalized. There is no central agency overseeing this market, aside from the safety regulator. There is little insight into the complete picture—for instance, how many mines are out there? Not even government officials can conclusively answer that question. Every year, a number is released: for example, “China produced 3 Bn tons of coal last year.” The real figure is probably different. Because of the deregulation, there is very little knowledge of the overarching trends in the segment.
The key, for an organization like ours, is to continuously watch the market, and to communicate with people and discover long-term trends and develop industry insights, instead of pure data points. Part of the advantage of being CERA is we are conducting research and speaking with our clients on a daily basis. We have the luxury of meeting members of the energy industry every day. For instance, we call our trader contacts and ask, “What volume of coal has been traded at the Qinghuangdao port today, and at what quality?”
These interactions are greatly beneficial. If we look at a data point—for example, the Qinghuangdao Coal Price Index—and note that the reported number is X RMB per ton, a lot of analysts would accept that as the coal price. However, we would know that, yes, this is the reported price, but generally transactive prices are a given percentage below or above this number. By working in this way, we get a much more complete view. Oftentimes it is not that the data is inaccurate or the authorities trying to cover up—it is a matter of understanding what the released numbers mean. Instead of representing, for example, 100% of the market, perhaps a data point only represents 80% of a given set of regions with certain regions not covered. Of course, knowing that is value in itself: it is an insight that will help one make decisions.
What are this company’s growth plans in China, and how will they compliment both the evolving needs of your clients and an evolving Chinese market?
At IHS we continue to have strong growth targets for ourselves and that is because we’re constantly expanding the areas and ways in which we can help our clients. Emerging markets are very important to our future growth today—not just in China or emerging Asia, but also Latin America, Russia, etc.
China is obviously a key growth region and we are deploying increasing resources in this market. Our focus includes both helping international companies looking to invest and operate in China, as well as Chinese companies that are looking to expand in their domestic market, and expand elsewhere in the world. We will continue to work in these directions.
We will also look to consolidate some of our practices, and deliver better value for clients. For example, we realized that supermajors had separate subscriptions or services contracts with different divisions within IHS. Some parts of BP may be more concerned with macroeconomic growth; some of its staff may be concerned with the transportation market; some may be concerned with oil price forecasts. Different divisions of the company therefore utilized different IHS products. Today we’re consolidating and integrating these services to provide a holistic pictures for decisionmakers. A supermajor in Asia will have a Head of Exploration, Head of Refining, Head of Power & Gas, etc.—and each will receive IHS reports or services. We now seek to bring all of these managers together, and have each of our own leaders in these areas present their findings and discuss how these areas interrelate. These connections are something that we at IHS discuss amongst ourselves quite often—but the group leads at the client companies do not necessarily have such interactions with each other. To provide higher value, we can bring them together in this way; we can also thereby help our clients identify key trends that can often cut across different divisions within a big company.
We often like to say that we are a business that has never existed before at this scale with this level of coverage. For example. CERA itself has competitors that offer comparable products. However, there is almost no competitor that can offer the entire range of capabilities that are offered by the IHS family of businesses which allow CERA products to very robust.
To illustrate, in CERA, in the past, we had a small team looking into transportation for the purpose of analyzing oil demand. During the past few years we have acquired three different consulting companies that focus exclusively on automotive markets. They’re consolidated as a single entity under IHS now known as IHS Automotive. Therefore the information and insight we have on the automotive market to help conduct analysis on oil demand are infinitely more robust than before. In the past, too, we had a small CERA team performing our economic forecast that we use to help forecast electricity demand. Today, there are hundreds of IHS economists sitting in different parts of the world working on economic research in a much greater level of depth. Leveraging this expertise allows us to have much more integrated views on the world.
It is quite exciting to think about the capabilities we are building. We have a group, for instance, that tracks ships operating in the open sea–tankers for LNG or other bulk commodities, for instance. This is extremely valuable to our team focusing on the liquefied natural gas market, because they would know when, for example, the LNG price goes down, that some of the LNG cargos that are going to a particular area may have decided that they will just park in the middle of the ocean and wait until prices go back up to sell the cargo. It helps provide better insights for our clients.
What is your final message on behalf of IHS CERA to the international readers of Oil & Gas Financial Journal?
China offers great opportunities for growth. However, there are extremely complicated, intricate relationships between the market and the government. As the country continues with its reforms, its marketplace is becoming increasingly dynamic. This poses challenges for companies that are trying to understand the key trends and market fundamentals. Therefore it is important to to use the right tools to help foresee what is to be expected. We at IHS are here to help our clients navigate these exciting opportunities.