In commodities markets worldwide, China has emerged as more than another large economy to be fed: it has become the most voracious consumer of almost everything: grains, metals, crude oil, with all indications pointing towards sustained growth in demand beyond the short term.
China's emergence as a major buyer of commodities is significantly altering the way commodities are bought now and will be bought in the future. Consider the following:
China must secure stable sources of grains and oilseeds to feed roughly one-fifth of humanity as its domestic agricultural output suffers from drought and a shortage of arable land.
China will need copper, steel and other raw materials to supply its massive urbanization drive in which 300 million peasants will be moved into new housing developments in existing cities or "satellite cities" that will be built around larger cities including Beijing and Shanghai.
As the world's fastest growing car market, China will need steady growing supplies of crude oil to feed its skyrocketing consumption, which could double to 12 million barrels per day by 2010.
China's impact on commodities markets is to push global prices upward, increasing market volatility. The unpredictability of its policies has traders on their toes, as shown by the almost instantaneous market reactions to Wen Jiabao's announcement in April that China was going to take steps to cool its economy.
At the Chicago Board of Trade (CBOT), which reflects global benchmark prices for grains and soybeans, Chinese demand and even its volatility are most welcome.
"People at the CBOT like China's influence," Dan Cekander, grains and oilseeds analyst at Fimat Futures in Chicago said. "They'll take the volatility to get that demand."
A major unknown for commodities traders in Chicago has suddenly become the Chinese government and how it plans to wield its growing influence on world markets.
How China wields its growing weight in the global commodities markets will have significant implications for the future. A breakdown of Chinese consumption trends of major commodities indicates that commodities markets (and prices) are becoming more and more tied to China's economy.
As China's population grows and its arable land continues to shrink due to deserts, satellite cities and golf courses, grain imports take on particular significance. The Communist Party has traditionally equated food security with national security.
The Chinese government appears to be liquidating large inventories of grains, signaling a shift in priorities that is likely to be a boon to grain farmers in developed, grain exporting countries and cause problems for poorer countries already dependent upon cheap grain imports, according to projections made by the International Monetary Fund in its World Economic Outlook survey.
One of those developed grain exporters, the US, is guardedly optimistic about China's growing dependence on imported grains. "China has been the promised land for demand for years, but the business never seemed to materialize," said Bill Nelson, associate vice president with US brokerage AG Edwards. "But I think now it will finally happen."
China, the world's second biggest consumer of corn, used up 119.4 million tons of corn in 2003, nearly one-fifth of global corn consumption. The US Department of Agriculture (USDA) projects Chinese corn output in 2004 will decrease by 6% while demand is expected to grow by 2%. The supply- demand gap has drained Chinese corn stocks to 21.4 million tons, their lowest level since the mid-1970s.
China has been an aggressive corn exporter for years, but it is now retreating from large exports, leaving Malaysia, Indonesia and South Korea to look elsewhere for corn. In 2003 the three countries together sourced 87% of their combined 13 million tons of corn imports from China. The USDA estimated that China will export no more than 8 million metric tons of corn in the 2003-04 market year (Sept – Aug), nearly a 50% drop from the previous market year.
And China has raised its low-tariff import allocations for corn under the World Trade Organization to 7.2 million tons in 2004. That doesn't mean the country will import that much corn, but it could. In 2003, the import quotas for corn were 6.5 million tons.
What has aggravated the situation for China and globally is that other coarse grain crops such as barley, oats and sorghum have also seen bad production years recently in many parts of the world such as Australia, France and even China itself, limiting availability of alternative supplies. Nelson said that in 2003-04 alone, China's corn imports should more than triple the previous year's total, fueling a price rise that he predicts will push prices 15% higher this summer than in April.
Wheat is following a trend similar to that of corn in China, which is the world's largest wheat producer and previously imported little of the grain. Recent import deals between the US and China raised total export commitments of US wheat to China to date to around 1.375 millions tons for 2003-04 (June-May) and 1.575 million tons for 2004-05, Nelson said.
As of mid-April, the USDA projected total Chinese wheat imports in 2003-04 at 2 million tons, up sharply from the 418,000 tons imported the previous marketing year. The increase in Chinese wheat imports comes at a time when its domestic production has fallen to 20-year lows, sending prices to 8- year highs.
Chinese consumption of wheat in 2003-04 is again expected to exceed its production, pegged at 86 million tons, down some 4 million tons on the year. As a result, ending stocks in China are expected to drop nearly 20 million tons to 41.37 million this marketing year, according to the USDA.
China is also the world's largest producer of rice, but that didn't keep rice prices across the country from rising 14% in commercial hubs such as Nanjing earlier this year. The jump in rice prices was a harbinger of inflationary trends to come, as food, especially rice, constitutes much more of the consumer price index in China than in other countries.
Six years of declining production have had a profound impact on China's rice supplies. While Chinese rice production is expected to drop roughly 7 million tons this marketing year to 115 million metric tons, its consumption is projected to hold near 135 million metric tons.
The USDA projected China's rice imports to reach 1 million tons this year, growth of nearly 400% year-on-year and the highest since 1995. Total world demand for rice is rising this year and it should again outstrip an increasing output, tightening global stocks to 85 million tons in 2003-04, their lowest levels since the early 1980s. Prices continue to rise while China imports more and more with no signs of slowing down.
Oilseeds and oils
Chinese production of oilseeds – including soybeans, cottonseed, rapeseed, sunflower seed and peanuts, is exhibiting the familiar trend of downward production combined with rising consumption as seen with other agricultural products. China consumes roughly 36 million tons of protein meals a year while the US consumes 32 million. China currently consumes nearly 30 kg of soybeans per capita annually, while US consumption is slightly under 158 kg, so there is much room for further growth.
"If China's per capita consumption were brought up to the same level as the Unites States, that would take an additional 6 billion bushels of soybeans," said AG Edwards' Nelson. "At 40 bushels per acre, that would take another 150 million acres."
Perhaps even more important for the soybean market has been China's emergence as a soy oil consumer. The USDA projected that China would import 1.93 million tons of soy oil in 2003-04, up more than 420% from just two years before and only a fraction of what it could import under the low-tariff import allocations required by the WTO, which total 3.12 million tons for 2004.
Prices in the soybean complex have been at their highest since 1988 in the U.S. and even more so in China, where, in April, they were carrying a premium of some US$3.00 a bushel to US levels.
In the early 1990s, China was a soybean exporter, with yearly total exports exceeding 1 million tons. In 2003, China's soybean imports exceeded 20.7 million tons to surpass domestic production for the first time, according to Chinese Customs. The USDA predicts that over the next few years, China will account for more than half the total of global soybean imports and half of soybean oil imports.
"The bottom line is that Chicago is the benchmark for grains and oilseed prices worldwide," Nelson said, "but the market here is really dictated by China." The country's growing soybean demand has this marketing year's imports projected at 20.5 million tons, in line with the previous year's total, but nearly double the amount two years before. In 2003-04, China's soybean production is projected to be marginally higher at 16.2 million tons. But demand for soybean meal is projected to reach a record 22.55 million tons and soy oil at a record 7.09 million tons.
China is expected to surpass India as the world's top importer of vegetable oils in 2004, a result of high soybean prices, with CBOT soy futures at highs not seen in 15 years. Chinese consumers are also showing new interest in palm oil, which is less expensive than soy oil. Oils traders expect China to purchase up to 5.5 million tons of palm and soy oil in 2004, one million tons more than India.
China's construction-fueled copper consumption is a prime example of the increased sway it exerts on commodities. China consumed one-fifth of the world's copper production in 2003 on the back of a 20% jump in consumption. During that period, copper futures at the New York Mercantile Exchange Comex rose by 72% and global refined copper inventories dropped by 16% to 1.78 million metric tons.
China's 2003 copper imports from Chile, the world's largest exporter of copper, grew by 37%. In the same year, Chilean copper exports to the US dropped by 54%. This is a trend that many analysts expect to continue in the short term.
Bill O'Neill, principal at LOGIC Advisors in New Jersey, said the base metals market, particularly copper, illustrates the appeal of Chinese demand to traders. Despite rising copper prices, China has been increasing its imports of copper due to falling domestic stocks.
Jim Steel, director of futures research for Refco in New York, said that just as China displaced the US as the primary consumer of copper two years ago, it is on track to displace the US in aluminum consumption this year. Aluminum imports have been strong, climbing 11% year-on-year in the first two months of 2004. Alumina imports were up 23% year-on-year in the same period.
China consumed 18.7% of the world's aluminum in 2003, while producing 19.7%. A recent Merrill Lynch survey predicted that China's annual production capacity for aluminum will jump 19% to 6.6 million tons in 2004 and 12% to 7.4 million tons in 2005. The survey also predicted that global aluminum prices should drop in 2006 after the global alumina supply catches up with China's production capacity.
China is both the world's largest consumer and producer of steel. In 2003 China consumed 2.5 million tons of steel, roughly one quarter of global consumption.
As domestic steel output grows rapidly, imports are not lagging far behind. In the first two months of 2004, steel production grew more than 31% year-on-year, reaching 43 million metric tons. Steel imports in the same period rose 21.5% to 6.6 million tons.
Steel prices in China rose 39.9% in the first quarter of 2004, but prices have dropped recently in response to government attempts to cool the overheating steel sector. In a six-week period that ended in mid-May, the price of steel products dropped by US$91 per ton, or about 17%, to US$419 per ton. Despite the price drop, steel prices were 30% higher than the same period in 2003. Refco's Steel said that there is a growing sentiment among commodities traders and analysts that high raw material prices may be slowing growth in both production and demand in China. "The markets are a bit overdone for the near-term. We have already seen some retracement in base metals, so more consolidation should be ahead," he said. But he added that Chinese demand is far from peaking, with additional price increases likely.
As China moves further from its agrarian economy, energy security is becoming as important as food security. China accounted for one-third of growth in global oil demand and overtook Japan as the number two oil importer in 2003. Oil has become a top priority for Beijing and is expected to increasingly influence China's foreign policy.
Bill O'Grady, director of futures research for AG Edwards, said that from 1985 to 2003, world per capita usage of crude oil averaged 4.5 barrels per year and remained relatively stable. Chinese per capita oil usage today totals 1.7 barrels per year per capita, a significant leap from 0.6 barrel in 1985. "If taking into account the growth rate from 1990 to 2003, China's oil demand should double by 2014, without assuming any population growth," O'Grady said. Plugging population growth into that equation, China's oil consumption could double by 2010-2012, O'Grady said, calling it a "conservative estimate." That would mean a current daily demand of 6.1 million barrels going to 12 million a day.
China does produce some oil, about 3.4 million barrels a day – or roughly half of what it currently consumes – but those output levels are expected to taper off over the coming years.
In 2003, US oil reserves were enough to last six months. Japan's reserves are estimated to be sufficient to sustain it for 119 days. China has virtually no oil reserves at all, a dangerous situation when a country is as dependent on imported oil as China. China recently established reserves in four coastal cities, but building up significant stores of oil will take time.
China imports around two-thirds of its oil from the Middle East, a reliance it is keen to reduce. Africa is emerging as a new source of crude oil for China. In 2003 Angola surpassed Oman to become the number three source of oil imports to China after Saudi Arabia and Iran, respectively. China is the top developer of oil reserves in Sudan, where it has its soldiers guarding a crucial pipeline.
Hu Jintao's tour of Europe in 2003 received more media attention than his stops in Egypt, Algeria and Gabon, but the oil and gas contracts that were signed during his visit to Africa are arguably more important to China's sustained development than anything accomplished during his stop in Europe.
While Hu was in Gabon, Sinopec unit Unipec signed a supply contract with French oil company Total Gabon, marking the first time for China to buy oil from the country. Sinopec also inked a protocol accord with Gabon covering areas including oil exploration and production.
During Hu's Algeria visit, the two countries signed an energy cooperation agreement that enhanced their existing close energy cooperation. Sinopec launched a US$525 million project to develop the Zarzaitine oilfield in the Algerian Sahara. In 2003 China National Petroleum Corporation signed a US$350 supply contract to import Algerian oil. China National Oil and Gas Exploration and Development Co recently won a contract to build a refinery in the North African country.
Energy cooperation with Russia and Kazakhstan, which has had some of the world's largest oil discoveries in recent years, is also a priority.
Natural gas has become increasingly appealing to China, which in the past year has signed major deals in Saudi Arabia, Indonesia and Australia, in addition to working to boost domestic production.
China's impact on the softs market, which includes sugar, coffee and cocoa, has been minor, but it seems destined to grow. China is the world's third-largest producer and consumer of sugar. China's domestic consumption of both coffee and cocoa have been steadily growing, but actual production and trade of those commodities remains miniscule.
"China has a steadily growing interest in coffee, but the country still is primarily a tea drinker," said Michael McDougal, senior vice president with Fimat. "As living standards improve in China, it should buy more sweets [made from cocoa], but right now it's no big business there."
The sugar trade is big in China and the country's influence in world pricing of that good is significant, McDougal said. China, like the US, is one of few producers of both sugar beets and sugar cane. Both production and usage of sugar in China have been strong, but in the 2003-04 marketing year (Oct-Sept), output is expected to fall short of demand, pushing China to import more than usual.
According to the USDA, China's 2003- 04 sugar production is projected around 10.57 million tons but its annual consumption is near 11.5 million. The sugar market in New York has been trading an abnormally small output following drought problems in north China's beet producing regions.
McDougal said traders are expecting Chinese sugar production to be closer to 9.5 million tons this marketing year, elevating imports to 1.0-1.5 million – a level not commonly seen. The result should be higher prices for sugar in the near-term. "Overall, I'd say that grain production in China will be the primary concern of the government there," McDougal said.
Rising demand for lumber imports is likely to remain strong due to increasing consumption and restrictions on domestic production inspired by environmental concerns. China is planting forests to fight erosion and encroaching deserts. At the same time, more Chinese are buying their dream homes, which increasingly have wooden floors, and hardwood furniture. This rise in consumption, coupled with strict logging restrictions, is a major opportunity for lumber exporters.
These trends have made China the top export market for lumber industries in neighboring countries. As it sucks in lumber from Russia and Indonesia, China also recently became the top export market for the US lumber industry. US hardwood shipments grew from US$40 million in 1999 to about US$120 million in 2002, according to the American Hardwood Export Council.
Playing the market
In the early days of its open-door policy, China was known for manipulating commodities markets worldwide. But that gambler's approach has yielded to pragmatism prompted by China's growing need of commodities, AG Edwards' Nelson said.
China is seen as being increasingly easy to understand, but there is a general sense among US traders and analysts that China still tends to put out some "misinformation" or unclear, incomplete data that directly affects prices, Nelson said. The imposition of trade barriers on genetically modified crops in the past couple of years, barriers that keep on changing, have been perceived as an attempt to manipulate the market.
In the near term, China has the potential to throw markets into confusion, but given its new penchant for transparency and its need for reliable supply lines of crucial commodities, China's trade practices will become clearer, Nelson predicted.
"Last winter China said it was coming to the US to buy soybeans one time and wheat another, and sure enough it did," he said. "It never used to do that. Like any buyer, it would want the best price, but its practice hasn't been the same as 10 to 15 years ago when you couldn't be sure until the grain was actually on the boat headed to China."