Analysis: Global power demand to languish in 2009
Source: BI-ME , Author: BI-ME staff
Posted: Tue January 13, 2009 12:00 am

INTERNATIONAL. .The outlook for energy commodities this year remains grim, says a new report from Merril Lynch. Neither cold winter temperatures in the Northern Hemisphere nor a steep fall in the price of energy have provided much support to the demand for oil, natural gas or coal.

In part, the low price elasticity of demand has prevented a recovery in consumption even after a collapse in energy prices. More broadly, as global economic activity continues to deteriorate, the risks to our energy forecasts remain skewed to the downside.

Bad economic data will inhibit a swift recovery in energy

Global leading indicators released in recent weeks have continued to plunge to new lows, suggesting further energy demand weakness ahead. Demand for cars, air travel or steel continues to contract, forcing manufacturers and service providers to downsize factories and service lines in all regions of the world. In turn, the rise in unemployment is further deteriorating energy demand prospects, and Merril Lynch said it does not expect any economic recovery until policy responses start to take hold in second half 2009. Thus, energy markets will remain closely linked to real economic activity, and a near-term rebound in prices is unlikely.

The environment for power generation is challenging

Merril Lynch said electricity demand should continue to suffer in this environment given the high correlation (0.8) to global economic activity. After a peak of 4.8% in 2007, it is estimates a global electricity generation growth of 2.6% for last year. While there is not a historical series for global power generation going back to the Great Depression, the previous two downturns clearly show that electricity intake can get hit hard during a recession. Based on the Merril estimates, world power generation will grow at an annual rate of 0.7% this year, before recovering to 2.2% next year, assuming global GDP growth rates of 0.9% and 3.1% for this year and next.

In part, the low price elasticity of demand for oil, natural gas or coal has prevented a recovery in consumption even after a collapse in energy prices. More broadly, as global economic activity continues to deteriorate, the risks to the bank's energy forecasts remain skewed to the downside. Neither a low price nor a cold weather has been able to spur US gas demand, even adjusting for the hurricanes last Autumn. The outlook for gas demand remains weak in 2009.

Power generation provides a good snapshot of the macro economy

How bad is the ongoing contraction in energy consumption? How much worse can it get? Power generation is indeed a very good coincident snapshot of the state of the global economy. Global electricity generation grew at an average rate of 4.2% over the most recent business cycle as global GDP growth neared 5%, compared to 2.5% power supply growth in the decade prior to that when global GDP averaged 3%.

Similar to oil consumption, the bulk of the electricity generation growth in the most recent cycle has come from emerging markets. Meanwhile, manufacturing industries in the OECD economies have become lighter and more energy-efficient. Within emerging markets, electricity demand growth has been particularly strong in Asia. Since 2002, China alone generated almost half of the electricity demand growth in emerging markets, expanding output at a phenomenal rate of 15% per annum.

More electricity demand destruction in the US in 2009

What are the main drivers of electricity production in the short-run? In the mature OECD regions, weather deviations are by far the strongest drivers, followed by economic activity and, to a lesser extent, fossil fuel prices. In the United States, electricity generation dropped from a peak of 7% yearly growth in January to a trough of -6% in the second half of 2008. On a three month moving average, electricity output is currently contracting at a yearly rate of 1.5%

After a year of virtually no growth in 2008, US electricity generation is expected to trail a flat to slightly negative growth profile in 2009. Energy conservation and more efficient power usage will certainly play a greater role during this downturn and could skew the risks to the downside. Still, it has to be said that US power generation is more sensitive to swings in weather than to the industrial economy, clearly indicating the importance of the residential and service sector use relative to manufacturing.

Given the sensitivity to weather, electricity demand could certainly expand under extreme weather conditions despite Merril's assumed 7% contraction in industrial production. On the bank's estimates, a 2-standard deviation colder-than-normal first quarter could push power generation into flat growth by February, somewhat making up for the 7.7% contraction in industrial activity that we discount.

Based on the Merril Lynch estimates, US power generation will not recover before the Summer. The subdued outlook for US power generation hinges on the dire outlook for US industrial production growth.

Power output is falling at unprecedented speed in Europe

The estimates for Europe are quite different. Using quarterly power generation data for the Euro area spanning back to 1990, Merril Lynch calculates that variations in industrial activity have almost twice as high an effect on power generation than temperature deviations from the seasonal normal. This result is somewhat surprising, particularly considering that residential and service sector power demand far outweighs electricity demand from the industrial sector. Meanwhile, the impact of oil and gas price changes on electricity generation is almost negligible.

Japan has also seen a collapse in power demand

In Japan, electricity and gas production is contracting very rapidly. From a peak of 13% at the start of the year, electricity output is now falling by 2.4% year on year. Similar to Europe, the industrial economy is a much stronger factor in determining electricity generation than are weather deviations or relative fuel prices. Given the bleak outlook for the Japanese economy, Merril Lynch believes that there is little scope for positive upside surprises to the amount of electricity produced near-term.

On the demand side, the amount of electricity consumed in Japan strongly correlates with the rate of industrial activity. Industrial production is now trending down at one of the sharpest rates ever recorded (8% month on month in November). Driven mainly by cuts to transportation-related production, the overall industrial economy in Japan is now on track to return to 1988 levels. Thus, based on the econometric estimates as stated before, the outlook for electricity consumption in Japan is nothing less than abysmal over the coming months.

Power demand and economic activity are closely linked in emerging markets

Compared to OECD economies, the relationship between power output and overall economic growth is even stronger in emerging markets. By sector, industrial demand for electricity outside the OECD is still mainly driven by heavy manufacturing, rather than services and households. In China, electricity output contracted at an alarming rate of 9% in November, as industrial users of energy, ranging from steel to auto to petrochemical producers continued to shut in plants and reduce output.

Indian electricity generation was also recently reported flat year on year, the lowest in three years, while power output has totally collapsed in Singapore and Taiwan.Overall in Asia and other emerging markets, electricity generation is falling of a cliff, with the latest numbers out of China indicating a 9% drop

Estimates do not bode well for coal consumption

Coal remains the main fuel for power generation around the world, with a share of over 40%, followed by gas (20%), hydro (16%), nuclear (15%) and then oil (5%). Coal-fired power generation has grown strongly in the past decade, driven by strong growth in non-OECD countries. In China, coal-fired power generation capacity tripled during the past decade. Consequently, electricity output also expanded very rapidly, creating enormous pressures on the global thermal coal market.

Nevertheless, due to role of coal in power generation globally, its share is likely to increase in coming years putting enormous pressures on the global thermal coal market.

 

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