Asia Brief: China‚Äôs Car Fleet ‚Äď The Largest in the World?
Guinness Atkinson Asset Management
By Edmund Harriss, James Weir
May 22, 2013
Car sales in China have grown rapidly since 2009 and it is on course to outstrip the US in terms of the size of its car fleet by the end of this decade. This presents a major challenge to the Chinese government, which must balance its people’s happiness and political stability with economic development in an environment which has already been compromised. The momentum of demand for new passenger ¬†vehicles is likely to make air quality worse and Beijing has introduced emissions and efficiency standards to address the problem. China will also need to use more high quality gasoline and new refining capacity may be needed. However, oil is relatively low as a proportion of overall energy usage and in aggregate China should be able to handle the additional energy needs of its growing vehicle fleet.
The largest car fleet in the world?
The growth in consumption in China has major implications for the environment, the global economy and world energy demand. One of the most significant drivers of this is the likely growth in the Chinese car fleet, ¬†and on current trends, it could ¬†outstrip the US car fleet ¬†by the end ¬†of the current decade (see chart below). This is not alarmism. It is simply based on continuing the current level of annual sales of around 20 million units and represents almost a tripling in the number of vehicles on the road in China. As with many things in China, the scale of this development is awe-inspiring, but this may well not be the end of it, given that China’s population is around four times that of the US and there ¬†is no reason in principle why car sales ¬†should slow down once the artificial level of parity with the US has been achieved.
An acceleration of vehicle ¬†sales ¬†in China has ¬†been underway ¬†for some time ¬†and ¬†in 2009 the ¬†government introduced a range of subsidies such ¬†as a ‘cash for clunkers’ ¬†scheme, and this provoked ¬†a doubling average sales volume, from half a million to around a million units a month. Perhaps most ¬†surprising is that even once the subsidies were withdrawn vehicle sales remained around one million units a month (see ¬†chart at the top of pg. 3). This has continued to climb, even despite a slowdown in economic activity over the last year, and China has now had higher average monthly car sales than ¬†the US for almost three years.
Rising car sales and Chinese energy consumption
Chinese energy ¬†demand has ¬†been growing rapidly as the ¬†economy has ¬†industrialized, but ¬†it is notable ¬†that ¬†oil demand has ¬†not ¬†kept ¬†pace ¬†with overall ¬†energy ¬†consumption (see ¬†chart ¬†below). ¬†This means that China potentially has the headroom to increase its oil demand without tilting its overall¬† energy ¬†usage too much ¬†in the ¬†direction of oil. The reason that ¬†China has been able ¬†to achieve ¬†this is because much ¬†of its baseline and industrial demand for energy ¬†is met by domestic coal deposits rather than imported oil.
This puts ¬†China at an advantage compared to its regional peers, all of whom went through a similar process as China when their investment-led growth phases cooled and consumption became more significant as a driver of Gross Domestic Product (GDP) growth. Unlike Japan, South Korea and Taiwan (see chart below), Chinese oil demand relative to primary energy consumption has barely crept ¬†above 20%, while these other ¬†nations peaked at 70-80% ¬†before ¬†falling back to around 50% following the end ¬†of their investment phases of growth. For Japan, South Korea and Taiwan, with few energy resources of their own, imported oil was the quickest and easiest method of ramping up energy consumption domestically, but it left them exposed to imported inflation ¬†if international oil prices rose. With large coal deposits of its own, China has been in an advantageous position, and this could ¬†allow it to rapidly expand vehicle usage without a debilitating effect on its balance of payments status and inflation.
The efficiency challenge
The Chinese government seems aware of the potential additional demand for energy ¬†as a result of the growth in the car fleet and increased passenger kilometers travelled, and the Ministry of Industry has ¬†announced that ¬†new fuel efficiency ¬†standards will be implemented from May 1st 2013. ¬†These ¬†standards aim to bring down the average fuel consumption of vehicles sold in China on a progressive basis between now and 2015 to 6.9 liters per 100 kilometers. This will be a challenge for the Chinese car manufacturers, in particular, the domestic makers ¬†which generally fail to meet this consumption standard at present.
The idea is to apply the new standards across the range of vehicles sold by a manufacturer, such that some more efficient vehicles ¬†may effectively ‘subsidize’ the less¬† efficient ¬†cars. Electric vehicles ¬†and plug-in ¬†hybrid vehicles ¬†are zero ¬†rated ¬†for the ¬†purposes of the ¬†scheme, and ¬†this should encourage manufacturers to consider including these in their fleet to help meet the overall targets. To date the sales of alternative fuel vehicles ¬†have been disappointing, and according ¬†to the Chinese Association of Automobile manufacturers (CAAM) 11,375 electric vehicles ¬†and 1,416 plug-in ¬†hybrids were sold in
There may be better prospects for natural gas-fuelled vehicles, ¬†although China is pursuing a different strategy to the US with a focus on passenger cars powered ¬†by compressed natural gas in China, rather than freight vehicles ¬†powered ¬†by liquid natural gas in the US. China has also concentrated on taxis and buses as early adopters, and half of the installed taxi fleet of 1.1 million taxis is already running on natural gas. By the end of the last 5 year plan in 2010, China had an installed base of 1,000 gas refilling stations for compressed natural gas, and the plan for the current five year plan to 2015 is to double this. ¬†However, the ¬†demand from ¬†consumers for these vehicles ¬†has ¬†been much ¬†more circumspect, and in 2012 it is estimated that less ¬†than ¬†30,000 natural gas passenger vehicles, ¬†only 0.2% of the total new passenger cars, were sold last year.
Protecting the environment
A significant increase in the Chinese car fleet ¬†presents serious challenges to the government, as it means significantly greater demand for fuel and greater carbon ¬†and pollutant emissions. The mandate for the new Chinese government is more complex than for previous ¬†administrations, and there ¬†is a recognition that the happiness and stability of the Chinese people can no longer be bought with just material gain. After decades of rapid economic expansion, the environmental hangover is serious, and poor air quality has become a serious matter for the authorities. Poor air quality is a major issue ¬†in the larger Chinese cities, not least Beijing, which has taken steps to force drivers to improve ¬†the quality of gasoline they use. On February 1st 2013, a new emissions standard, Bejiing V, was introduced, and this is similar to the Euro V emissions standards. The new standard will prevent new vehicles ¬†being sold or registered if they fail to meet stricter emissions standards for particulate matter. While this is unlikely to solve the issue in the near term, it is at least a start in dealing with an issue ¬†that could get much¬† worse if the projections for car sales ¬†in China over the rest of this decade come ¬†to pass.
Although Beijing V, and potentially China V, should be helpful in reducing particulate matter emissions, it will be difficult to roll it out nationally in the near future given China lacks the refining capacity to scale ¬†up the supply ¬†of the required high-grade fuels, ¬†and many of the vehicle manufacturers sell vehicles ¬†that are not in compliance with the new standard.
More cars means more journeys and more roads
There is growing demand for passenger vehicle transportation, and Chinese highway journeys ¬†have been growing with little interruption since the early 1990s (see chart at top of pg. 6). Although public transportation has seen faster growth in terms of passenger usage, China’s scale and geography suggest ¬†that ¬†affordable personal transportation could ¬†see significant growth in the coming years. This offers the possibility of both a growing fleet of vehicles ¬†and greater usage of those vehicles.
As well as developing the vehicle fleet, ¬†the government is also encouraging the development of an appropriate road network for the country. In line with encouraging economic development outside of the coastal provinces, the government is keen to build new roads to make the interior of the country a better place for economic activity. The scale of the challenge is not trivial ‚Äď it is estimated that at the end of 2010 there ¬†were 1,200 townships and 120,000 villages ¬†without paved roads. ¬†This is a significant cost to the economy, and logistics is estimated to cost 18% of GDP in China, compared to 8% in the European Union and 9.5% in the US. In the 12th 5 year plan there is significant spending on new roads planned, with the ultimate aim of having all townships and 90% of villages accessible by 2015.
China on the move
Getting ¬†China on the ¬†road ¬†is a herculean task, and China may well have the ¬†largest car fleet ¬†in the world in a few short years. ¬†Energy¬† consumption will inevitably ¬†rise as a result of the ¬†growth ¬†in car sales, ¬†but China is in a favorable position relative ¬†to its peers, as it uses ¬†much ¬†less ¬†oil in its energy¬† mix relative to other Asian peers at this stage in their development. Although the rapid nature of this growth means that the Chinese car fleet will be in aggregate relatively young, there is good demand for both ¬†SUVs (Sports Utility Vehicles) and ¬†high performance luxury cars, which tend ¬†to use ¬†more energy than the lower powered, smaller cars.
The scale of the investment required in both fixed infrastructure and vehicles ¬†offers a growth opportunity to investors, while the government needs to keep ¬†its people on-side and manage the process responsibly. The government’s first task remains to limit the damage from increased emissions and keep its first tier cities as places where people can live and work happily and safely.
Asian equities performed well in April, with most ¬†markets up strongly. ¬†South Korea was the notable outlier, ¬†which finished the month down 2.45%. For the year to date ¬†only China and South Korea remain ¬†in negative territory, and ¬†five of the ¬†markets have already ¬†achieved ¬†double digit returns. The top-performing markets in April were New Zealand, Australia ¬†and ¬†Malaysia, while the ¬†Philippines and New Zealand have been the best ¬†performers year to date.
The malaise in South Korea is partly related to continued sabre-rattling by the North Korean regime, but it is also due to sluggish growth in the economy. To address this, the South Korean central bank recently ¬†cut interest rates ¬†for the ¬†first time ¬†since ¬†October 2012. ¬†This takes ¬†policy interest rates ¬†to 2.5%, which is their ¬†lowest ¬†level ¬†since¬† early 2011. Despite the ¬†weak equity ¬†performance, there ¬†are signs¬† of recovery in the Korean property ¬†market ¬†with April’s data ¬†showing lower unsold inventories, higher transaction volumes and flat prices.
China continues to confound investor expectations with good GDP growth of 7.7% in the first quarter failing to spark a sustained recovery in equities. It seems the market is still coming to terms with the slower pace of economic growth, and the ¬†newly re-appointed central bank governor, ¬†Zhou ¬†Xiaochuan, described the current growth rate as ‘normal’, and that China must ¬†sacrifice short-term growth for restructuring. Concerns also ¬†remain about China’s indebtedness, ¬†with one ¬†of the ¬†international rating agencies reducing China’s sovereign ¬†debt rating in April as a result of the growth in non-bank lending.
Elsewhere in the ¬†region, ¬†Indonesia’s credit ¬†outlook was downgraded from ¬†positive ¬†to stable as a result of an ongoing disagreement between President Yudhoyono and the parliament over fuel subsidies. Investors ¬†had hoped that the fuel subsidies would be reduced or withdrawn altogether in the near ¬†future, ¬†but the President demanded that parliament offer cash ¬†transfers to the poor to soften the impact ¬†of the ¬†removal. ¬†Parliamentary approval ¬†has ¬†not ¬†yet been granted, and ¬†the ¬†debate between¬† the two sides could take some time.
Over the last five years, the S&P 500 index has outperformed both ¬†the Asian and European benchmark indices (the MSCI All Country Far East Free ex-Japan Index and STOXX Europe ¬†50 Index). The Asian reference benchmark we use has performed sluggishly so far this year, with China and South Korea particularly holding back the wider market ¬†due ¬†to their heavy benchmark weights. European equities remain well behind the other ¬†two regions, although they have performed relatively well so far this year.
China Economic ¬†Monitor
Chinese growth remains relatively healthy despite a slowdown in recent months. At 7.7% in real terms for the ¬†first quarter of 2013, this is well ahead of the ¬†levels ¬†recently ¬†achieved ¬†by other ¬†economies of its size, although it is lower than China has achieved ¬†in recent ¬†years. The economy is on track to achieve the new government’s stated target ¬†of doubling real GDP and GDP per capita between 2010 and 2020. There have been signs ¬†of softness in growth elsewhere in Asia, but so far Chinese policymakers have not reacted by cutting interest rates, ¬†nor has ¬†there ¬†been a move on the currency in response to the devaluation of the Japanese Yen in recent ¬†months.
Deposit growth has rebounded strongly in recent ¬†months to achieve a rate of 16% in April, its highest level since June of 2011. Although the Chinese banks have substantial deposit-taking franchises, there ¬†is some disquiet at the ¬†central bank ¬†at the ¬†level ¬†of wholesale financing undertaking by the banks, ¬†and ¬†this growth ¬†in deposits may be a reflection of a desire ¬†to shore ¬†up the ¬†liability side ¬†of their balance sheets. On the lending side, loan growth remained solid at 16% year over year in April, which is reasonable. However, total ¬†social ¬†financing grew 81% in April year¬† over year, suggesting that other ¬†forms ¬†of financing grew much ¬†quicker than ¬†bank lending. Set against the background of slower growth in China, there remains a question in some investors’ minds as to where the additional financing is going and how much is going to state-owned enterprises and the property sector at the expense of the private sector.
The data ¬†suggest that ¬†inflation ¬†in China remains well under control, ¬†with falls ¬†in both ¬†the ¬†rate ¬†of growth in the retail price index and the producer price index in April. Consumer prices also seem to be manageable, with falls in wholesale pork prices in recent weeks suggesting that inflation is being ¬†held ¬†at bay despite the central bank’s monetary stimulus policies. However, there ¬†is some concern that ¬†the low inflation ¬†could ¬†in fact reflect sustained weakness in underlying economic activity, with falling producer prices suggesting that corporate margins in manufacturing could come under pressure.
Passenger vehicle sales ¬†in China fell slightly in April to 1.44 million units. Although this is disappointing, the absolute level of sales ¬†remains above that sold in the US in April (1.28 million units), and is high by historical ¬†standards. The fall in unit sales ¬†is in line with the data we see elsewhere in the economy, which suggests that growth is reasonable, but has not re-accelerated in the way we hoped earlier this year.
Performance data quoted ¬†represents past performance and does not guarantee ¬†future results. Index performance is not illustrative of Guinness Atkinson fund performance and an investment cannot be made in an index. ¬†For Guinness Atkinson Fund performance, visit ¬†gafunds. com.
Mutual fund investing involves risk and loss of principal ¬†is possible. Investments in foreign ¬†securities involve greater ¬†volatility, political, economic and currency ¬†risks ¬†and differences in ¬†accounting methods. Non-diversified funds concentrate assets in fewer holdings than diversified funds. Therefore, non- diversified funds are more exposed to individual ¬†stock volatility than diversified funds. Investments in smaller companies involve ¬†additional risks ¬†such ¬†as limited ¬†liquidity ¬†and greater ¬†volatility. ¬†The Fund may invest in derivatives which involves risks different ¬†from, and in certain cases, greater than the risks presented by traditional ¬†investments.
The MSCI All Country Far East Free ¬†ex-Japan Index ¬†(MSCI AC Far East free ex-Japan Index) ¬†is a free float- adjusted, capitalization-weighted index that ¬†is designed to measure equity ¬†market ¬†performance in the ¬†Asia region ¬†excluding Japan. The Index is made up of the stock markets of China, Hong Kong, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan and Thailand.
The MSCI All Country Pacific Free ex-Japan Index (MSCI AC Pacific Index) is a free float-adjusted, capitalization-weighted index that is designed to measure equity market ¬†performance in the Pacific region.¬†¬† The Index is made up of the ¬†stock markets of Australia, ¬†China, Hong Kong, Indonesia, Korea, Malaysia, New Zealand, Philippines, Singapore, Taiwan and Thailand.
The S&P 500 Index is a broad based unmanaged index of 500 stocks, which is widely recognized as representative of the equity market in general.
The STOXX Europe ¬†50 Index (STXE 50), Europe’s leading Blue-chip index, provides ¬†a representation of supersector leaders in Europe. The index covers 50 stocks from 18 European countries: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Italy, Luxembourg, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the United Kingdom.
Consumer Price Index (CPI) is a measure that examines the weighted average of prices of a basket of consumer goods and services, such ¬†as transportation, food and medical care.
Producer Price Index (PPI) is a family of indexes that measures the average change in selling prices received by domestic producers of goods and services over time.
Retail Price Index ¬†(RPI) is a measure of consumer inflation produced by the ¬†United Kingdom’s Office for National Statistics.
One cannot invest directly in an index.
This information is authorized for use ¬†when preceded or accompanied by a ¬†prospectus ¬†for the Guinness Atkinson Funds. The prospectus contains more complete information, including investment objectives, risks,¬† fees and expenses related to an ongoing investment in the ¬†Funds. Please read the ¬†prospectus carefully before investing.
Opinions expressed are subject to change, are not guaranteed and should not be considered investment advice
Distributed by Quasar Distributors, LLC.
(c) Guinness Atkinson Asset Management