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Is $77 oil cheap? Look to the future of cars in China

In late 2007, Jean Claude Gandur, the founder of Addax Petroleum, a Toronto-listed oil company that had built up a big production portfolio in West Africa, pretty much knew how his company's story would end. Addax, he predicted without the hesitation, would become a takeover target and it would go to a Chinese, perhaps an Indian, buyer.

Why? Because China's demands for energy were growing faster than anyone in the West realized, he said. Chinese oil companies would pay top dollar to lock up supplies and wouldn't shy away from political hot spots. He called it right. In mid-2009, Sinopec, China's biggest oil products company, snapped up Addax for $52.50 a share, valuing the company at $8-billion - a 47-per-cent premium.

Mr. Gandur would not be surprised by the news this week that China has displaced the United States as the world's biggest energy user. According to the International Energy Agency, China consumed 2.5 billion tonnes of "oil equivalent" last year (the measure translates all forms of energy, from coal to solar, into the equivalent oil energy value). That's about 4 per cent more than the United States, although U.S. per capita energy use is still five times higher.

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China's energy consumption growth rates are even more impressive and were wildly underestimated by the IEA and other energy demand forecasters. Between 2000 and 2009, China's energy use more than doubled, thanks to double-digit economic growth rates and a rising population. The IEA predicted energy use would rise 3 to 4 per cent a year. The real figure was four times greater.

The United States is still the leading oil consumer, at 19 million barrels a day against China's second-place 9.2 million. But China could catch up fast. There's a reason why its oil companies have become the industry's most voracious oil project buyers in recent years. Not long ago, China was a net oil exporter. Now it's glomming onto every drop it can find, from Alberta to Sudan.

Which raises the question: Are oil prices, at about $77 (U.S.) a barrel, cheap?

It's impossible to say. Prices might seem expensive if you think a double-dip recession is in store for Europe and North America and that, recession or not, oil consumption growth will turn negative on those two continents because of efficiency gains, deindustrialization, the rise of the electric car and the like.

They might seem cheap if you think China's energy consumption, having doubled in the past decade, could double again this decade. Yes, China is spending fortunes to develop solar and wind power. But there is no doubt that oil and coal will power China's climb up the industrial ladder for many years to come.

Don't forget the consumer angle. Guess what? The Chinese love cars as much as Europeans and North Americans do, and transportation fuels are crude oil's biggest market.

A new book called, Country Driving, A Journey Through China From Farm to Factory by Peter Hessler. says China aims to have more highway miles than car-obsessed United States within a decade. Car sales are exploding in China. In Beijing alone, more than 1,000 new cars hit the road every day. J.D. Power and Associates says the number of passenger cars sold in China went from 326,000 in 1995 to 8.7 million last year, making China, not the United States, the world's biggest car market. The number of cars sold in China is expected to rise to 13.5 million in 2015, though that too could be a massive underestimate.

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Here's why. Car ownership rates in China (and India) are very low by Western standards. A UBS report called "What if everyone in ChIndia had a car?" notes that only 4 per cent of Chinese over the age of 14 and 1 per cent of Indians have cars. In South Korea, the figure is 26 per cent; in the United States, 44 per cent; in Japan, 46 per cent.

If the car penetration rate were to reach simply the South Korean levels, it would imply a 1,125-per-cent growth rate in the number of cars in China and India, UBS says. That would boost global auto sales, in dollars, 5.7 times. Imagine if penetration rates were to reach American or Japanese levels? Now you know why every auto maker CEO on the planet would sell his mother, grandmother and spouse to get into the Chinese market. You can assume most of the new Chinese cars will be powered by gasoline or diesel.

And we haven't even talked about the peak oil theory, which says that oil production, at 85 billion barrels a day, is pretty much the limit. Nor have we talked about Saudi Arabia's reluctance to bring on new production. As my colleague Jeff Rubin noted Wednesday in his "Smaller World" blog, King Abdullah recently ordered a halt to all further underground oil exploration, arguing that any new discoveries should be left to future generations of Saudis.

Add in China's desire to turn itself into the world's biggest parking lot and you have a recipe for ever-rising oil prices, even if the Western economies remain sluggish. Two years ago, oil prices were almost twice today's levels. Something is wrong with $77 oil.

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