It’s an obvious correlation really, but here goes anyway. Waning industrial activity and general consumer malaise leads to reduced appetite and consumption of electricity.
Merrill Lynch has noted the link and suggest looking at global power generation for a good snapshot of the economy. They say:
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% (Chart 6). 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.As a result, Merrill says it expects electricity generation growth to have fallen to 2.6 per cent in 2008, achieving a rate of just 0.7 per cent this year, before eventually recovering to 2.2% next year – assuming global GDP growth rates of 0.9% and 3.1% this year and next.
Of course, that’s hardly any surprise.
What is interesting is their observation that in Europe power output is falling at an unprecedented speed, as it is in Japan.
Using quarterly power generation data for the Euro area spanning back to 1990, we calculate 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.
Meanwhile in Japan:
From a peak of 13% at the start of the year, electricity output is now falling by 2.4% YoY. Similar to Europe, we find that the industrial economy is a much stronger factor in determining electricity generation than are weather deviations or relative fuel prices. Given our bleak outlook for the Japanese economy, we believe that there is little scope for positive upside surprises to the amount of electricity produced near-term.
So in a nutshell, Merrill says that both in Europe and Japan power generation is responding more significantly to industrial swings than to weather conditions – interesting considering residential and service sector power demand far outweighs industrial.
For Japan, where industrial production fell by 8 per cent month-on-month in November, Merrill sees electricity consumption becoming nothing less than abysmal.
All of the above, they say, does not bode well for coal demand in 2009, as most electricity in emerging markets (where the bulk of growth in generation has come from) is generated using coal.
The other key implication, not noted by Merrill, is what it means for companies already locked into long-term supply deals. Furthermore, with generation down on the back of falling industrial demand, there will be a massive amount of spare capacity sitting idle. In the end, if the situation really is as grave as Merrill makes out, the only solution will be the mothballing of plants, an expensive and politically sensitive process. What’s more it’s a fairly inelastic solution, meaning once the capacity is out it’s not that easy to bring back at short notice.
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