Oil prices had gained 20 per cent since late June, with China’s rising imports a key motor. Has last week’s drop, driven by pessimism in Beijing, broken the spell?
On Thursday, China’s huge property developer Evergrande filed for bankruptcy in New York. In recent weeks, Zhongrong Trust, a wealth management firm dealing with $87 billion of clients’ money, missed payments to investors. It is exposed to Evergrande and two other struggling real estate groups.
Last week, official data showed a weakening of Chinese factory output, fixed asset investment and consumer spending in July compared with a year ago.
The People's Bank of China cut key interest rates for the second time since June, in contrast to the US Federal Reserve which raised rates last month. Economic growth is likely to fall short of Beijing’s target of 5 per cent and stimulus measures so far have been half-hearted.
How does this square with the oil market narrative for much of this year?
The consensus was for a weak first half and a strong second. Continuing consumption growth – in China above all – and remaining post-Covid recovery have been expected to collide with Opec discipline on production levels and a slowing of US output growth.
On the supply side, this is largely coming to pass. Saudi Arabia’s voluntary cuts are filtering through to the market, Russia’s announced export reductions are also evident, and American drilling is down.
The demand side looks good too, but manifests the contradiction between oil market statistics on one hand, and wider economic data on the other.
The International Energy Agency has been the most bullish. In January, it pinned Chinese demand growth this year at just over 0.8 million barrels per day. Now, it sees almost 1.6 million barrels per day of expansion, almost three-quarters of the global total. Other forecasters predict between 0.8 and 1 million bpd.
The IEA estimates global oil demand reached the level of 103 million bpd for the first time ever in June. Growth is expected to slow next year, but China would still account for 60 per cent of the anticipated 1 million bpd gain.
The country’s oil imports rose 1 million bpd in the first half of the year. The key question is how much of this represents genuine demand, and how much is taking advantage of lower prices, especially of discounted Russian and Iranian crude, to fill inventories?
It is hard to be sure of Chinese stocks, but about half the increased imports appear to have gone into storage, with more than 1 billion barrels stockpiled in total, enough to cover all national consumption for more than two months.
Imports hit a three-year high in June. Then, as prices rose in July, Chinese buyers cut back, putting less into storage.
This stabilisation mechanism is much larger and more responsive than the hyped potential of the US strategic petroleum reserve for market fine-tuning. It makes the task of the Opec group harder, delaying the feed-through of the deeper voluntary production cuts by Saudi Arabia and Russia. China’s purchases of Gulf and US crude for October and November have eased off substantially from June.
This signal is ambiguous, though. The country’s refineries are running at record rates.
High runs are supported by strong exports of diesel to hungry markets in other Asian countries, but they are closely tied economically to their big neighbour. However, heavy refinery maintenance is expected in the fourth quarter.
So how do we reconcile this apparent disconnect of generally robust Chinese demand figures and forecasts, with weakening economic indicators, and a rather slow and limited response of crude oil prices to Opec’s deeper production cuts?
Part of the puzzle is what is considered “oil” for production versus consumption purposes. The IEA expects China’s demand for petrochemical feedstocks to grow 900,000 bpd this year, but much of that consists of natural gas liquids rather than derivatives of crude oil.
New refineries concentrate on making petrochemicals rather than fuels: Saudi Aramco’s purchase for $3.4 billion of 10 per cent of Rongsheng Petrochemical, which completed last month, and its investment in a $12.2 billion refining and petrochemical complex to be built in the north-eastern city of Panjin, are intended to capitalise on this trend.
However, while domestic petrochemical demand is patchy, the refiners are boosting output so much that margins have gone negative. Higher exports will force competitors in the rest of Asia and Europe to scale back.
By contrast, diesel is the motor of the Chinese economy – driving lorries, trains, ships, cranes, bulldozers and generators. The slowing property and industrial sectors are particularly threatening. The IEA has cut its diesel forecasts, seeing consumption in the second half of the year down 150,000 bpd on the second quarter, and very little expansion next year.
Inventories of diesel have risen, while those of petrol, the fuel of everyday motorists, have been dropping all year. For petrol, though, longer-term signs are not encouraging, because of the surging share of electric vehicles. The IEA sees Chinese petrol demand peaking next year, while the leading state oil companies PetroChina and Sinopec put the peak date in 2025.
Jet fuel is another key component of demand, and here, domestic flights are now about 17 per cent above pre-Covid levels, but international travel is still down more than half. Recent approval of more outward-bound travel should be the final brick in rebuilding the wall of pre-pandemic oil demand.
The cuts by Opec are likely to succeed in driving the global market into deficit in the remainder of the year and supporting prices beyond last week’s slippage.
Barring a major oil supply upset somewhere, what happens in Beijing – signs of stronger stimulus and a firm response to struggles in the financial and property sectors – is the crucial deciding factor for oil prices up to December.
This positive but patchy and opaque outlook will keep markets, and Opec policymakers, on tenterhooks.
Robin M. Mills is CEO of Qamar Energy, and author of The Myth of the Oil Crisis