There is a mystery at the heart of the global oil market. China has soaked up a torrent of oil imports this year, filling tanks and underground caverns. Without this, prices would be much lower. But why is Beijing snapping up oil it doesn’t obviously need? How much is it going to keep buying? And for how long?
The first part of the puzzle is exactly how much crude the Middle Kingdom has absorbed. It does not release figures for storage capacity or volumes, so they have to be estimated. Its aboveground tanks can be assessed by satellite, but a growing portion of its capacity is now below-ground. The amount going into storage can be approximated by looking at the difference between the sum of imports and domestic production on the one hand, and the amount refined on the other.
All of these figures have uncertainties, relating for instance to how much crude comes by pipeline from Russia, versus tanker deliveries which can be easily monitored. The quantity processed in small refineries and petrochemical plants is particularly unclear.
Overall, China seems to have built stocks this year to August at a rate of at least 500,000 barrels per day. It may have anywhere from 800 million to 1,400 million barrels in storage – a wide margin of doubt. That is equivalent to about 73 to 127 days of oil imports. The country is not part of the western-dominated International Energy Agency but, for comparison, the IEA requires its members to hold oil inventories of at least 90 days of net imports, as a cushion against disruptions.
Official media indicates that state stocks should rise to more than 1 billion barrels. Other comments suggest there may be an aim to build up to 2 billion barrels. There is plenty of room to keep filling: state-owned oil major Sinopec did let slip recently that Chinese storage was about 70 per cent occupied.
And China keeps boosting its capacity. State companies will add at least 169 million barrels across 11 sites during this year and next. Other projects, including by smaller or private companies, would swell this total further. Over the past five years, about 180-190 million barrels of capacity was built, so the pace is actually accelerating.
The effect has been profound. Opec+ output has risen by about 1.2 million barrels per day from January to August. On average, therefore, China’s inventories have soaked up nearly all the extra production. This will become harder, of course, as the oil exporters’ group has continued to add barrels from September. But certainly Chinese tanks have been vital in avoiding a sharper decline in prices.
Russell Hardy, chief executive of trading giant Vitol, observed that, despite the Opec+ boost, stocks in OECD countries have not risen. In fact, they remain well below the five-year average. The increase in global inventories is mostly accounted for by China, and by “oil on water”. This comprises crude en route in tankers, which has swelled because of sanctions on Russia and Iran, and longer voyages to avoid attacks in the Red Sea.
The size, pace and acceleration of China’s stock-builds is puzzling. Its overall oil consumption is expected to peak around 2027, as its economy matures, and it rapidly switches over to electric vehicles. It may soon be left with tankage well in excess of likely needs.
So why is China doing this? There are four levels of theory, which are not mutually exclusive.
First is the simple commercial explanation. Oil prices are well below the long-run historic average. With oil, as with other commodities, Chinese companies buy when they feel it is cheap. Especially, it makes sense to snap up as much discounted Iranian and Russian crude as possible while available.
This view has some merit. Longer-dated oil prices are in moderate contango – prices for delivery in months after April are higher than prompt prices. But the spread is not enough to cover storage costs and interest charges, making this an unprofitable trade on its own.
The extra expenditure is cheap for an economy the scale of China’s – on the order of $10 billion for this year’s purchases. However, if Beijing had not been buying so aggressively, prices would be a few dollars per barrel lower, saving it perhaps another $10 billion across all its imports. That assumes, of course, that Opec+ would still have made its bumper production increases.
The second explanation is risk mitigation. Beijing is concerned about threats from tighter US sanctions on Moscow and Tehran, and further trade restrictions. Strategic stocks are a cheap insurance policy. Storing dollar-denominated oil at home is better than making its trade surplus hostage to the US Treasury.
A third line of thought is that this is explicitly preparation for eventual conflict against the US: a war or at least embargo in which supplies from the Gulf and through the narrow Strait of Malacca would be cut off. This is a very real vulnerability, as the case of Japan in the Second World War illustrates. Maximum vulnerability is temporary, as China electrifies, but even a country driving entirely in BYDs will need petroleum for fighter jets and warships.
The fourth explanation is the most serious. Speaking at the DMCC Energy Club seminar in Dubai on Thursday, Li-Chen Sim of Khalifa University noted the “conspiracy theory” that China could be girding its loins for war against Taiwan imminently. Russia’s preparations in 2021 before its invasion of Ukraine, its throttling of natural gas supplies to Europe, were misread or ignored by many. But an invasion of the island very soon appears unlikely.
So where does Beijing lead the oil market next? Its strategic goals imply that purchases will be at least 500,000 barrels per day over the next three years, continuing to support prices but not adding extra tension. At the more aggressive end, it might buy around 900,000 barrels per day, very helpful for the aims of Opec+ to boost output without hurting prices too much.
Virtually all forecasts point to a significant surplus next year, even with this stockpiling. If a deficit or a supply shock does nevertheless materialise during the next three years, Chinese stocks would be crucial in easing a price spike. Beijing’s exact mix of motivations may remain enigmatic, but oil exporters will not complain.
