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As Napoleon famously said, “When China awakens, she will shake the world.” The period of China’s awakening is well past us now. As crisis grips the Middle East, it is the turn of the Middle Kingdom to steady the world.
In the face of the most dramatic energy shock in modern history, oil and gas prices have been surprisingly restrained. Brent crude finished the week at $92 a barrel, a very moderate level with a tenth of the world’s oil supply still cut off.
Of course, markets are hoping that the current negotiations between Washington and Tehran will yield progress on peace, and at least a reopening of the Strait of Hormuz. Then the hard work of freeing the ships and restoring Gulf oil exports and production could begin.
But the physical oil market runs not on hope but on hard facts. One of the most important of these facts in the current crisis has been Chinese behaviour.
China, the world’s largest oil importer, second-largest oil consumer, and seventh-largest producer, has managed to cut its petroleum purchases substantially.
A report from Michal Meidan of the Oxford Institute for Energy Studies in May casts a keen eye on this phenomenon – how China has achieved it, and what might come next.
Average oil imports of about 11 million barrels a day in recent years dropped to 9.3 million bpd in April, with further falls expected in May and June. That has taken some of the pressure off other Asian oil users. It has slowed the drawdown of inventories elsewhere. Without this Chinese chess move, the shock would have been severer and more sudden.
The release of strategic stocks by the International Energy Agency countries – the US, Europe, Japan and a few others – has been crucial too. The US Strategic Petroleum Reserve, though, was drawn down from 585 million barrels to 350 million barrels to counter the Russia-Ukraine crisis in 2022, and hardly replenished since.
By contrast, China’s strategic stocks are estimated at 1.1 billion to 1.3 billion barrels. Its stock-filling last year was essential for absorbing the surge of extra production from the Opec+ group, the converse of its cutback this year. Without Beijing’s bumper purchases, prices would have fallen much further, or, Opec+ might have chosen to produce less. Either way, the market would have entered the current war in the Gulf in much worse shape.
This build-up of inventories caused much head-scratching by analysts. Was Beijing preparing for a campaign against Taiwan, fortifying itself from US sanctions and tariffs, bargain-hunting while prices were low, taking advantage of discounted sanctioned barrels from Russia and Iran, parking surplus dollars in hard assets rather than US treasuries, or simply piling up precautions against any geopolitical shock? Whatever the motives, this year it has certainly proved a wise move.
In cutting its oil imports, Beijing seems to be pulling most – but not all – of the levers at its command. The Chinese leadership want to keep their economy running, of course. They want to avoid catastrophe if the closure of the strait is much more prolonged. Nevertheless, while the domestic market takes priority, it is not in their interest to starve their key customers and trading partners of energy either.
Beijing does not yet appear to have given permission for releases from its strategic reserves. Meanwhile, commercial crude stocks are being drawn down, though not as quickly as one might expect.
Refiners have sharply cut runs. Refineries are capable to some extent of switching outputs – producing more petrol, diesel and jet, the key transport fuels, and less naphtha, the input to petrochemical plants.
Most of the burden of the lost output appears to have fallen on the petrochemical sector – which, before the war, was suffering from overcapacity and weak margins. Some petrochemical output might therefore be unnecessary. The plants can use up their inventories for a while, before cutting supplies to customers. Conversion of China’s abundant coal to chemicals is also growing.
Transport fuel demand may also decline somewhat, because of the economic slowdown, higher prices, and the steady adoption of electric vehicles. And estimates of stocks of refined products, held in hundreds of thousands of locations over the country, are very uncertain. China would normally have a month of end-user demand in inventory, but it might be significantly more.
We can draw three important conclusions. First, the opacity of Chinese data is a crucial blind spot for the market. Despite insightful analysis from Ms Meidan and others, and the watchful eye of satellites, much about the country’s oil stocks, refining, consumption and imports is still guesswork. This may serve Chinese security policy. But it makes it harder to assess and respond to energy crises.
Second, China’s role has evolved from that of the early 2000s. Up to 2008, its vast appetite for commodities was a destabilising force – sucking in ever-rising amounts of oil and other materials, driving up prices, and triggering geopolitical confrontations.
Now, in the oil and gas market at least, it has evolved into a stabiliser. Beijing appears to have an impressive amount of control over its home industry. A mix of government mandates, pricing policies and discreet guidance has so far managed to balance economic output and energy security.
Third, this stability cannot last forever. If the blockage or even half-blockage of the Gulf drags on, Chinese commercial inventories will fall to levels the government will find dangerous. It then faces the choice of whether to authorise major releases from its strategic stocks. That is, after all, what they are there for. If it does not, domestic fuel and petrochemical output will be threatened, or the country’s oil imports will rise sharply, pushing up world prices again. But the leaders in Zhongnanhai are not inclined to explain to the outside world when and how they might act.
