The big new bad boy in oil is China, but not in the ways you think
Link copied to
Experts are beginning to whisper a new name as the primary global oil market mover and it’s not OPEC, but China and its demand for hydrocarbons.
An analysis from energy site Oil Price suggests oil prices, specifically the North Sea benchmark Brent, have been reacting in a more sustained fashion to Chinese factors, for example the trade war with the US or new economic data, than to moves in the Middle East.
This is important for the ASX’s Australia-based oil producers, such as Triangle Energy (ASX:TEG) and Buru (ASX:BRU), and even the odd US-based ones like Otto Energy (ASX:OEL), which sell their oil under Brent pricing.
Brent prices surged in September to a four-year high of $US86 ($127) a barrel after a drone attack on a Saudi oil facility, but rapidly returned to $57.41 two weeks later after the market realised there was no imminent supply risk. Attention returned to China.
Prices have recovered slightly to around $US63 today.
But expectations for how China is moving the market have been based on four misconceptions, says the Oxford Institute for Energy Studies.
In a new paper, the centre says while China’s oil demand will remain strong next year, the market is misunderstanding the impact of the trade war, an infrastructure stimulus, and the opening of two mega-refineries.
But the institute says trade talks, which have been front and centre of most China economic analyses, are not much of a factor here.
“For example, even though Chinese exports to the US have fallen by 13 per cent or about $US30 billion since tariffs were first imposed in mid-2018, its exports to the rest of the world have expanded by more than enough to offset the loss of sales to the US,” the report said.
“The government has stuck to its decision to phase out subsidies, suggesting that Beijing will continue to pursue structural economic changes even as trade tariffs complicate the external environment.
“Beyond the trade deal, US–China structural tensions are unlikely to be resolved any time soon. As such, the Chinese economy is set to continue slowing in 2020.”
Markets have been expecting sharp changes in China’s economy and consequently how much oil it needs.
China has avoided injecting credit into its economy as a stimulus, avoiding a credit-fueled boom but also slowing a sharper deceleration through more targeted infrastructure spending.
But this has caused oil demand to halve in 12 months.
The Oxford study believes an infrastructure boom has not materialised, due to a lack of viable projects and local governments paying down debt rather than spending.
“But whereas an infrastructure stimulus was widely expected to boost demand for industrial fuels (diesel, bitumen, petcoke) and especially diesel (traditionally the fuel of mining equipment and coal transport), demand in China contracted in the year-to-September by 1.4 per cent y/y,” the report said.
“But while the growth rate of the Chinese economy is set to continue slowing next year, the nature of government support measures and the fate of the trade deal will impact product demand growth. Assuming a limited trade deal and ongoing support from the real estate sector, alongside a marginal recovery in the auto sector, demand for black oil more broadly should improve.”
This was a talking point in 2019, as the 400,000 barrels of oil per day (bopd) Hengli started in Liaoning province and the 200,000 bopd Zhejiang Petrochemical started in Zhejiang province.
China’s gasoline supply was expected to surge, leading to a deluge of exports and a domestic market oversupply, meaning less crude needed to make yet more gasoline. But while Hengli has ramped up Zhejiang has not.
“All eyes are now on Q4 19, as refiners have ample product export quotas left and could export a whopping [450,000bopd] of gasoline – a massive y/y surge given that it comes off a low base in Q4 18,” the study said.
“Given expectations that next year’s quota allocation will be even higher, refiners have a strong incentive to export and exhaust this year’s allowance, regardless of economics.
“But if the new mega-refineries do not produce as much as gasoline as previously expected, the outflow may not be as bad as the market expects.”
The institute is expecting Chinese oil demand to remain strong, as state and independent refineries receive new crude import licences and as liberalisation creates new opportunities.
But China’s problem is maintaining a diversity of sources.
“US sanctions on Iran and Venezuela have complicated China’s efforts to maintain some diversity in its import sources, while the tariffs have stemmed US flows to China,” the study said.
Imports from Saudi Arabia are dramatically higher.
Beijing is seeking to keep Middle East oil at a maximum of 50 per cent of imports, with Brazil “likely” to become a bigger source for China from now.