Oil Price Outlook: Watch China, The Silent Bear

It couldn’t have come at a more inopportune time for OPEC and the ​​oil bulls who live off the cartel, but China has started to slow its buying of crude—in the same way it has slowed its imports of copper.

The reduction is small so far, down just 3% from January to June, year-on-year. We know this alone won’t be enough to crash an oil market that’s up 50% year-to-date. But we also know that when the world’s second largest buyer puts the squeeze on its demand for anything, it is never a good thing.

Import quota shortages, refinery maintenance and rising global prices combined in China’s first contraction in half-year oil consumption since 2013.

Analysts at Eurasia Group broke the phenomenon down in a note:

“Imports were scaled back as surging prices for crude oil have eroded refinery profit margins... if OPEC+ doesn’t agree to raise supply soon, high oil prices will also likely lead to demand destruction in even more cost-sensitive emerging markets, especially India.”

OPEC+ groups the 13 original members of the Saudi-led OPEC, or the Organization of the Petroleum Exporting Countries, with 10 assorted oil producers led by Russia. The 23-nation alliance has been in disarray since the start of July as OPEC’s top members, Saudi Arabia and the United Arab Emirates (UAE), have been unable to agree on production levels for August.

OPEC+ was supposed to have agreed a hike of at least 400,000 barrels per day for August. 

OPEC Itself Disrupted Oil Rally/h2

Until the Saudi-UAE row, oil had a near-perfect rally, with US crude up 57% on the year and U.K. Brent up almost 50% on the model unity shown by OPEC on production. The producer alliance began by holding back 10 million barrels daily from the market to bring back prices virtually destroyed by the coronavirus pandemic. 

OPEC+ had started adding to production in recent months, and only marginally. Until now, it has been withholding almost 6.0 million barrels of daily capacity from buyers in a market that could be starved of supply as peak summer demand for energy kicks in. This is what had led to oil’s fairytale-like rally from minus $40 for a barrel of US crude at the height of the COVID pandemic to around $75 now. While the market is still upbeat, it has also turned a lot more volatile since the OPEC snafu on August production. 

But oil’s troubles aren’t confined to OPEC alone. 

The spread of coronavirus variants and unequal access to vaccines threaten the global economic recovery, finance chiefs of the G-20 large economies warned on Saturday. While Southeast Asia and Australia have largely been the focus of new variants, Western capitals haven’t been spared either. 

The United States recorded the highest number of COVID cases since May over the weekend as the highly-transmissible Delta variant became more prevalent. There is fear that COVID variants could again dent global travel, impacting oil consumption.

Enter China, The ‘Silent Bear’ /h2

With China emerging as the third negative force against oil, the demand outlook becomes more questionable. The country isn’t just a cheerleader of commodity supercycles; it can also be a silent bear when prices aren’t going its way or are hurting its economy. 

Take for instance, the copper story.

LME Copper’s rally this year was huge, but there was something even bigger: China’s price squeeze.

After the world’s most in-demand base metal reached record highs of $10,746 a tonne on the London Metal Exchange on May 10, its biggest buyer decided that enough was enough. 

Through a systemic reduction of copper imports in the weeks that followed—the cutback actually began in April and accelerated after that—China brought the rally in copper to a dead end from May. 

Three-month copper futures on the London Metal Exchange lost more than 8% in June—their most since March 2020. Since the start of July, the market hasn't gone anywhere, trading either flat or in the red most of the time. 

Copper Story A Worthy Reminder of What China Can Do/h2

Prior to China’s squeeze, LME Copper enjoyed an almost uninterrupted rally between April 2020 and May this year. And China was buying all the way through. The difference was copper’s price, which was under $5,200 a tonne in the spring of last year. By this spring, it had more than doubled.

The record high price by May received sharp pushback in China, with physical buyers sitting on the sidelines and manufacturers trimming their operations. The increasing gap between the Chinese Producer Price Index (borne by industry) and the Consumer Price Index (paid by end-users) showed the rising burden for manufacturers.

China’s tempering of the copper market has taken 12% off prices from the May record high of $10,746, with Tuesday’s LME three-month futures for the metal trading at just around $9,400. 

So, what else can China do with oil?

Beijing has also done plenty to try and cool the market, said Osama Rizvi, an energy analyst at Primary Vision Network.

Writing in a blog earlier this month on why oil may not hit $100 a barrel despite the demand hype for it now, Rizvi cited China as a big factor.

Noting that Chinese refiners took 589,000 barrels out of their refineries in May alone, Rizvi said: 

“China amassed a huge amount of oil when prices hit a 20-year low and as prices continue to rise, China will be increasingly incentivized to tap its reserves rather than import expensive oil. While this is unlikely to change the underlying fundamentals of oil markets, the reduction in Chinese imports is certainly one of the factors that could finally drive a shift in oil market sentiment.”

Another geopolitical factor to keep an eye on was US-China relations, he said, relating the United States’ bid to block the purchase of South Korean chipmaker MagnaChip (NYSE:MX) by Chinese equity funds as one to watch. 

This week, the State Department added 14 Chinese companies and other entities to an economic blacklist over alleged human rights abuses and high-tech surveillance in the Muslim-populated region of Xinjiang.

Added Rizvi:

“An escalation, at any point, between the US and China on the trade war front would spell trouble for oil markets and hurt the current bullishness in markets. It is these geopolitical changes that historically have had the biggest role in shifting the tone of media coverage and, by extension, the dominant sentiment in oil markets.”

Bottomline: China’s immense power in influencing both the demand and pricing of anything should never be ignored. 

Disclaimer: Barani Krishnan uses a range of views outside his own to bring diversity to his analysis of any market. For neutrality, he sometimes presents contrarian views and market variables. He does not hold a position in the commodities and securities he writes about.

Get The App

Join the millions of people who stay on top of global financial markets with Investing.com.

Download Now

Written By: Investing.com