China’s Oil Demand May Be Overestimated

Robust oil demand in Asia has supported the bullish sentiment on the oil market in recent weeks, but the higher oil prices may cool off crude purchases from the world’s most important oil-importing region.

Asian, and in particular Chinese, oil imports have been strong since the start of the year. But signs have already emerged that no crude buying spree will occur in the second quarter with oil prices above $60 eating into refining margins, and with planned maintenance at Chinese refineries beginning in March and April.

The rally in the oil futures market and the bullishness of investors in the paper market are currently stronger than the actual physical crude oil market and pricing for cargoes going to China and other countries in Asia, Reuters columnist Clyde Russell notes.

China’s Imports Could Slow Down In Q2

Granted, the world’s top oil importer, China, significantly boosted its crude imports in January 2021 compared to the end of 2020, on the back of strong buying from independent refiners who started to use their allocated import quotas for 2021. Buying from the so-called teapots, which account for around a fifth of total Chinese imports, had slowed down toward the end of 2020 as many of the refiners had already used up their quotas earlier in the year, taking advantage of the lowest prices in years to stock up on low-priced crude.

The strong imports in January 2021 helped to support global oil demand at a time when lockdowns in Europe—and in some cities in China—were weighing on the market.

However, the crude oil that China imported in January was purchased in October and November, when oil prices were somewhere in the $40s.

With Brent Crude now regularly flirting with the $65 mark, the buying appetite has slowed down, not only from China but also from India. These two markets have generally been the largest growth drivers of demand in recent years.

In addition, Chinese refiners are set to enter into the planned spring maintenance this month and next, which could further dampen crude purchasing from the world’s top oil importer in the second quarter.

“Demand is very slow now and there are many available cargoes to choose from,” a source at a Chinese refinery told Reuters last week.

China is also reportedly close to reaching its storage capacity limits, and it would not make sense to fill it to capacity with $60-plus oil when it went on a buying spree at $20-30 oil last spring.

India Unhappy With Higher Oil Prices

India, the world’s third-largest oil importer, which depends on imports for around 80 percent of its oil consumption, is also getting restless about the higher oil prices in recent weeks, which push up its oil import bill and domestic inflation.

Earlier this week, India called on the OPEC+ group again to boost production from April, saying that it does not support “artificial cuts to keep the price going up.”

As oil prices rallied to hit their highest level in 13 months, India started to call on OPEC+ as early as in January to consider the effects of higher oil prices on consumption in recovering economies.

Robust Asian Demand Or Investors Chasing High Roll Yields?

Oil demand in Asia’s top importers is certainly higher than the lows at the start of the pandemic, but “resilient Asian demand” is certainly not the only driver of oil futures prices these days.

Many officials in the industry, from OPEC Secretary General Mohammad Barkindo to the biggest oil company in the world, Saudi Aramco, are touting this “resilient demand in Asia.”

Asian demand is improving, but the rally in the paper market may be masking the slowdown in physical demand right now.

The tightening oil supply and the expectation of much stronger demand later this year have strengthened the oil futures curve in backwardation, the state of the market where the prices of the nearer contracts are higher than those further out in time.

With the forward futures curve with declining prices, investors who are long on oil get positive roll yield when the time comes to roll the contract they hold. At that time, they must sell the contract at the higher price and replace that position with the next contract with a lower price, creating a positive roll yield. And the steeper the backwardation, the higher roll yield they get.

“An increased backwardation in the oil market where the spot price trades the highest on the curve, a reflection of a tightening market, has seen the return from holding a passive long position rise close to 10% on an annualized basis and near the most favorable conditions the market has been able to offer investors during the past decade,” Ole Hansen, Head of Commodity Strategy at Saxo Bank, wrote in a commentary on Wednesday.

Add to this the growing allure of oil futures as a hedge against inflation, and we have investors and speculators fueling a rally on the paper market that is not necessarily indicative of the actual demand for physical crude oil.

Higher oil prices and refinery maintenance could lead to slower Chinese imports in the coming months, and the market currently focused on ‘when oil will hit $70’ could realize that China’s actual oil demand may not be as strong as oil futures prices suggest.

By Tsvetana Paraskova for