How China Could Spark A Major Reversal For Oil Prices

The huge discrepancy between China’s massive economic growth and its minimal oil and gas reserves made it the big global backstop bid for crude oil and many other commodities over the past 20 years or so. According to figures from the Energy Information Administration (EIA), China surpassed the U.S. as the largest annual gross crude oil importer in the world in 2017, having become the world’s largest net importer of total petroleum and other liquid fuels in 2013. Since the full breakout of the COVID-19 virus across the world in 2020, China’s strictly-enforced ‘zero-COVID’ policy has damaged its economic growth engine and its appetite for the oil and gas used to fuel it. There have been murmurings that this policy may be relaxed but these have not proven correct and are unlikely to be in the near future, leaving the big bid sidelined in the oil markets, and a plethora of other bearish factors set to dramatically push oil prices down.

At the outset of March, China saw the largest wave of COVID infections since those across Wuhan in early 2020, with the new cases focused across its northeast and coastal regions, mostly in the Jilin and Shandong provinces. At that point, although official rhetoric did not signal any softening in the zero-COVID containment strategy in the near term, the previous December had seen a refinement of the strategy to one incorporating the idea of ‘dynamic clearing’. “This provided local governments more flexibility in imposing restrictions, allowing daily increases in symptomatic cases to be capped at around 200 on a national basis,” Eugenia Fabon Victorino, head of Asia Strategy for SEB, in Singapore, told Even back then, though, she added, there were clear limits to this flexibility, with China’s still-aggressive approach to tracing possible exposures to the virus putting more than 184,000 individuals under medical observation in isolation within two weeks or so of that new March outbreak.

Soft though oil prices looked at that stage, they looked considerably softer still with news at the end of March that the economic powerhouse city of Shanghai, population 26 million, had been placed in a two-stage lockdown. This was then followed in early April by news that the authorities in other cities, including Ningbo (population 4.2 million) and the capital Beijing (22 million) had begun implementing limited restrictions to curb the spread of the virus. Again, at that point, there had been hopes of a softening in the zero-COVID approach, stoked by the publication in the second week of April by the Chinese Center for Disease Control and Prevention (CCDC) of a guide that outlined measures for quarantining at home. These measures seemed to indicate the possibility that people suffering from very mild symptoms or none at all, but having tested positive for COVID, might be able to quarantine at home rather than having to go to centralized state-run facilities to do so. Hopes that such measures might be introduced, however, were also dashed when the CCDC in a later clarification simply reiterated the previous set of strict policies.

At that point, the bearish effect on global crude oil prices of the ‘China COVID’ factor was highlighted by OPEC in its report wherein it cut its global oil demand forecast for 2022 by 480,000 barrels per day (bpd). At almost the same time, the same reasoning was given by the International Energy Agency (IEA) in the lowering of its global demand outlook for 2022 by 260,000 bpd. Even then, with Brent crude around the US$110.00 per barrel (pb) level, and pervasive talk of a potentially bullish-for-prices ban on Russian oil in Europe whistling through the markets, the IEA further warned that even though crude oil prices had come back down from recent highs they still: “Remain troublingly high and are a serious threat to the global economic outlook.” These actions and comments were made even before China stepped up its counter-COVID programs, with the end of April seeing announcements of mass testing for the virus being rolled out across Beijing, and other cities, including Hangzhou (population 12.2 million). By the onset of May, some analysts had calculated that the effect of ongoing lockdowns in China was reducing crude oil demand from the country by around one million barrels per day, with no indication of when or how this decline would end.

Even before the transmission of COVID surged in mid-March, several major banks had regarded China’s 2022 economic growth target of ‘about 5.5 percent’ as too ambitious and the big data releases in April showed they were right. April’s official Purchasing Managers’ Index (PMI) – the key indicator that shows the state of the country’s manufacturing activity (with a reading above 50 showing an expansion and below 50 marking a contraction) came in at just 47.4 for the month, the lowest level since February 2020. China’s own National Bureau of Statistics (NBS) senior statistician, Zhao Qinghe, stated that: “The production and operation of… enterprises have been greatly affected [by COVID-related actions].”

Late last week, leading independent global economic and investment strategy research house TS Lombard (TSL), told that it believes that China’s economy will likely contract this quarter and slashed its full-year 2022 China economic growth forecast to just 3.3 percent (although it thinks that for political reasons the official report from Beijing will be of 2022 economic growth close to 5.0 percent). Although the current Omicron wave of COVID appears to have peaked and the number of areas classified as high/medium risk has fallen in recent days from their recent highs, it remains the case that mobility remains low and stimulus measures are less effective under zero-COVID conditions and structural headwinds, according to TSL. “Beijing is firmly committed to ‘zero-COVID’, making further lockdowns almost inevitable during the remainder of 2022,” Rory Green, head of China and Asia research at TS Lombard, in London, told last week. “Healthcare limitations, including the low vaccination rate and insufficient numbers of hospitals and staff, combined with politics ahead of the Q4/22 Party Congress - Xi is closely associated with current COVID policy - make an ending of strict COVID restrictions unlikely in the next nine months,” he said.

It is true that China bounced back quickly and strongly from its previous major outbreaks of COVID up to 2020 but it is now harder for it to recover than it was back then. “Two years ago China bounced back from the initial Wuhan lockdown thanks to very strong external demand, limited trade competition, a property boom, and a relatively less infectious COVID strain but in 2022, diametrically opposite conditions apply,” underlined Green. “We expect China to recover slowly from the current Omicron wave, particularly as stimulus multipliers are lower and although a large infrastructure push is underway and monetary policy will continue easing, it remains the case that mobility restrictions, consumer confidence, and wage growth all make stimulus less effective,” he concluded.

By Simon Watkins for