As the world’s largest net importer of crude oil and other liquids since September 2013, any significant variation in Chinese demand for oil resonates quickly and profoundly in global oil pricing. Having come out of lockdown against COVID-19 earlier than most other countries, China’s oil demand has already recovered very quickly, to over 90 per cent of pre-coronavirus outbreak levels, supporting crude oil pricing. However, June saw a new outbreak of COVID-19 in Beijing, after 50 days without a new case being recorded, prompting fears over a widespread second wave that, aside from any other effects, could seriously affect China’s oil demand and, therefore, oil prices.
“The COVID-19 outbreak in Beijing is the highest-level test of the ability of the Chinese authorities to contain the pandemic after the initial outbreak in Wuhan, and the city’s status as the national capital, political centre and focus of international attention give it an importance which reaches beyond its economic weight,” Bo Zhuang, the Singapore-based chief economist and director of China research for TS Lombard told OilPrice.com last week. “A city-wide tightening of the lockdown could undermine China’s narrative about the success of its anti-virus campaign, setting a high political threshold for escalation of protection measures,” he added.
For the moment, it appears that the same localised lockdown strategy that was implemented against second-wave outbreaks in northern China in April and May is being applied in Beijing. However, if these ‘Level-2’ measures – concentrated in the areas around the Xinfadi wholesale food market where the outbreak is believed to have originated and focussed on mass testing and contract tracing – fail to contain the outbreak by the middle of July, then the city is likely to move to a higher ‘Level-1’ lockdown. This would include significant prohibitions on mobility, among other measures. “As things stand, a localised lockdown in Beijing remains our base case and we assign the prospect of a move to Level-1 a 30 per cent probability,” said Bo. “The Level-2 lockdown measures are likely to have a negative impact on the services sectors but that impact will not be as severe on overall economic activity as it was in February and March,” he added.
More specifically, Beijing did not downgrade its emergency response to Level-3 until 6 June so the extremely recent re-designation to Level-2 simply returned the coronavirus-related restrictions to where they were at the beginning of June and had been for all of May. “Over the April to May period – under Level-2 lockdown measures – both industrial production and retail sales continued to recover,” Bo told OilPrice.com. “What would be more serious would be the spread of infections to surrounding provinces causing lockdowns there as well and, as it stands, we put the probability of this happening at 10 per cent,” he said. “If this were to happen, China would be dealing with a major second wave and an outright recession would be on the table once again,” he underlined.
Although there are no official guidelines about what factors will prompt a shift into the full Level-1 emergency response, he identifies two as being key in this respect. One is new clusters being found that cannot be linked to existing clusters through contact tracing. So far in the latest outbreak, most of the confirmed cases detected in Beijing can be traced back to merchants or visitors to the Xinfadi market and their family members. The other one is the number of daily new infections exceeding 100 for more than three consecutive days.
On the proviso that the outbreak trajectory of the coronavirus in China does not move into Level-1 territory, the outlook for Chinese oil demand in the coming months is healthy, albeit to a differing degree depending on which forecasts are believed. On the one hand, a number of independent analysis firms expect China’s oil consumption to increase by just over 2 per cent in the second half of this year compared to the same period last year, to just over 13.5 million barrels per day (bpd), driven principally by increased transportation and industrial use. On the other hand, the International Energy Agency stated in its May report that China’s demand will fall by 5 per cent year-on-year (y-o-y), to total 13.2 million bpd in the second half of this year.
China’s tight hold on new coronavirus outbreaks and its corollary response to the initial widespread outbreak are likely to militate towards a relatively positive resumption of its engagement with the Phase 1 trade deal with the U.S., which, prior to the pandemic, was a key mover of oil prices and markets in general. “Overall, China’s imports under Phase 1 are lagging seriously, but a catch-up is likely during the second half of this year, and generally China appears willing and able to meet most of its commitments,” Lawrence Brainard, chairman of the emerging markets panel for TS Lombard, in London, told OilPrice.com. “The target for energy imports so far this year reflects the largest shortfall, less than 5 per cent, of the prorated target [but] the failure to meet this target undoubtedly reflects the collapse of energy prices in recent months and the delays caused by the global recession,” he said. “However, it should be relatively easy for China to step up purchases of U.S. energy products, including crude oil and LNG [liquefied natural gas], provided U.S. export prices are in line with world market prices,” he underlined.
On the other side of the equation as well the omens look broadly positive. “We, like many others, were surprised by United States Trade Representative, Robert Lighthizer’s, comment that he feels ‘very good’ about progress in fulfilling Phase 1 of the U.S.-China trade deal,” Brainard told OilPrice.com. “[During a speech to members of the Economic Club of New York at the beginning of June] Lighthizer said Beijing has done a ‘pretty good job’ fulfilling its commitments under the deal – even against the backdrop of a global pandemic,” he added. “These comments were made despite the increasingly sharp rhetoric from the White House and elsewhere in Washington against Chinese moves in Hong Kong and the passage of legislation providing for sanctions against those responsible for the repression of Uighurs and other Muslim groups in China, and President Trump is expected to sign the bill soon,” he underlined.
At the same time, from the domestic economic perspective, after dropping its GDP growth target at the National People’s Congress (NPC), China seems to be taking a more realistic approach to stepping up stimulus measures. “During the recent weekend sessions of the NPC, Premier Li Keqiang stated that policy focus will be on three critical battles, six stabilities and six securities,” Eugenia Victorino, head of Asia strategy for SEB, in Singapore, told OilPrice.com. “Although the six securities were only introduced in a Politburo meeting in April this year, it is notable that employment remained at the top of the list and while the three lists of policy focus may seem complicated, we can summarise the policy target as finding a balance between full employment and financial stability,” she said.
Whilst the statements from the NPC have taken a cautious tone on stimulus, the announced fiscal targets delivered on expectations and the fiscal impulse is expected to be significant, according to Victorino. “Combining the rise in the target for central government deficit to the additional COVID-19 special bonds to be issued by the central government and the increase in local government special bond issuance, the announced fiscal impulse is around 4 per cent of GDP,” she said. “Nevertheless, the use of a budget stabilisation fund could further augment actual fiscal spending but we will not know how much stimulus will be released until we see how overall credit growth evolves in the coming months,” she added. This said, despite this careful messaging from Beijing, it is clear that significant monetary stimulus is already in progress. As of April, aggregate financing had risen by 13.2 per cent y-o-y, up from 12 per cent by end-2019. Historically, based on previous easing cycles, monetary stimulus tends to lead economic activity by six to nine months.
All other factors remaining equal, this backdrop should militate into the same sort of pricing range into which the markets had settled prior to the OPEC+ deal falling apart in December and the subsequent disastrous Saudi-led oil price war. The lower point of the band (US$40 per barrel of Brent and above) is the level at which the vast majority of U.S. shale producers in good areas can make a profit and also hedge out a year or two (or more) into the future for the possibility of a sudden drop in oil prices. It is also the budget breakeven price per barrel of oil for Russia. The higher point of the band (US70 per barrel of Brent and below) is the level at which senior U.S. economic advisers are comfortable that no threat is on the horizon for the U.S. economy in general and for gasoline prices in particular. Above this price point, U.S. President Donald Trump historically starts to Tweet threats to the Saudis and to OPEC about prices being too high and the fact that the Saudi Royal Family would “not last in power for two weeks without the backing of the U.S. military.”
By Simon Watkins for Oilprice.com