If ever there had been a time when crude oil was going to reach the US$200-plus per barrel (pb) levels posted in clickbait headlines or bank research reports talking their own books then it is now. With Russia’s invasion of Ukraine, geopolitical risk has not been higher in recent memory, there are swingeing cuts in the ready supply of oil and gas from bans in place or set to come in on Russia for the same reason, and the prospect of compensatory supplies coming from Saudi Arabia or any of its OPEC brethren have been dashed in the realisation finally that endless talk over their abundant spare capacity was just a lie. And yet, oil prices are nowhere near US$200 pb and nor have they been close – in fact, they are looking soft – and the key factor at play in this has China’s handling of Covid-19. These fears remain well-founded and, despite the endless chatter of the ignorati to the contrary, China is not set to reverse its Draconian handling of the disease any time soon, casting a long shadow over oil prices for a long time to come.
Given the huge discrepancy between its need for various commodities to power its economic growth and its lack of many of these resources, China was almost single-handedly responsible for the commodities pricing super-cycle that occurred between 2000 and 2014. This notably included crude oil and even beyond the 10 percent annual growth years seen in China during its boom manufacturing growth-led years, it has remained the largest annual gross crude oil importer in the world, surpassing the U.S. in this regard in 2017. In short, for best part of 25 years, China has been by far the biggest backstop bid in the global oil markets. And yet, as it has migrated it growth-generation policy from being principally driven by manufacturing and towards goods and services connected to the expansion of its own middle class, the headline GDP growth numbers have been in decline, and this was seen before the onset of the Covid-19 pandemic. It was against this already deteriorating economic growth profile, then, that China’s economy-crimping hard-line defence against Covid-19 has compounded many existing problems.
Although China came out of the first big wave of Covid-19 in the first half of 2020 in better economic shape than any other major country, its certainty at that point that this had been due to its exceptionally tough handling of the pandemic led to the continued backing for the ‘zero-Covid’ policy that it saw as the reason for its success in this regard. When massive new outbreaks of Covid-19 occurred earlier this year in China, and led to the shutdowns of several major cities, oil markets had looked at comments coming out of several Chinese agencies as evidence that a softer line on the handling of the pandemic might be in the offing and might mitigate downside price risks for the oil pricing matrix. In particular, the optimists cited the publication in the middle of April by the Chinese Center for Disease Control and Prevention (CCDC) of a guide that outlined measures for quarantining at home. This would have alleviated the economy-paralysing effects of people having to quarantine at centralised state-run facilities, even if suffering from very mild symptoms or none, having tested positive for Covid-19. These hopes, however, were dashed as, when asked for further clarification of these home-quarantining procedures, the CCDC simply reiterated the previous rules. China’s President, Xi Jinping, then personally reiterated that: “We must adhere to scientific precision, to dynamic zero-Covid…Persistence is victory.”
Last week’s sudden and sharp plunge in oil prices in a very short space of time is a stark reminder to oil bulls of the profit and loss swing fragility of long positions with the shadow of this ‘China Factor’ hanging over the global oil markets, about which this author has written several times, most recently at the end of May. It is also extremely apposite to note here that even the tiniest inkling of a resurgence of Covid-19 in China is sufficient to have such a dramatic negative effect on crude oil prices. Last week’s price fall resulted only from news that Covid-19 cases in Shanghai over the previous weekend had hit their highest levels since late May and that several other Chinese cities, including Xi’an and Lanzhou, had placed restrictions on their residents in response to a rise in Covid-19 cases. The point that the markets are, rightly, pricing in is that it does not require much at all in the way of rises in Covid-19 cases for China’s ‘zero-Covid’ policy to go into full swing. In this context, even at the height of the outbreaks across the country earlier this year, the government did not increase its flexibility to any greater degree than had been shown in the previous huge outbreaks, which was to allow daily increases in symptomatic cases to be capped at around 200 on a national basis before the full ‘zero-Covid’ measures are put into place.
While the isolation period for incoming travellers has been cut by half to seven days of centralised quarantine, local governments are still expected to eliminate domestic outbreaks as soon as possible with widespread testing, contact tracing and quarantine policies,” Eugenia Fabon Victorino, head of Asia Strategy for SEB, in Singapore, told OilPrice.com. “[Although citywide lockdowns are meant to be implemented as a last resort, the policy of regular and frequent testing in major cities will keep the fear factor elevated, in our view, and the Covid strategy will likely translate into sporadic restrictions in various parts of the country in the face of virus outbreaks,” she said. “The recent rise of infections in Anhui province has already triggered lockdowns in some counties and, in Shanghai, the 24 positive cases reported on 5 July prompted a three-day mass testing exercise in nine districts and parts of three other districts, out of a total of 16,” she underlined.
Although the severe degree of resonance that China’s ‘zero-Covid’ policy has for oil prices appears even greater than from the broader impact on China’s economic growth trajectory, many economic analysts are also now predicting extremely low economic growth – by China’s standards – this year. Among others, SEB’s Victorino, predicts 4.3 percent GDP growth for 2022, while TS Lombard’s head of China and Asia research, Rory Green, sees just 2.5 percent real GDP growth in 2022 at best, down from 3.3 percent as recently as two months ago. “Beijing is firmly committed to ‘zero-Covid’, making further lockdowns almost inevitable during the remainder of 2022,”, he told OilPrice.com. “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 remainder of the year,” he said.
Bad though this is for China’s economy – and for oil prices – much worse may be to come. “Weakness in the property sector will keep bond defaults rising and a fresh stimulus package is required to offset the deteriorating fiscal balances of local governments,” said Victorino. “[However], at only 2.7 percent of GDP, the possible stimulus package underscores the government’s ambivalence to flood the economy with supportive measures,” she underlined. For Green, a new variant of the Covid Omicron variant – subvariant BA.5 – is of extreme concern. “China is experiencing what could prove an economically devastating wave of the Omicron subvariant BA.5, with the number of areas classified as high and medium risk being 483 [as of 7 July], well above the peak of around 240 in April/May,” he said. “The full extent of spread is as yet unknown, but the outbreak shows no sign of slowing, and until a clear geographical boundary is established, estimating the economic fallout is difficult, and caution is warranted,” he added. “Last week, we downgraded China growth [to 2.5 percent], in the face of market optimism, on our judgment that a significant level of reopening – that is, sufficient to boost mobility/spending/credit demand and so on – was still six to nine months down the road, so in late Q1 2023,” he concluded.
By Simon Watkins for Oilprice.com