What The "Chinese Oil Card" Means for Global Prices

What The “Chinese Oil Card” Means for Global Prices

by | published October 2nd, 2018
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Crude prices continue to advance.  Right now, both primary benchmarks – Brent (set daily in London and the main global yardstick for oil trades) and WTI (West Texas Intermediate, set each day at Cushing, OK for New York futures contracts) – are at four-year highs. Finally, the pricing declines following a November 2014 Saudi-led OPEC decision to defend market share rather than price have been erased.

The wide assumption points toward continuing price increases, given that the renewal of full US sanctions against Iran will kick in on November 4. Over the past two sessions, indications have appeared that the upward pricing move is accelerating.

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WTI closed trade at 2:30 PM yesterday hitting $75.30 a barrel, up 2.8% for the day, 4.2% for the week, and 7.9% for the month. Brent closed at $85.04, up 2.8%, 3.8%, and 9.8%, respectively.

As the serious move toward $90-$100 a barrel oil intensifies, there are several overriding international concerns emerging. A major element revolves around China.

In fact, more so than at any time in the past several years, what happens in China will in large measure determine what happens globally.

Here’s what’s going on (and why it’s so disconcerting)…

The Overheated Oil Market Is Moving to A More Demand-Centered Focus

As I have noted previously here in Oil and Energy Investor, the upward pricing trend is being fueled by escalating declines in production from Venezuela, Nigeria, and Libya, a tightening energy balance as global demand remains robust, resistance of both Saudi Arabia and Russia over increasing production beyond the already agreed to injection of about 1 million barrels a day; and the export limitations of moving much more US volume to the international market.

As well, Iranian declines in both production and exports are expected from the Iranian sanctions, but early figures point toward these being even more significant than initially forecasted.  To put this in perspective, from 2.3 million barrels a day in July, I now estimate that Iranian exports will total less than 900,000 in November. That’s a whopping 40% drop in four months.

An overheated oil market is good news for those investing in oil futures contracts but will also provide some cost problems elsewhere. During the price collapse throughout 2015 and early 2016, cost cuts at the wellhead were pushed upstream to be absorbed by oil field service (OFS) providers. Now, with prices escalating, the North American OFS sector is already exhibiting marked inflationary pressures.

However, the main impacts on oil prices are global. That’s because those prices take measure of the supply/demand dynamics in the most rapidly expanding areas. The established North American and Western European markets, the traditional focus, have not been driving the price for some time. With the wave of demand moving to Asia and remaining with an Asian focus for at least the next several decades, what drives prices will be less supply and more demand-centered moving forward.

Which brings me to my principal observation today about the “Chinese oil card” and what it may mean for global prices…

What Happens in China Doesn’t Stay in China

There are at least three factors to consider in appraising “the China oil card.” The first is the one turned to initially by most pundits – the rising power of the Chinese economy. Any inference that China is slowing down is quickly translated into a declining demand for energy. As the oft-mentioned driver of the developing world, that then becomes immediately translated into a perceived cut in energy needs.

The problem with this line of reasoning is that, whether the Chinese economy is adding 7% or 5%, it is hardly declining. And then there is this. Energy domestic demand continues to advance as the Chinese middle class expands and manufacturing to meet consumer interest does as well.

Yet, second, Chinese oil sourcing has been changing. Until vast amounts of internally available shale and tight oil are exploited (and China has more than any other nation), and perhaps even beyond, the nation will be dependent on importing crude.

Where that oil is coming from, on the other hand, is another matter.

A developing pipeline network from Russia has been in service for a while with Moscow more recently pushing an expanded venue from Siberia. However, imports are primarily coming via tanker.

Here, focus has centered on two countries now part of a separate geopolitical dynamic. One is Iran. Throughout the earlier sanction period, China was Teheran’s main target for oil exports. For its part, Beijing welcomed the volume because it had a large trade surplus with Iran. That meant it could effectively purchase oil largely by using payments in kind, rather than with hard currency.

That improved balance sheets as well as strengthen the national balance of payments.

China is likely to figure prominently in Iran’s crude calculations once again as new US sanctions are imposed. This time, Chinese imports are also to include more sophisticated swaps of both oil consignments and futures contracts.

The other country is the US. China had been increasing imports from the US, both crude oil and refined oil product. With increasing exports moving globally from American producers, it had become a useful lever in diversifying sourcing, especially when it came to negotiating price with Russia.

That is until a tariff war ended up with Beijing putting retaliatory fees on both US crude and oil products. How this budding trade war ultimately plays out will have much to say about whether what was until recently regarded as a positive development for both US producers and Chinese end users comes to an end.

Finally, in what may be the longer-term implication from the Chinese-American tiff, China has begun positioning out of Gulf of Mexico offshore project holdings to other locations.

Controlling drilling operations in other parts of the world and exporting production back home remains another ingredient in the Chinese multifaceted approach to obtaining oil. That Beijing appears ready to rotate out of opportunities to work with American companies on joint projects so close to the US border is not just a new wrinkle.

It may be the most disconcerting signal that a geopolitical winter is approaching.



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