China may no longer be a growth pillar for global oil markets

After a relentless seven-month march, the oil price rally appears in danger of collapsing after oil prices pulled back sharply from their recent highs. Oil prices have been struggling to reverse last week’s losses as markets worry about a drop in demand after the Federal Reserve raised the interest rate by three-quarters of a percentage point, the largest increase since 1994. Brent crude futures were down 38 cents, or 0.3%, at $112.74 a barrel on Monday, with first-month prices falling 7.3% last week, their first weekly drop in five. Meanwhile, US West Texas Intermediate (WTI) crude oil was trading at $109.38 a barrel, down 18 cents, or 0.2%, with first-month prices falling 9.2% last week, the first fall in eight weeks.

According to Commerzbank analyst Carsten Fritsch, Friday’s sharp price decline can be seen as a belated reaction to recession concerns, something that has already been weighing on other commodity prices for some time. Analysts and market pundits believe a recession is more likely after the Fed approved the biggest interest rate hike in more than a quarter century to curb rising inflation.

But oil markets may soon have to climb another big wall of worry: the slowdown in the Chinese economy.

Even as megacities like Shanghai and Beijing grope for full reopening and fiscal stimulus begins to kick in, China is still faces many uncertainties about its economy. China is the world’s largest importer of crude: last year, China imported 11.8 million barrels per day, surpassing the United States, which imports 9.1 million barrels per day.

In May, the oil price rally came to a screeching halt after Beijing adopted a “zero-Covid” strategy and announced strict Covid-19 containment measures, including major lockdowns. While strict lockdowns and curfews managed to curb the latest Covid-19 outbreak in the country, they had a negative impact on Chinese consumer demand and manufacturing output. According to YoY figures for April, retail sales fell 11.1%, industrial production 2.9% and manufacturing 4.6%. Meanwhile, the Chinese yuan and the MSCI Emerging Market Currency Index fell in tandem in April.

Unfortunately, the ailing Chinese economy cannot be fixed with simple measures like lockdowns this time.

economic slowdown

President Biden recently announced that the The US economy could grow faster this year than China’s economy for the first time since 1976, with growing signs that the Chinese economy may be entering a prolonged era of slow growth. The world’s second-largest economy is projected to grow just 2% this year, significantly lower than the 2.8% rise in US gross domestic product.

Maintaining a zero COVID policy has been slowing the economy and adding huge extra costs to the government budget, leaving Beijing in a dilemma over whether to increase debt or tolerate weak economic growth.

Fiscal strains were already mounting before Covid spending pressures kicked in, including a drop in revenue from land sales due to the housing slowdown, as well as tax relief for businesses cutting government revenue. In fact, official data shows that the vast budget deficit hit a record high of nearly 3 trillion yuan ($448 billion) in the first five months of the year.

Related: China could see another energy crisis this summer

The People’s Bank of China (PBOC) remains cautious on concerns about further weakness in the yuan, which could trigger large capital outflows in a cycle of Fed rate hikes. Yuan and bond yields Corporate bonds fell sharply after the PBOC announced a cut in banks’ reserve requirements in mid-April. Since then, the currency has stabilized, but bond yields have risen again. Net debt issuance by the government registered more than 700 billion yuan ($104 billion) in May, the two highest monthly totals since mid-2020, and more liquidity will be required from the PBOC if the rapid cut in the local government debt issuance will continue.

Beijing will now be forced to advance a larger part of next year’s planned quota or take other strong steps to bolster local government finances. It may also allow more informal lending by city governments, though that would be difficult given high bond yields. Unless Chinese lawmakers act to significantly tighten local government finances and the PBOC is willing to risk further depreciation of the yuan, a weak rebound in the third quarter is seen as the most likely scenario.

In the long term, it’s going to be hard for China’s economy to keep growing like a weed, let alone outperform the US economy given that the country is in long-term demographic decline. In contrast, the US is likely to continue to increase its population. It looks more and more like China will turn out like Japan in the 1980s, where they were thought to overtake the United States but stalled, their population began to shrink and things quickly went south for the Asian nation.

Fortunately, some experts remain optimistic about the path of oil prices.

“Supplies will remain tight and continue to support high oil prices. The norm for ICE Brent remains around $120 a barrel.” PVM analyst Stephen Brennock has told Reuters.

By Alex Kimani for Oilprice.com

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