Even if Saudi Arabia’s claim about how swiftly it will recover from the recent attack on its oil infrastructure can be believed – which it cannot – the Houthi/Iran alliance has demonstrated that it can hit the Saudi’s oil and gas industry at will. “Military assessments suggest that similar attacks are fundamentally difficult to protect against and, in our view, the market is under-appreciating the long term effect of the attacks,” Eugenia Victorino, head of Asia strategy for SEB, in Singapore, told OilPrice.com earlier this week.
Given this, and China’s position as the world’s top oil importer – essential for keeping its economic growth on track – the questions are: how well positioned is China to weather higher oil prices and how will it affect its position in the ongoing trade war with the U.S.?
To begin with, China’s level of oil imports has been steadily growing, from an already very high base, with last year seeing the country import 462 million metric tons of crude, a 10% increase over the previous year. At the same time as its basic economic demand for oil has increased, China has also sought to dramatically build up its strategic petroleum reserves through an increasing number of different channels, regardless of any – as it sees it – ‘short-term considerations’, such as U.S. sanctions on various countries.
“China’s top five sources of oil imports currently account for 55 per cent of its total crude imports, down from 60 per cent in 2013,” said Victorino. “And over that five year or so period, China has reduced its dependence on oil from the Middle East region as a whole,” she added. Specifically, by the end of 2018, the share of China’s oil imports from the Middle East had declined to 41 per cent from 47 per cent five years before. “Russia overtook Saudi Arabia as the top source, while Brazil surged in the ranks over the same period and in the meantime 2.9 per cent of 2018 crude imports came from the U.S., although the escalation of the trade tensions has seen the average share of oil imports from the U.S. decline to 1.3 per cent as of July,” she added.
In broader economic terms, the effects on the economy of the other protagonist in the trade war – the U.S. – via the conduit of gasoline prices was quantified at least in part a while back by various U.S. think tanks and trade associations. The rule of thumb for the U.S. is that every US$10 per barrel change in the price of crude oil results in a US$0.25 change in the price of a gallon of gasoline. In turn, for every US$0.01 that the average price of gasoline falls, more than US$1 billion per year in additional consumer spending is freed up, according to the American Automobile Association in Washington.
A crucial adjunct to this is that consistently rising at-the-pump gasoline prices over US$3 per gallon and towards US$4 is regarded as presidential electoral suicide. Indeed, Bob McNally, the former energy adviser to the former President George W. Bush, highlighted that: “Few things terrify an American president more than a spike in fuel prices.”
For China, though, the across-the-board economic correlations are less clear. The sensitivity of its headline inflation, for example – a key concern for China, given its high-growth economic model – to global oil prices is not unduly worrying. “Assuming a steady yuan, we estimate headline inflation can rise by 0.2 percentage points for every 10% increase in oil prices with a lag of one month,” said SEB’s Victorino. “While the transport sub-index of the CPI [consumer price index] basket has a high sensitivity to the evolution of crude oil prices, it has a relatively low weight in the CPI basket overall,” she added. Although China’s National Bureau of Statistics has not revealed the specific weights of the CPI sub-indices, SEB estimates transport accounts for 10-12 per cent of the CPI. Conversely, she underlined, in light of the positive relationship between factory gate prices and industrial profits, gains in the oil prices are supportive of the industrial sector.
Rising gate prices and industrial profits, in fact, reduce the chances of corporate defaults and, therefore, the need for China to embark on more pre-emptive fiscal stimulus programs. The current regime in Beijing is extremely wary of embarking on more of these fiscal spending programs, as it is aware of the dangerous level of financial shocks coming from the already high degree of leveraging in the system. “The commitment to deleveraging and financial risk control is unwavering and [Vice Premier] Liu He still has the ear of [President] Xi Jinping,” Rory Green, Asia economist for TS Lombard told OilPrice.com last week.
“The President remains convinced that another round of excessive debt creation could be fatal to China and more importantly to the regime,” he added. “The President, having removed the constraint of [presidential] term limits, has every incentive to focus on longer-term growth sustainability and risk control,” he underlined.
This unwillingness to embark on new fiscal stimulus programs is a function of Beijing’s broader confidence and willingness to accept lower economic growth overall and this, in turn, ties into China’s future stance in the ongoing trade war negotiations with the U.S. “Economic pressures are not so strong to force Beijing to concede on trade and the [ruling Communist] Party position throughout the dispute has been, and remains, constant,” said TS Lombard’s Green. “Any deal cannot cross its two red lines: it cannot mandate changes to the state-led-economic model and it must include significant easing of tariffs,” he added. “In turn, concessions are offered in three key areas: reduction of the trade surplus, IP [intellectual property] protection and market opening and limited commitment on RMB [renminbi] stability,” he told OilPrice.com.
There is every reason to believe that the impact of the trade war will variously continue to impact the global hydrocarbons markets, depending on the relative prominence of other key factors – mainly, geopolitical risk right now – but, said Green, the trade war calculus can be simplified by fixing one side of the equation. “The Chinese position [as above] will not change and a deal, therefore, depends on U.S. acceptance of limited Chinese concessions, which – given the election campaign underway in the U.S. – is not certain,” he concluded.