The politics of the oil market turned even more predatory than normal when Saudi Arabia fired the first shots in a seismic price war last weekend. The Saudis were furious that Russia refused their request for production cuts. The Russians said no because they want to make life more painful for the US shale oil sector. But the reaction to the row was devastating for all the producers: the oil price fell more than 30% at one stage on Monday in its biggest one-day drop since 1991.
At first glance the Chinese look more like bystanders in the row – although it was the onset of the coronavirus crisis in Wuhan that crushed much of the demand for oil and its various derivatives in the first place.
In fact, the customs data for January and February isn’t showing much sign of that slowdown on oil deliveries, with imports rising 5.2% on the same period last year. However, that’s because most of the deliveries were contracted in November or December last year, before the coronavirus took hold.
Fewer cars on the roads, hundreds of flight cancellations and a long period of industrial shutdown will see demand for refined products drop a third in the first quarter compared to last year, says PetroChina’s research institute, and other analysts agree that it’s only in the March and April numbers that the real impact of the virus on the oil sector will become clearer.
With shipments still arriving, where has the oil been going? Some of the crude is being stockpiled by Chinese oil firms or by the government in the nation’s strategic reserve. According to commodity data firm Kpler, inventories soared to a record high of 782 million barrels at the end of February. There are anecdotal reports that commercial storage in Shandong is reaching capacity, with cargoes being diverted to South Korea, Malaysia and Singapore. Some of the biggest oil tankers are being pressed into service as floating storage units too.
Stocks of gasoline, diesel and jet fuel are likely to increase substantially as well, despite cuts to production of oil-based derivatives at the refineries. CNPC, Sinopec and CNOOC – the biggest state-owned refiners – reduced output by as much as a fifth in February. Smaller, privately-owned refineries (or ‘teapots’ in industry parlance) are cutting back even further. The whole sector is also trying to sell its surpluses overseas, with record exports predicted this month.
The Chinese are the world’s biggest importer of oil, buying more than a fifth of global exports. So on the face of it they should be beneficiaries of a price war, especially one that’s being fought between their two biggest suppliers.
On the other hand, the Chinese are also the fifth-largest oil producer, with about 5% of the global total. For their oil majors the situation is disastrous and all three saw their share prices plummet on Monday, just like their peers from other countries. PetroChina (CNPC’s listed unit) and Sinopec will probably suffer more than CNOOC, whose production costs are lower. But the hit to revenues will result in heavy losses at all three giants – as well as lower dividends for investors.
The problem for the producers is that the price war comes at a time when the market is already dangerously weak. HSBC forecasts that there will be no increase in global demand for oil this year, the first time that’s happened since 2009.
China’s significance as a market also means that the oil firms will be desperate for signals that the Chinese are starting to recover from the Covid-19 outbreak, both in bringing the virus under greater control (reports of new cases have fallen to their lowest levels – with only nine confirmed on Thursday) and in helping the economy to pick up pace (the transport ministry says that 300 million people have now returned to work).
Signs of a more concerted stimulus campaign from the Chinese government would be even more welcome on the assumption that the additional spending would feed through into more demand for crude.
Another angle to watch is whether the Saudis increase their oil exports to the Chinese. Sales soared 47% last year, when the Saudis replaced the Russians as China’s top supplier for the first time in four years. Part of Riyadh’s plan for the price cuts is growing its market share further and they will be hoping to reinforce this relationship in the months ahead.
That also gives the Chinese the chance to drive a harder bargain. “If the spread remains so wide, it’s definitely worth considering seeking incremental Saudi light and medium barrels, while cutting down on Russian cargo purchases,” a procurement boss at a trading arm of PetroChina told S&P Global on Monday.
Donald Trump’s take on the price war on Monday was that it’s good for consumers because it will mean lower gasoline prices at the pump. Yet changes in buying patterns could have a knock-on effect on China’s purchases of American oil at a time when it is supposed to be buying $52.4 billion of US energy exports as part of the phase-one trade deal signed in January.
Commentators had earlier argued that the January deal was doomed because the Americans won’t be able to increase output fast enough to fill the extra orders. But now the difficulties are different. The forecasts for Chinese oil demand have already been kiboshed by the coronavirus and the ructions among the oil exporters are making Saudi oil a much more attractive proposition. That is sowing doubts about whether Beijing will back away from its commitments to buying American oil, bringing more pain for US shale producers – whose breakeven price is said to be around $40 a barrel.
As the US drillers feel the financial pressure, that could lead to a major round of layoffs and other economic consequences for a series of states that are battlegrounds in November’s presidential election (such as Pennsylvania and Ohio). No doubt this will draw the current occupant of the White House back into the heart of the row, a prospect that neither Beijing, Moscow or Riyadh will be relishing.
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