Triple digit oil is back

China will import more oil and gas from refineries like this in Russia

The crisis in Ukraine is spilling over into stratospheric prices in the world’s commodity markets. Oil has climbed more than 40% over two weeks to its highest levels in nearly 15 years, while prices for thermal coal and wholesale gas have both reached record levels. Something similar is happening to wheat prices and nickel more than doubled in value on Tuesday alone.

Much of the focus in China is on energy commodities, where the price increases are creating alarm at a time when the government has just revised the GDP forecast down to 5.5%, compared to last year’s 6% target (see Talking Point). The more immediate concern for policymakers is whether higher prices for crude and natural gas will force up local inflation rates.

Officials from the National Development and Reform Commission, the top state planning agency, were insisting this week that the target for consumer price inflation of about 3% for the year is well achievable. In part that’s because consumer price rises have come in well below that level in recent months, increasingly just 0.9% in both January and February. Much of the inflationary pressure was eased by falling pork prices and an appreciating yuan against the dollar, which is offsetting the impact from more expensive imports.

Lian Weiliang, the NDRC’s vice chairman, also assured reporters on Monday that the impact of rising energy prices was controllable because Chinese imports of crude oil and natural gas are diversified, with a “very high” share on long-term contracts. The government would also be proactive in maintaining an adequate supply of the major commodities, he added.

Beijing can always protect consumers by capping prices from the state-owned producers such as CNPC as a fallback against the surging costs of energy commodities. Nonetheless, the Chinese still find themselves in an unenviable position as the leading importer of many of the world’s commodities (they bought more than $250 billion of crude on global markets last year, for example).

The war in Ukraine comes at a time when Sino-Russian ties have been tightening, including new oil and gas deals worth an estimated $117.5 billion that were announced as recently as last month. In one example Russian giant Gazprom confirmed the annual sale of 10 billion cubic metres of natural gas to CNPC over a 30-year period, underpinned by a new route for gas into China. Russian gas already reaches China via the massive Power of Siberia pipeline, which was launched in 2019.

In the longer term China may choose to buy more Russian gas as part of efforts to reduce its dependence on coal and meet targets for cutting greenhouse gases. Yet the immediate reaction to escalating energy prices is going to mean more coal consumption as the Chinese  turn back to coal as a way of bolstering domestic power production.

NDRC officials have announced a decision to build up new government reserves of more than 200 million tonnes of coal, for instance, as well as encouraging local energy producers to boost their own stockpiles.

China is the also largest importer of Russian coal and it announced another new deal for $20 billion of additional supply only a few days before the invasion of Ukraine.

For imports of oil, the Chinese are choosing a different direction to the Biden administration, which announced a ban on Russian supply on Tuesday this week. Beijing has also expressed its opposition to wider sanctions on trade with Moscow, with President Xi Jinping warning his French and German counterparts that restrictions would “deal a blow to the stability of global finance, energy, transportation and supply chains, dragging down the world economy amid the pandemic,” according to China’s state broadcaster CCTV.

Beijing has been bitterly opposed to efforts from Washington to block sales of Iranian oil in the past, describing the restrictions as illegal and unilateral. It was also unimpressed when Western countries acted in concert to block Russian banks from the Swift international payments system last week. “China and Russia will continue regular trade cooperation based on the spirit of mutual respect and equality,” the ministry’s spokesperson insisted and Wang Yi, the foreign minister, has also described China-Russia ties as “rock solid”.

Beijing is hardly alone in rejecting blanket bans on purchases of Russian energy, with German chancellor Olaf Scholz also speaking out against embargoes on gas imports. The European Union hasn’t followed Biden’s lead in snuffing out Russian oil supply either, although it has vowed to reduce its use of Russian gas by two-thirds this year.

The Chinese might still choose to buy up  unwanted oil supply, however, especially if Russian Urals crude is offered at discounted prices as part of a strategy for redirecting flows to more willing customers.

That would create new opportunities for China’s refiners to stockpile cheaper crude, although there have been also been concerns about the financing of Russian oil shipments, which have seen at least two of China’s largest state-owned banks hold back on issuing dollar-dominated letters of credit.

Because of the lack of European support for a fuller blockade, China is unlikely to come under sustained pressure to choke off its own purchases of Russian energy. Anyway, the American campaign against imports of Iranian oil could also be instructive, as Washington hasn’t been enforcing the restrictions on business between Iran and its fuel customers in China.

The searing pressure on commodity prices is now prompting the Biden administration to reconsider  its restrictions on oil exports from countries like Venezuela and Iran, with talk of lifting some of the sanctions in a bid to replace much of the Russian contribution. But in fact, Chinese purchases of Iranian crude had already reached new heights in the first month of this year, surpassing 700,000 barrels a day in January, Reuters has reported. This was well beyond the peak recorded by Chinese customs in 2017, before Donald Trump reimposed sanctions on Iranian oil exports.

Independent refiners from China, or so-called “teapots”, are said to be doing most of the business, buying at least $20 billion of Iranian crude over the past two years. “We’re seeing more plants taking Iranian oil, because they are cheaper,” a China-based executive told the news agency.

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