How China Could Trigger the Next Big Rough Selloff

If there was ever a time when crude oil was going to reach the levels over US$200 per barrel (bp) displayed in clickbait headlines or bank research reports talking about their own books, it is now. With Russia invading Ukraine geopolitical risk has not been higher in recent memory, there are drastic cuts in oil and gas supply due to bans in place or on the about to enter Russia for the same reason, and the prospect of countervailing supplies from Saudi Arabia or one of its OPEC brethren were dashed upon finally realizing that the endless talk of their abundant capacity reserves were a lie. And yet oil prices are nowhere near US$200 a barrel nor have they been close – in fact, they appear to be weak – and the key factor at play here is the management of Covid. -19 by China. These fears remain well-founded and, despite the incessant chatter of ignorant on the contrary, China is not ready to reverse its draconian handling of the disease anytime soon, casting a long shadow over oil prices for a long time to come. Given the huge gap between its need for various commodities to fuel its economic growth, and its lack of many of these resources, China was almost single-handedly responsible for the commodity price super cycle that has unfolded. is produced between 2000 and 2014. This included crude oil. and even beyond the years of 10% annual growth seen in China during its years of manufacturing growth, it remained the largest annual gross importer of crude oil in the world, surpassing the United States. in this regard in 2017. In short, for nearly 25 years, China has been by far the biggest supply of support in global oil markets. And yet, as he shifted his growth-generating policy from being primarily focused on manufacturing to goods and services linked to the expansion of his own middle class, overall GDP growth figures have declined, and this was seen before the start of the Covid-19 pandemic. It is therefore against this already deteriorating economic growth profile that China’s intransigent line of defense against Covid-19 has aggravated many existing problems.

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Although China emerged from the first major wave of Covid-19 in the first half of 2020 in better economic form than any other major country, its certainty at that time that this was due to its exceptionally difficult handling of the pandemic led to continued support for the “zero-Covid” policy which it saw as the reason for its success in this regard. When massive new outbreaks of Covid-19 occurred earlier this year in China and shut down several major cities, oil markets looked to comments from several Chinese agencies as evidence that a softer line on management of the pandemic may be on the horizon and may mitigate downside risks to the oil price matrix. The optimists cited in particular the release in mid-April by the Chinese Center for Disease Control and Prevention (CCDC) of a guide outlining home quarantine measures. This would have mitigated the crippling effects on the economy of people forced to quarantine in centralized state-run facilities, even if they suffered very mild symptoms or none, after testing positive for Covid-19. . Those hopes were dashed, however, because when asked for further clarification on these home quarantine procedures, the CCDC simply reiterated previous rules. Chinese President Xi Jinping then personally reiterated that: “We must adhere to scientific precision, dynamic zero-Covid… Perseverance is victory.

The sudden and sharp drop in oil prices last week in a very short period of time is a stark reminder to oil bulls of how fragile the long profit and loss wobble is with the shadow of that “China factor” that weighs on world oil markets, about which this author has written several times, most recently at the end of May. It is also extremely pertinent to note here that even the slightest hint of a resurgence of Covid-19 in China is enough to have such a dramatic negative effect on crude oil prices. Last week’s price plunge was only the result of news that Covid-19 cases in Shanghai over the previous weekend had reached their highest level since late May and that several other Chinese cities, including Xi’an and Lanzhou, had imposed restrictions on their residents in response to an increase in Covid-19 cases. The point that markets are rightly pricing in is that it doesn’t take much at all in terms of rising Covid-19 cases for China’s zero-Covid policy to be in full swing. In this context, even at the height of the epidemics across the country earlier this year, the government did not increase its flexibility to a greater degree than had been shown during the previous huge epidemics, which was to allow d daily increase in symptomatic cases. capped at around 200 on a national basis before full “zero-Covid” measures were put in place.

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“While the isolation period for incoming travelers has been halved to seven days of centralized quarantine, local governments should still eliminate national outbreaks as soon as possible with widespread testing, contact tracing and quarantine policies.” , Eugenia Fabon Victorino, Head of Asia Strategy for SEB, Singapore, said OilPrice.com. “[Although citywide lockdowns are meant to be implemented as a last resort, the policy of regular and frequent testing in major cities will keep the fear factor elevated, in our view, and the Covid strategy will likely translate into sporadic restrictions in various parts of the country in the face of virus outbreaks,” she said. “The recent rise of infections in Anhui province has already triggered lockdowns in some counties and, in Shanghai, the 24 positive cases reported on 5 July prompted a three-day mass testing exercise in nine districts and parts of three other districts, out of a total of 16,” she underlined. 

Although the severe degree of resonance that China’s ‘zero-Covid’ policy has for oil prices appears even greater than from the broader impact on China’s economic growth trajectory, many economic analysts are also now predicting extremely low economic growth – by China’s standards – this year. Among others, SEB’s Victorino, predicts 4.3 percent GDP growth for 2022, while TS Lombard’s head of China and Asia research, Rory Green, sees just 2.5 percent real GDP growth in 2022 at best, down from 3.3 percent as recently as two months ago. “Beijing is firmly committed to ‘zero-Covid’, making further lockdowns almost inevitable during the remainder of 2022,”, he told OilPrice.com. “Healthcare limitations, including the low vaccination rate and insufficient numbers of hospitals and staff, combined with politics ahead of the Q4/22 Party Congress – Xi is closely associated with current Covid policy – make an ending of strict Covid restrictions unlikely in the remainder of the year,” he said. 

Bad though this is for China’s economy – and for oil prices – much worse may be to come. “Weakness in the property sector will keep bond defaults rising and a fresh stimulus package is required to offset the deteriorating fiscal balances of local governments,” said Victorino. “[However], at just 2.7% of GDP, the eventual stimulus package highlights the government’s ambivalence to flooding the economy with support measures,” she said. For Green, a new variant of the Covid Omicron variant – the BA.5 subvariant – is extremely concerning. “China is experiencing what could prove to be an economically devastating wave of Omicron’s BA.5 sub-variant, with the number of areas classified as high and medium risk standing at 483. [as of 7 July], well above the peak of around 240 in April/May,” he said. “The full extent of the spread is still unknown, but the epidemic shows no signs of slowing down, and until a clear geographical boundary is established, it is difficult to estimate the economic fallout and caution is advised. bet,” he added. “Last week, we downgraded China’s growth [to 2.5 percent]in the face of market optimism, on our judgment that a meaningful level of reopening – i.e. enough to boost mobility/spending/demand for credit etc. – was still six to nine months away, so at the end of the first quarter of 2023,” he concluded.

By Simon Watkins for Oilprice.com

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