The sharp drop in crude oil prices last week on news that China had extended a Covid-19 lockdown in Chengdu, the capital of the southwestern province of Sichuan, for the majority of its 21 million residents, again highlighted the capacity for such news to cause major sudden falls oil prices in a market characterised by uncertain demand and supply. As the largest annual gross crude oil importer in the world, surpassing the U.S. in this regard in 2017 (having become the world’s largest net importer of total petroleum and other liquid fuels in 2013), China has long been the global backstop bid in the oil market. Between 2000 and 2014, it was almost single-handedly responsible for the commodities pricing super-cycle that occurred during that period. Such Draconian Covid-related lockdowns have a direct and significant effect on China’s economic growth, which in turn effects its demand for oil, and the lockdowns are a direct function of the country’s ‘zero-Covid’ policy. There is no sign whatsoever that this policy will be substantially modified, let alone abandoned, any time soon. To a large degree, China’s adherence to its zero-Covid policy, in which ultra-tight lockdowns are introduced across entire cities immediately that a relatively miniscule number of Covid-19 cases are identified, has been a product of the country’s own early success in handling the pandemic. China came out of the first big wave of Covid-19 in the first half of 2020 in better economic shape than any other major country, precisely because of its tough handling of any outbreaks of the disease, as it had not managed to produce a truly effective vaccine of its own and eschewed buying in proven vaccines from non-domestic suppliers. When massive new outbreaks of Covid-19 occurred earlier this year in China, and led to the shutdowns of several major cities, oil prices fell on the prospect of reduced demand from China, but did not fall as far as they might, given the broad-based belief that China would probably be forced into taking a softer approach to its handling of Covid-19 in the near future. The previous December had seen a refinement of the zero-Covid strategy to one incorporating the idea of ‘dynamic clearing’, which provided local governments more flexibility in imposing restrictions, allowing daily increases in symptomatic cases to be capped at around 200 on a national basis. It was thought that this number might be increased, given that in the new outbreaks in March alone 184,000 individuals with possible Covid symptoms had been put under medical observation in isolation in the first two weeks of those outbreaks.
The number was not increased, but further optimism arose from comments made by several Chinese agencies about a possible softening up of the zero-Covid rules, and then came the publication in the middle of April of the Chinese Center for Disease Control and Prevention (CCDC) guide that outlined measures for quarantining at home. These would have alleviated the economy-paralysing effects of people having to quarantine at centralised state-run facilities, even if suffering from very mild symptoms or none, having tested positive for Covid-19. These hopes again, though, were dashed as, when asked for further clarification of these home-quarantining procedures, the CCDC simply reiterated the previous rules. China’s President, Xi Jinping, then personally reiterated that: “We must adhere to scientific precision, to dynamic zero-Covid…Persistence is victory.” As it now stands, China still does not have an effective vaccine against Covid-19, nor does it have an effective post-infection anti-viral, and it still refuses to buy in such supplies from non-domestic suppliers, despite repeated offers from all major producing countries to make such supplies available to it. Even before the extension of the Chengdu lockdown that has added another 21 million people to the total, 44 million people in China were already in lockdown.
Back at the end of July, then, all of this had translated into radically reduced economic growth projections for China, with the corollary dampening effect on oil prices. Two of the most consistently correct analysts on China in recent years - Eugenia Fabon Victorino, head of Asia Strategy for SEB, and Rory Green, TS Lombard’s head of China and Asia research – had already downgraded their GDP growth estimates for China earlier in the year but did so again. SEB now sees China’s economic growth this year at just 3.5 percent, and TS Lombard at only 2.5 percent. Victorino had exclusively told OilPrice.com back then that: “Local governments are still expected to eliminate domestic outbreaks as soon as possible with widespread testing, contact tracing and quarantine policies.” She added: “[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 [zero-] Covid strategy will likely translate into sporadic restrictions in various parts of the country in the face of virus outbreaks.” Green, also speaking exclusively to OilPrice.com, had said: “Beijing is firmly committed to zero-Covid, making further lockdowns almost inevitable during the remainder of 2022.” He added: “Healthcare limitations, including the low vaccination rate and insufficient numbers of hospitals and staff, combined with politics ahead of the Q4/22 Party Congress – and Xi is closely associated with current Covid policy - make an ending of strict Covid restrictions unlikely in the remainder of the year.” Just over a week ago, the People’s Bank of China (PBOC) stepped in to try to alleviate negative economic pressures that are building in several sectors, with back-to-back cuts in its various policy interest rates. Having surprised the market with a 10 basis points (bps) reduction to its 1 year Medium Term Lending Facility (1y MLF) and its 7day reverse repo rate (7d RRP), the PBOC doubled down with a deeper cut (15 bps to 4.30 percent) on its 5y Loan Prime Rate (5y LPR), highlighted SEB’s Victorino. “The deeper cuts in the 5y LPR reflects policymakers’ intent to stabilise the property sector, and the adjustment will weigh on average mortgage rates further given that the minimum mortgage rates is set at 20 bps below the 5y LPR,” she said. “Yet, even before the latest rate reductions, financial conditions have been easing for months, with the PBOC having been guiding the interbank funding lower via liquidity injections, [but] although lower borrowing costs are designed to prop up demand for credit, flush liquidity conditions have yet to put a floor on the deteriorating confidence onshore,” she added. Of particular concern, in terms of broader financial disruptions in China, is the deleterious state of the real sector. “Drip feed support for the real estate sector has yet to stem the bleeding and the crisis of confidence in the housing market continues,” Victorino told OilPrice.com. “Latest bank earnings reports have seen state-owned banks doubling estimates of overdue loans related to the mortgage boycotts, meanwhile China’s largest state-owned bad asset management companies have reported plunging earnings due to credit impairments related to their property exposure,” she said.
The probability of further lockdown-related oil price shocks in the next few weeks looks high, given that the Mid-Autumn Festival holiday began on 10 September and that Golden Week (incorporating China National day) begins on 1 October. The Chinese government has already warned people against travelling during these upcoming major holidays.
By Simon Watkins for Oilprice.com