By Barani Krishnan
Investing.com -- It was probably months late in coming. But China has finally done what it has been toying with ever since the fertilizer hit the fan on its inflation: slash some of its pricey oil imports by turning to its reserves instead.
It’s an audacious gamble. In trying to control inflation at home, Beijing is effectively suppressing the global price of oil; using what it has stockpiled to only buy again from abroad when the price is right. As the largest importer of crude, China’s purchases are closely watched as an indicator of demand. If it buys more, the price will rise and if it buys less, it will drop.
In the casino analogy, what Beijing is doing is betting against the house, with the “house” in this case being OPEC and its allies. And that's a tough house to bet against.
With grains and metals, when you cut your buying, the sellers in the producing countries will typically let prices drop enough to get your business back. With the Organization of the Petroleum Exporting Countries and its allies, however, the opposite is likely to happen. Once oil prices start falling steadily and significantly, the alliance will gang up to cut production, and send the market back up - often higher than it had fallen.
How far the Chinese go at this game will depend on how much tolerance is shown by the 23-nation OPEC+, which comprises the 13-member Saudi-led OPEC and its ten oil producing allies steered by Russia.
Since taking back control of the demand-decimated oil market from the height of the coronavirus pandemic, OPEC+’s unyielding production cuts have enabled crude prices to trade at multiples to their 2020 lows. The alliance has only now started adding to output. But it can roll them back at a blink should China’s stockpile releases prove detrimental to the market.
The market action in the 48 hours after China’s announcement also showed how fleeting a win can be for the republic.
Crude prices tumbled almost 2% right after the stockpile move. But in the next session itself, the market recouped two-thirds of what it lost on U.S. supply tightness from Hurricane Ida. The rebound was also aided by signs that Sino-U.S. ties may improve after a cordial Xi-Biden phone call (ironic that while China was trying to get crude prices down on one side, it indirectly boosted them another way).
Anyway, this isn’t about how the market fares one day or the other. It’s about whether Beijing will be able to effectively keep oil inflation down. And there are mixed views on whether it can.
Some longtime market commentators, like John Kilduff of New York energy hedge fund Again Capital, feel China’s hand in the situation is overrated.
“Based on their past success with metals and other commodities, they think they have the Midas touch to manage the inflation in their economy through oil price controls too,” said Kilduff. “They may have some levers to pull but it’s never going to be too lasting, given the counter-reaction we can expect from OPEC+. Over the longer run, China will probably find out the hard way that it’s hard to keep at this.”
China’s National Food and Strategic Reserves Administration said its stockpile release was “to ease the pressure of rising raw material prices.” It said a “normalized” rotation of crude oil in the state reserves is “an important way for the reserves to play its role in balancing the market”. The agency also said that putting national reserve crude oil on the market through open auctions “will better stabilize domestic market supply and demand”.
We get why China is doing this. Some of its factories are already cutting production from a combination of surging energy costs and electricity shortages. Factory-gate inflation in the No. 2 economy accelerated in August to a 13-year high.
The question, though, is does Beijing have enough oil reserves to play the long game on this?
The last publicly-disclosed figure on China’s so-called SPR, or Strategic Petroleum Reserve, in 2017, was 237.66 million barrels in all.
That somewhat aligns with what consultancy Energy Aspects Ltd estimates for the current Sino reserve: 220 million barrels.
As important as the reserves is consumption. According to CEIC, another consultancy, China consumes some 14.2 million barrels per day.
Given its dynamic need for oil, there’s simply no way China can go without importing oil for too long. Neither should we expect it to. What China can do instead is a significant stock release whenever the oil market is - or appears to be - overheating. That could be effective in muting oil price shocks, even if it doesn’t pressure them all the time. In that way, China gets what it wants without triggering OPEC+’s ire.
Some say China could emerge as a new negative force in oil, making the demand outlook more questionable. From here on, Beijing can no longer be viewed as just a cheerleader of commodity supercycles; it can also be a silent bear when prices aren’t going its way or hurting its economy.
“The oil market is in deficit. But this China story could disrupt it (from) staying in deficit for the rest of the year,” said analyst Ed Moya at online trading platform OANDA.
Osama Rizvi, energy analyst at Primary Vision Network, says China could be one reason why oil does not hit $100 a barrel.
“China amassed a huge amount of oil when prices hit a 20-year low and as prices continue to rise, China will be increasingly incentivized to tap its reserves rather than import expensive oil,” said Rizvi. “While this is unlikely to change the underlying fundamentals of oil markets, the reduction in Chinese imports is certainly one of the factors that could finally drive a shift in oil market sentiment.”
Oil/Gas Market & Price Roundup
Oil rose to briefly top $73 a barrel on Friday, supported by growing signs of supply tightness in the United States as a result of Hurricane Ida and as U.S.-China trade hopes gave riskier assets a boost.
London-traded Brent crude, the global benchmark for oil, settled at $72.92 per barrel, up $1.47, or 2.1%. For the week, Brent rose 0.4%.
New York-traded West Texas Intermediate, the benchmark for U.S. oil, settled at $69.72 per barrel, up $1.58, or 2.3%. For the week, WTI rose 0.6%.
Natural gas prices, meanwhile, settled down on Friday but still finished the week up. Most-active October gas on NYMEX’S Henry Hub settled the day down 1.9% at $4.938 per mmBtu, or million metric British thermal units. For the week, the spot gas contract gained 4.8%, extending the 7.8% gain from last week and 13.5% from the week prior.
Gas prices have been on a tear since the year began on weather extremities and underwhelming production. The rally gained further momentum this month after Hurricane Ida shut down a swathe of gas production facilities on the Gulf of Mexico.
For the year, gas prices are up 95%, with analysts estimating they could reach $6 per mmBtu next.
Energy Markets Calendar Ahead
Tuesday, Sept 14
Cushing inventory estimates
Wednesday, Sept 15
American Petroleum Institute weekly report on oil stockpiles.
Thursday, Sept 16
EIA weekly report on crude stockpiles
EIA weekly report on gasoline stockpiles
EIA weekly report on distillates inventories
EIA weekly report on natural gas storage
Friday, Sept 17
Baker Hughes weekly survey on U.S. oil rigs
Gold Market & Price Roundup
Gold booked its first weekly loss in five as brief euphoria for longs over the dismal U.S. jobs report for August gave way to dismay as the dollar rebounded on relentless talk of a Federal Reserve stimulus taper.
Most-active December gold futures on New York’s Comex closed down $7.90, or 0.4%, at $1,792.10 an ounce. For the week, it fell 2.3%, its most since the week to July 29. It was also Comex gold’s first weekly loss since the end of July.
Friday’s drop in gold was partly pressured by data showing US producer prices rising by 8.3 percent in August, their most in over a decade, as inflationary pressure grew unrelentingly in an economy trying to break out of the shackles of the coronavirus pandemic.
The Fed’s stimulus program and other monetary accommodation have been blamed for aggravating price pressures in the United States.
The central bank has been buying $120 billion in bonds and other assets since the COVID-19 outbreak of March 2020 to support the economy. It has also been keeping interest rates at virtually zero levels for the past 18 months.
The question of when the Fed ought to taper its stimulus and raise interest rates has been hotly debated in recent months as economic recovery conflicts with a resurgence of the coronavirus’ Delta variant. The argument for a taper was, however, weakened considerably after US jobs growth for August came in at 70 percent below economists’ target.
The dollar initially tumbled on that jobs report, fueling gold’s rally to a four-week high of almost $1,837. But almost immediately after that, the Dollar Index Dollar Index, which pits the dollar against six major currencies, rebounded, sending gold to a low of just above $1,783.
After declining 3.5% in 2020 from business shutdowns owing to COVID-19, the US economy expanded robustly this year, expanding 6.5% in the second quarter, in line with the Federal Reserve’s forecast.
The Fed’s problem, however, is inflation, which has been outpacing economic growth.
The Fed’s preferred gauge for inflation - the core Personal Consumption Expenditures Index, which excludes volatile food and energy prices - rose 3.6% in the year through July, its most since 1991. The PCE Index including energy and food rose 4.2% year-on-year.
The Fed’s own target for inflation is 2% per annum.
Disclaimer: Barani Krishnan does not hold a position in the commodities and securities he writes about.