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China Protests Catch Oil Markets Off-Guard

By: Harry Altham, Energy Analyst, Market Analysis EMEA & Asia

China Protests Catch Oil Markets Off-Guard
 
Harry Altham
Energy Analyst, EMEA & Asia

Oil prices have begun the week with a sharp decline, as anti-COVID protests that began on Friday evening in Xinjiang spread to large cities across China over the weekend. Brent has slipped to lows beneath $81.00 for the first time in 2022 (and is now entering oversold conditions), and the prompt spread has flipped into its deepest contango since December 2020 ($0.28). In terms of market sentiment, we saw the largest reduction in long positions in Brent for eight months as prices tumbled last week; total open interest remains exceptionally low (2.4M in futures and options combined) as traders continue to face unfavourable conditions.

image 56467
Source: ICE, StoneX
european divisions GROW
A key consideration in oil markets is the proposed $65-$70 price cap on Russian oil, for which discussions are expected to continue within the E.U. today. It remains the case that the bloc is divided; Poland and the Baltic countries believe the price is too lenient to Russia (as it is around $5.00 higher than what Russia currently receives per barrel), while Greece believes the cap is too low. For Russia’s part, President Putin has planned legislation that bans the trade of Russian oil within the price cap; it remains unclear whether trade would be permitted with countries that bought beneath the cap (as would currently be the case) without referencing the price ceiling in contracts. 
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Source: Bloomberg, StoneX
CHINA FACES UNPRECEDENTED PROTESTS

The latest reports out of China suggest clashes between police and residents took place in Shanghai last night. Brent’s exposure to fragile demand conditions encouraged selling, to which the stronger dollar (finding its footing after weeks of losses) gave greater impetus as USD denominated commodities grew more expensive. However, the dollar’s strength failed to last, and yet the oil benchmarks failed to recover. It is our assessment that the persistent weakness in the oil complex is due to China’s record COVID cases, which topped 40,000 for the first time since the pandemic began three years ago. Given the strength of China’s security apparatus, we do not currently believe significant demand destruction as a direct consequence of the protests is likely, although the volatility we are seeing in markets reflects uncertainty over what could happen; China has not seen protests this prominent since 1989 – and the country is much changed since then. 

In terms of risk-off, the Hang Seng Index led the stock market selloff in falling by 1.54%. Looking forward, the Hang Seng P/E ratio (when looking at estimated earnings against the trailing 12 month period) is almost 50% higher on the forward basis despite a 30% y/y price decline; though this is reflective of conservative earnings forecasts, we believe the forward ratio is reflective of expected high growth rates in 2023 (when China is widely expected to exit its COVID curbs). We believe the protests will place greater pressure on the Communist Party to lift the COVID curbs sooner and push that expected growth higher; the anti-COVID demonstrations appear to be displaying elements of wider dissatisfaction with the ruling Communist Party and the Government will be keen to avoid a snowball effect like the one seen in 1989. We therefore take the developments as bullish for oil overall, although the uncertainty could cause considerable volatility this week (should the protests continue).

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