Inflation and China Halt Oil’s Seemingly Irrepressible Rise

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

Mon, 13 Jun 2022, 10:14

Inflation and China Halt Oil’s Seemingly Irrepressible Rise

Harry Altham

Energy Analyst, EMEA & Asia

Growing COVID cases in Beijing and Shanghai are weighing heavily on energy markets this morning, with 166 positive cases being linked to a single bar in Beijing as officials warn of a ‘ferocious’ outbreak; Brent has dipped below $120 for the first time in a week amid the concern. A total of 37 new cases were also reported in Shanghai; the cases have brought about new restrictions on indoor gatherings and regular testing in both cities. Chinese oil demand was estimated to be 1.6M bbd below June 2021 levels in March and April. However, data had shown peak congestion in China to have risen above January 2021 levels for the last four weeks, with traffic rising by as much as 20% in Beijing and Shanghai. As a result, markets had been pricing in demand recovery in the world’s second largest consuming nation, but the Government’s zero-COVID policy has remained in place and remains a substantial demand-side risk. Future weakness in China’s demand recovery will persist until the moment when the zero-COVID policy is changed or removed, which we see as improbable until the Communist Party Congress in November. This leads us to believe that global demand forecasts, many of which are contingent on ‘post-COVID China’, are overestimating oil consumption in the second half of this year, although weak demand for China will not be sufficient to balance oil markets due to the forecast 1.7M bbd loss of production out of Russia.

Beijing road traffic data, indexed to January 2021 baseline. Source: Baidu via BNEF.

Shanghai road traffic data, indexed to January 2021 baseline.Source: Baidu via BNEF.

Also weighing on markets is this inflation across the West, with particular attention being paid to this week’s FOMC meeting which is expected to yield another 50 basis-point rise in benchmark interest rates. Aside from rising energy prices, the headline issue is the Russian blockades on Ukrainian ports that is preventing the export of food, which has resulted in climbing grain prices and is causing the United Nations to warn of an imminent global food shortage. Supply chain disruption in U.S. ports remains an issue, as is the risk of further COVID lockdowns in China causing bottlenecks to exports. However, Goldman Sachs is reporting that higher inflation will not impact U.S. oil demand over the summer; a statement which is backed up by the 9.2M bbd of gasoline supplied to U.S. markets in the last week of May – in line with peak consumption estimates by the IEA. Though Barclays (among other banks) believes rising inflation could see the FOMC raise interest rates by 75 basis points, we consider this unlikely as Fed Chair Jay Powell has repeatedly stated the need to give clear signals to markets, and all indications have pointed towards a 50-basis point rise.

Libyan oil output is falling close to zero, as facilities continue to suffer from political and militia related disruption. A series of protests in the West of the country have shuttered Es Sider and Ras Lanuf ports, while the Hariga Port has been forced to close due to the closure of the Sarir oil field; militias have overrun a number of facilities in the centre of the country. Oil Minister Mohamed Oun is quoted as saying the Wafa Field (40k bbd) is the only facility in Libya with continuous production. It is thought that production across the country is averaging just 100k bbd, which is 90% lower than the 1.1M bbd produced in 2021. Though Libya is exempt from OPEC+ quotas, the fall in production will still impact the group’s overall performance and adds more balance sheet pressure to global oil markets. We see these problems as persisting throughout the summer as the political infrastructure in Libya remains weak and divided; this will chiefly add pressure to European gasoline markets due to the low density of Libyan oil (as well as geographic proximity).

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Inflation and China Halt Oil’s Seemingly Irrepressible Rise

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