The Crude Report: Impact of Covid on China’s crude market

Author Argus

Covid lockdowns threaten to crush Chinese short term oil consumption, adding another layer of complexity to a market plagued by sky-high prices in the wake of sanctions.

Some 200mn Chinese oil consumers were put under mobility restrictions of varying severity this month, as China faced its most significant spike in Covid cases since early-2020.

This threatens to eliminate a large component of the "pull factor" that shifted the centre of oil demand growth to Asia from the OECD in recent years.

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James Gooder: Hello, and welcome to another edition of "The Crude Report." This is a regular podcast in which Argus media's specialists give a view of what's happening in the world of crude oil. And very pleased today to welcome Tom Reed back to the pod.

His responsibility is China. He's the editor of the "Argus China Petroleum" report, which I hope you all received. Let's get straight into it. Lockdowns are the theme. Much of the world, of course, is putting Covid behind it, whatever the reality of the level of infection is.

But Covid lockdowns threatening to crush Chinese short-term oil consumption, adding just another layer of complexity to a market, which has been plagued by sky-high prices in the wake of the sanctions and other effects of the Russia, Ukraine conflict. I mean, some 200-million Chinese oil consumers were put under mobility restrictions of varying severity this month.

China's facing its most significant spike in Covid cases since early 2020. This threats to eliminate a large component of the pool factor that has in recent years shifted the center of oil demand growth to Asia from the traditional OECD developed economies.

So, Tom, Covid looks like it's not over after all? The rest of the world is lifting its travel restrictions, but China's gone back to the status quo ante of widespread lockdowns and a drop in oil demand as a result. Give us a rundown on what's going on.

Tom Reed: Thanks, James. So, what we've seen in March is a renewal of lockdowns. And as you say, it's affecting cities with a population of a combined 200 million or so; pretty extensive. And I think to a large extent, China's really a victim of its own success here, you know.

The first lockdown they put in place in 2020 was famously successful. I mean, it was very stringently applied, and it was very rigorously enforced, and it managed to keep Covid out until now. And that's come to be seen to a large extent as being a hallmark of Xi Jinping's success as a politician and a mark of his personal authority.

And this is a really important year for President Xi. At the Communist Party Congress in October or November, he's expected to seek, and I think it's fair to say, secure a third term as party leader, which is a really high, unusual move. And everything's got to be seen to be going to plan — according to his plan. And there are, as the economists like to describe them, growing headwinds.

But, so the problem is, of course, the dominant Omicron strains are far more transmissible than the original variant, which China was so successful at containing. Omicron's far harder to stamp out. And so they are putting in place pretty stringent restrictions. Again, people in Shanghai, for example, have been confined to their homes for four days.

We've seen panic-buying groceries, online shopping websites crash, and a lot of, you know, truck drivers charged with breaching lockdown rules, and that sort of thing. But at the same time, China is trying to nuance what it's doing.

They got quite a lot of grief in December when they locked down the city of Xi'an in Shaanxi province. And there was a lot of, like, social anger over how that was handled. So it's aiming to do things a little more tactfully this time: locking down discrete districts of the city rather than the entire place, and locking down for shorter periods of time, rather than just blanket month-long shutdowns, while it carries out mass testing.

And the goal here is kind of ambitiously — I think — given the rate of transmission, to test faster than the virus can spread, and this is all having a big impact on oil demand.

I think a lot of people in the market expect, or at least they would hope, that the current outbreak is brought under control by May. But according to our estimates that we were doing in the report that you just mentioned, we reckon gasoline demand in March-April, will contract by 150,000 b/d. We think there's gonna be a full-year loss to oil demand of around 80,000 b/d, albeit, most of it concentrated, or loaded, into March-April.

This is all led to a big drop in crude buying on the spot market. And that's encouraged refiners to bring forward the maintenance programs that, you know, typically happen in spring, but are maybe now happening in March-April more than April-May. And we think also refinery runs, again, a fall quite steeply as a result of this drop in fuel demand. So our surveys have refinery runs in China falling by 300,000 b/d in March versus February.

James: It's quite an impact, isn't it? And, you know, your description of what's happening in China now makes me quite nostalgic for the early months of 2020. Let's talk a little bit about, you know, China and Russia. I mean, one of the key relationships here, and a lot of people are wondering just exactly, given much of the world's response to Russia's actions in Ukraine how China, is still kind of enigmatic on this point.

I mean, going back to February, not that long ago, President Xi and Putin were saying that there were “no limits” to the two countries' friendship. And of course, Russian oil is extremely cheap at the moment. We have Russian crude, Urals crude delivered into Northwest Europe at more than $31 below North Sea Dated, this is below the regional benchmark, $31 when prices are about $100 — so there’s a significant difference there. We really have two oil markets running separately.

Now, of course, Urals crude continues to flow into European refineries through term contracts, but gradually they're gonna be wound down. And certainly in the publicly declared spot markets, no one in Europe and certainly no one in the United States is touching this Russian crude, and yet it continues to be exported.

So India has been a significant buyer; has bought more in the past month than it did in the whole of last year, I think, or thereabouts. But as for China, I mean, is China not also in a position to benefit from these very cheap supplies of Russian crude? I mean, many countries won't touch it, but China potentially could. So even though demand may be down, there could be some large margin to be made.

Tom: Absolutely, you would think so, wouldn't you? You would think given the proximity, politically, that the two countries have, and given China's own attitude to...if not the conflict in Ukraine, then certainly the Western response, which it says just displays a cold war mentality, that there would be some kind of economic or commercial rapprochement over very cheap crude oil.

But there's a lot of caution, particularly, from Chinese state-owned companies about their exposure to those Western-led sanctions. And it's worth pointing out that despite the friendship and despite Beijing's concerns about NATO, the whole situation in Ukraine, I think is almost certainly seen as highly costly and highly irrational in terms of, certainly, Beijing's economic interest.

You know, there's a lot of kind of, "What?" So while it's certainly possible that a lot of demand from Russian crude has gone underground since sanctions were announced or even is relatively visible (as you mentioned, in the case of India), I actually rather doubt that Chinese firms are buying on the scale that many had expected.

And I think that's particularly true of Urals crude, where there is a relatively high degree of visibility, maybe in Northwest Europe. It's possible we might see Chinese refiners snapping up super cheap ESPO Blend crude in North-East Asia, where there's another huge spot market for Russian crude around the ports of Kozmino and Qingdao — and the actors in that market are perhaps less well known than, say, Shell is in Northwest Europe.

But so far that doesn't really seem to be happening. It could simply be that refiners are waiting to see just how low spot prices can go before they come back into that market for Russian crude. There's been a thriving trade in crude of Iranian origin for some time now in the Chinese market.

It could simply be that Russian crude appears to be more expensive than Iranian crude for now. But there are also these bottlenecks that, while the Russian producers, you know, really want to export and the refiners in China would very much like to have cheap crude, there's a lack of intermediaries prepared to buy from Russia and sell to China. And that's really, what's kind of clogging up, I suppose, that mechanism at the moment.

James: Yeah. I think a lot of this stuff is still working its way through. I mean, there has become a route to market for Iranian crude, let's say, which has become established during the period of sanctions against that country and everything with Russian crude, which of course, you know, one of the top three producers in the world, it's a huge impact. And the re-routing of some of these is still underway, I guess.

But as you said, there is an impact on demand from the new lockdowns or the new restrictions in China, but there, just as everywhere, crude stocks are low. We've had an extremely backwardated market where current prices are much higher than those further forward.

So there's been a very low incentive to buy and store crude: if anything, to avoid high prices in the short term, people have been bringing crude out of storage. So given now that Asian spot markets are trading for cargos to be arriving in May or June, if, as you suggested, its aim is if China managed to get the current manifestation of the Covid epidemic under control by May, where will it get the crude it will need to run its refineries in the second quarter of this year, if not from Russia?

Tom: So far, what we've seen, as we've seen elsewhere, I think, in times of panic, is a flight to safety, and currency markets obviously that tends to be in the U.S. Dollar — in crude markets, that means Saudi Arabia. So we did see Chinese refiners buy vast amounts of Saudi crude for May delivery in the immediate aftermath of the invasion of Ukraine.

They piled into the market that they were keen, secure supplies of Saudi crude before their European competitors, who most certainly are shunning Russian crude, could get there first. But I think high prices are generally starting to constrain demand. China is at the end of a very long global oil supply chain, it takes 60, 70 days to send crude to China from the North Sea or from the U.S.

And when markets are in backwardation, as you mentioned, they are, that puts Chinese refiners at a huge disadvantage because it becomes very costly to send crude from the Atlantic base in the east. And spot market differentials in China have to rise to compensate for that big spread between prompt and forward prices.

And we are seeing refiners really discouraged by these spot premiums, which are at record high levels of, like, $10-12/bl. And of course, they have quite bad refining margins. And we are also seeing at the other end of that spectrum, Chinese consumers increasingly inclined to drive less or fill up their cars less just because gasoline's so expensive.

In China, regular gasoline costs more than it does in America. It's around $4.50 per U.S. gallon, in China, currently (the Yuan equivalent). But of course, in China, household disposable incomes are far lower. It's 10% of what it is in America and wage growth has been slowing since the pandemic. So I think we are starting to see demand erosion as a result of these various problems of high prices and the Covid controls.

James: Indeed. Well, Tom, it's been fascinating. Thanks very much for your insights. I won't ask you to give away any more of your treasures because anybody listening needs to get their latest copy of "Argus China Petroleum" and read all about it. But thanks very much for joining in the podcast today.

Tom: Thank you, James.

James: And thank you very much to everybody that's listening. So it's been a pleasure as ever. Keep listening and keep following all of the developments of the market in the "Argus Crude Report." Thanks very much.

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