In early 2020, the Chinese economy was looking up. The government signed its ‘phase one’ trade deal with the US, instilling (some) confidence in markets, and macroeconomic support measures— introduced by Beijing in late 2019—were starting to kick in.
While the country’s GDP growth was still set to slow this year, the Chinese government’s pledge to double the size of the economy by 2020 compared with 2010 was deemed supportive for economic activity and oil demand. But then Covid-19 swept through the country, and the containment measures led to the steepest contraction of GDP on record.
Refinery runs were slashed and oil product demand plummeted, although estimates of the demand loss vary between 10pc year-on-year in Q1 2020 to as much as 30pc. China’s crude appetite remained strong, though, increasing by 0.6mn bl/d year-on-year—equivalent to Malaysia’s entire oil output. China is shaping up to be a strong source of support for the crude market, even in times of economic downturn. But China too has its limits.
Space to spare
One reason for the ongoing strength in crude arrivals has simply been timing. Cargoes were booked in Q4 2019, when refining margins were strong. Buyers were expecting an uptick in demand, especially during the Lunar New Year, which is also peak travel season. Crude cargoes kept flowing in, but few people travelled.
Even as refiners slashed throughputs, clean products as well as crude oil piled up in tanks. Product storage space is running out, but there is still some 350mn bl of crude tank space. China has physical space to absorb more crude, especially since the government has reportedly asked buyers to step up purchases and take advantage of depressed crude prices. But even China’s large storage capacity is finite, especially if product demand is slow to recover—both in China and globally—and refiners cannot clear product tank space.
Restrained growth
Crude arrivals could slow for April and May as distributors sell down products stocks during planned refinery maintenance periods. But Beijing’s liberalisation agenda will still help to bolster the crude market. The Chinese government is opening its market to non-state refiners and traders, which could previously source their feedstock only from state-owned majors.
Beijing has for several years now been awarding licences to import crude directly from international markets, but it has kept the scheme on a closely monitored leash.
This year, Beijing has front-loaded its licencing process to allow these independent refiners to capitalise on $20/bl and $30/bl oil. Independent refiners are therefore withdrawing from storage, raising runs and making room for cheaper cargoes.
But the independents, too, cannot escape the constraints of a gradual recovery in China and a sharp contraction in global activity. With limited retail outlets in China and no ability to export products, they may be bringing forward their crude buying, but they will eventually have to reduce it to compensate at some point later in the year. While state owned refiners are better placed in that they can export products, they too are bumping up against infrastructure and demand limits.
And cheap crude feedstock can go only so far to stimulate Chinese end-user refined product demand. The lower oil price does not filter through to prices at the pump as the government taxes them heavily and does not adjust them to reflect crude prices any lower than $40/bl.
Waiting game
But, more importantly, despite its efforts to reinvigorate activity, Beijing cannot magically restart the economy or oil demand. Local travel is returning only gradually, as some pandemic control measures remain in place and concerns about incomes—following the hit to jobs and industry—weigh on tourism.
International travel also remains constrained and will be limited by the ability of foreign governments to tame the spread of Covid-19. So, although oil product demand is set to recover in the second half of 2020, the sharp contraction in Q1 2020 demand—combined with the gradual nature of China’s economic recovery—suggests demand for oil products could fall from 2019 levels over 2020 as a whole.
This would be the first annual contraction in 30 years. It also means that, even though refiners are stocking up on crude now, it could at the significant expense of purchases later this year.
Michal Meidan is director of the China energy programme, Oxford Institute for Energy Studies
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