Update on China's Oil Demand - Sept 23

Update on China's Oil Demand - Sept 23

Postby dan_s » Fri Sep 23, 2022 9:39 am

Notes below are from RBC Capital

September 22, 2022
Oil Strategy: Demystifying China’s Energy Roadmap

Unpacking Our Latest Thoughts on China and Implications for Physical Markets
Our Take: In this piece, we quantify the impact of the recent policy developments, highlight China’s role
as the global swing refiner and assess the scorecard for Chinese market share. An unintended
consequence of the zero COVID policy is that China has shored up energy security at the most opportune
time. China has restocked diesel while the rest of the world remains short. As such, China has and will
shield itself from the energy crisis that will continue to ripple throughout Europe this winter. The recent
announcement to increase refined product export quotas has net positive implications for physical crude
imports, but we fear that the motive for doing so has bearish read-throughs for the greater Chinese
economy. We see such as deliberate government action to lend assistance to the industrials and
manufacturing complex. Physical oil markets have softened over recent months, but policy measures
should help. We anticipate an incremental bump of 1.47 mb/d in crude imports relative to the past three
months due to China’s refined product guidance, which should support the physical crude softness.

Reading the Tea Leaves
China has done the following over the past 10 days: 1) Re-opened Chengdu, a megacity of 21 million,
following a multi-week lockdown, 2) Held talks with western COVID vaccine makers to potentially supply
the nation, and 3) Embraced a seasonally abnormal large refined product export quota of 15 million
tons. The optimist could suggest that directional arrows of progress indicate that a broader re-opening
may be in the cards, but it is important to ask whether these measures stem from a position of strength
or a position of weakness for the Chinese government. Our read is that it may be the latter. We believe
that there are near term net positives for the crude oil market, but remain concerned about what these
policy driven actions signal about the broader Chinese economy.

With the exception of last year, rarely has the oil market been strong when Chinese demand has been
weak. In fact, steadfast Chinese oil consumption growth has shielded the market during periods of
weakness over recent decades. Instead, the tables have turned over the past 18 months. The post COVID
rebound in demand and a tightening global supply framework has buoyed markets despite the Chinese
oil data trending weaker. Unless President Xi Jinping pivots to prioritize the economy over its zero COVID
policy (which some have speculated given his recent travels), following its 20th National Congress next
month, it is difficult to see the net positives for the oil market as fears of China’s mounting property
crisis intensify. Qualitative speculation could ebb constructive, but reprieve in the Chinese oil data has
been elusive. We read the recent government led increasing of refined product export quotas as an
attempt to spark economic revival. We believe that Chinese refined product storage is near full and see
raising quotas as the government opening the spigot to help stimulate the refining sector.

How We Got Here…China Snapshot So Far This Year
China has been prioritizing energy security throughout the year given that refiners had, until
recently, been running at reasonably strong rates despite draconian lockdown policies
resulting in weak end user demand and a heavy handed self-imposed refined product export
restrictions (diesel exports have fallen by nearly 75% so far this year compared 2020 levels).
The natural read through given the stagnant state of demand, curtailed product exports and
strong-enough runs throughout much of this year, is that product inventories are likely high
and full. The bottom line is that domestic refiners can only continue to run so hard, for so long
before bumping up against storage constraints given status quo weak domestic demand and
limited appetite to open the export release valve. This has been a smart policy from an energy
security perspective given that if, and when China emerges from its zero COVID policy, it will
be one of the only major economies with re-stocked diesel inventories in a world otherwise
thrust into an energy shortage, with tight diesel stocks across most of the developed world. In
short, China has been prioritizing its energy security at the most opportune time relative to
the rest of the world.

Where China is Going…
China’s manufacturing sector is struggling. Domestic refineries, the majority which are pseudo
state owned, have not capitalized on the historically high global product crack spreads seen
earlier this year given the clamp down on low government issued export quotas. Opening the
export spigot serves a multi-fold purpose. First, it provides a boost for a refining sector, which
would otherwise see utilization fall until consumer demand rebounds. Second, it gives refiners
breathing room by running down diesel inventories, which allows domestic refineries to pick
up runs and capitalize on Asian refining margins, which still trade at multi-fold the levels of
recent history.

A weakening domestic product demand picture leads to larger export quotas required to
support the refining sector. Assuming that inventories remain near maxed out and stock
change is relatively flat, such a scenario would suggest that refinery production of gasoline has
fallen 369 kb/d over the past three months. The strengthening of runs could, and should lead
to a rebound in crude imports assuming that the goal of the government is not to further
deplete crude inventories in an otherwise energy scarce world.

The bottom line is that increasing refined product export quotas has at net positive read
through for the direction of physical crude imports (naturally, the relationship between
imports and runs has a strong positive correlation – R-square of 0.88. See Figure 1), but the
motive for doing so has more bearish read-throughs for the greater Chinese economy. In fact,
what does such policy suggest about the state of the Chinese economy? We read this as
government assistance to the refining sector and lending broad support to the domestic
industrial and manufacturing sectors given the macro headwinds.

China has typically always stimulated the economy during turbulent patches, either through
financial measures or policy driven ones. One could make the argument that policy to ramp
product exports is China’s attempt to help ease Europe’s diesel shortage heading into the
winter. We put little credence in such a view. First, this does not fit with the historical Chinese
energy playbook. Second, need we remind readers that that Xi traveled to meet Putin as
recently as last week?

Quantifying Product Export Quotas and Market Implications
Given product balances for Chinese diesel and gasoline, we consider the scenario of opening
the spigot for policy driven product exports increasing and model out the degree of refinery
runs required to support such an increase in exports. This is clearly bearish for refined product
margins, or regional cracks spreads, but the incremental bump in runs required to support
increased exports is a net positive for crude demand.
Here, we estimate the incremental bump
in crude imports required to support such a flywheel.

Our regression centric modeling suggests that the ramp in product exports leads to an
incremental 550 kb/d of incremental refinery runs (this is a fancy way of saying crude demand)
relative to levels seen over the summer. Additionally, in order to support such runs, our models
indicate that Chinese crude imports will have to rebound to the 10.5 mb/d range through the
balance of the year, which implies an incremental bump of 1.47 mb/d from levels seen over
the past three months. This should help shore up the recent softness in physical markets seen
over recent months. To be clear, recent Chinese buying patterns have fallen to the lowest level
since 2018. While the incremental bump to recent import patterns is strong, reverting to 10.5
mb/d of crude imports simply pushes levels back to the range seen earlier this spring.
Dan Steffens
Energy Prospectus Group
Posts: 30137
Joined: Fri Apr 23, 2010 8:22 am

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