China’s Covid lockdowns are the biggest threat to oil markets

The sharp fall in crude oil prices over the past week on news that China had extended the Covid-19 lockdown in Chengdu, capital of southwestern Sichuan province, to the majority of its 21 million people once again underscored the capability such news causes can be large sudden drops in oil prices in a market characterized by uncertain demand and supply. As the largest annual crude oil importer in the world surpass the US. In this respect, in 2017 (after becoming the world’s largest net importer of oil and other liquid fuels in 2013), China had long been the global backstop supply in the oil market. Between 2000 and 2014, it was almost single-handedly responsible for the commodity price super cycle that took place during that period. Such draconian Covid-related lockdowns have a direct and significant impact on China’s economic growth, which in turn affects demand for oil, and the lockdowns are a direct function of the country’s “zero Covid” policy. There are no signs that this policy will be fundamentally changed or even abandoned in the foreseeable future. China’s adherence to its zero-Covid policy, which sees ultra-tight lockdowns imposed on entire cities as soon as a relatively low number of Covid-19 cases are identified, was in large part a product of the country’s own early success in dealing with it Pandemic. China emerged from the first major wave of Covid-19 in the first half of 2020 better economic health than any other major country precisely because of its harsh handling of outbreaks of the disease, having failed to produce a truly effective vaccine of its own and refraining from buying proven vaccines from foreign suppliers. As massive new outbreaks of Covid-19 emerged in China earlier this year, leading to the closure of several major cities, oil prices fell on the prospect of lower demand from China, but didn’t fall as far as they might given broad-based belief that China will likely be forced to pursue a softer approach to Covid-19 in the near future. As of last December, the zero-Covid strategy had been refined into one that incorporated the idea of ​​”dynamic clearing,” giving local governments more flexibility in imposing restrictions and allowing the daily increase in symptomatic cases to be tracked on a national basis about 200 limit . It was thought that number could be increased given that in the new outbreaks in March alone, 184,000 people with possible Covid symptoms had been placed under medical surveillance in isolation for the first two weeks of those outbreaks.

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The figure was not increased, but further optimism came from comments from several Chinese authorities about a possible relaxation of the zero-Covid rules, and then came the release of the China Center for Disease Control and Prevention (CCDC) in mid-April. ) Guide outlining home quarantine measures. These would have mitigated the economy-crippling impact of people having to quarantine in centralized government facilities even if they were suffering from very mild or no symptoms after testing positive for Covid-19. However, those hopes were dashed again when the CCDC, when asked for further clarification on these home quarantine procedures, simply repeated the previous rules. China’s President Xi Jinping then personally reiterated: “We must adhere to scientific precision, to dynamic zero Covid…Perseverance is victory.” As it stands now, China still does not have an effective vaccine against Covid-19, nor an effective post-infectious one antiviral agent, and despite repeated offers it still refuses to buy such stocks from foreign suppliers, and all major producing countries refuse to provide it with such stocks. Even before the extension of the lockdown in Chengdu, which added another 21 million people, there were already 44 million people in lockdown in China.

Back then, at the end of July, all of this had translated into radically reduced economic growth forecasts for China, with the corresponding dampening effect on oil prices. Two of the analysts who have been most consistently correct on China in recent years – Eugenia Fabon Victorino, Head of Asia Strategy at SEB, and Rory Green, Head of China and Asia Research at TS Lombard – already had their GDP growth estimates earlier in the year corrected down for China but did it again. SEB now sees China’s economic growth this year at just 3.5 percent and TS Lombard at just 2.5 percent. Victorino had told it exclusively OilPrice.com at the time: “Local governments are still expected to eliminate domestic outbreaks as quickly as possible through widespread testing, contact tracing and quarantine measures.” She added: “[Although] citywide lockdowns are to be implemented as a last resort, the policy of regular and frequent testing in major cities will keep the fear factor high in our view, and that [zero-] The Covid strategy is likely to result in sporadic restrictions in different parts of the country amid virus outbreaks.” Green, also speaking exclusively to OilPrice.com, had said, “Beijing is firmly committed to zero Covid, which means more lockdowns for the Makes the rest of 2022 almost inevitable.” He added, “Healthcare restrictions, including the low vaccination rate and insufficient number of hospitals and staff, coupled with the policies ahead of the Q4/22 Party Congress – and Xi is tight with the current one Covid policies linked – making an end to the strict Covid restrictions unlikely for the remainder of the year.” Related: Record US LNG exports to Europe may not last

Just over a week ago, the People’s Bank of China (PBOC) stepped in to try to ease negative economic pressures building up in several sectors with back-to-back cuts in its various benchmark interest rates. After surprising the market with a 10 basis point (bps) cut on its 1-year medium-term lending facility (1y MLF) and 7-day reverse repo rate (7d RRP), the PBOC doubled with a deeper cut ( 15 bps to 4.30 percent). ) on its 5-year loan prime rate (5-year LPR), highlighted SEB’s Victorino. “The deeper cuts in the 5-year LPR reflect policymakers’ intent to stabilize the real estate sector, and the adjustment will further weigh on average mortgage rates as minimum mortgage rates are set at 20 basis points below the 5-year LPR,” she said . “But even before the recent rate cuts, financial conditions had been easing for months as the PBOC turned down interbank funding through liquidity injections. [but] Although lower borrowing costs should support credit demand, liquidity conditions have yet to put a stop to deteriorating onshore confidence,” she added. Of particular concern in view of broader financial disruptions in China is the adverse state of the real sector. “Drip-feed support for the real estate sector has yet to stem the bleeding and the crisis of confidence in the real estate market continues,” Victorino told OilPrice.com. “Recent bank profit reports have shown that state-owned banks have doubled estimates of mortgage boycott-related delinquencies, while China’s largest state-owned bad asset management firms have reported falling profits due to credit shocks related to their real estate exposure,” she said.

The likelihood of more lockdown-related oil price shocks in the coming weeks seems high as the Mid-Autumn Festival holiday started on September 10 and Golden Week (including China’s National Day) begins on October 1. The Chinese government has already warned people not to travel during these upcoming major holidays.

By Simon Watkins for Oilprice.com

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