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

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The sharp drop in crude oil prices last week on news that China had extended the Covid-19 lockdown in Chengdu, the capital of the southwestern province of Sichuan, for most of its 21 million residents, again highlighted the ability of such news to cause major sudden drops in oil prices in a market characterized by uncertain supply and demand. As the world’s largest annual gross importer of crude oil, overtaking the united states. In this regard in 2017 (having become the world’s largest net importer of total oil and other liquid fuels in 2013), China has long been the global backstop in the oil market. Between 2000 and 2014, it was almost solely responsible for the commodity price supercycle that occurred during that period. These draconian covid-related lockdowns have a direct and significant effect on China’s economic growth, which in turn affects its demand for oil, and the lockdowns are a direct function of the country’s ‘zero-covid’ policy. There is no sign that this policy will be substantially changed, let alone abandoned, any time soon. To a large extent, China’s adherence to its zero-Covid policy, in which ultra-strict lockdowns are introduced in entire cities immediately after a relatively minuscule number of Covid-19 cases are identified, has been a product of its own early success. of the country in managing the pandemic. China emerged from the first big wave of Covid-19 in the first half of 2020 in best economic way than any other major country, precisely because of its harsh handling of any outbreak of the disease, as it had failed to produce a truly effective vaccine of its own and avoided buying proven vaccines from non-domestic providers. When new massive outbreaks of Covid-19 occurred earlier this year in China and led to the closure of several major cities, oil prices fell on the prospect of reduced demand from China, but not as much as they could, given the wide La based belief that China would likely be forced to take a softer approach in its handling of Covid-19 in the near future. The previous December had seen a refinement of the zero-Covid strategy to one that incorporated the idea of ​​’dynamic cleaning’, giving local governments more flexibility in imposing restrictions, allowing daily increases in symptomatic cases to be limited to about 200 nationally. . It was thought that this number could be increased, given that in the new March outbreaks alone, 184,000 people with possible Covid symptoms had been placed under medical observation in isolation in the first two weeks of those outbreaks.

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The figure was not increased, but more optimism was raised by comments from various Chinese agencies about a possible relaxation of the covid zero rules, and then came the publication in mid-April of the Chinese Center for Disease Control and Prevention (CCDC ). ) guide that described measures for home quarantine. These would have eased the crippling effects on the economy of people having to quarantine in centralized state facilities, even if they suffer from very mild symptoms or none, having tested positive for Covid-19. However, these hopes were again dashed when, when asked for further clarification of these home quarantine procedures, the CCDC simply reiterated the previous rules. Chinese President Xi Jinping personally reiterated that: “We must adhere to scientific accuracy, zero-Covid dynamics… Persistence is victory.” As it stands now, China still does not have an effective vaccine against Covid-19, nor does it have an effective post-infection antiviral, and it still refuses to buy such supplies from non-domestic suppliers, despite repeated offers from all over the world. major producing countries to make these supplies available. Even before the Chengdu lockdown extension that added another 21 million people to the total, 44 million people in China were already in lockdown.

Then, at the end of July, all of this translated into radically reduced economic growth projections for China, with the corollary of a dampening effect on oil prices. Two of the most consistently correct analysts on China in recent years, Eugenia Fabon Victorino, head of Asia Strategy for SEB, and Rory Green, head of China and Asia research at TS Lombard, had already lowered their GDP growth estimates. for China earlier in the year. but he 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 him exclusively OilPrice.com back then that: “Local governments are still expected to stamp out domestic outbreaks as soon as possible with widespread testing, contact tracing, and quarantine policies.” She added: “[Although] the citywide closures are meant 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 opinion, and the [zero-] The covid strategy will probably result in sporadic restrictions in various parts of the country in the face of virus outbreaks.” Green, also speaking exclusively to OilPrice.com, said: “Beijing is firmly committed to zero-Covid, making more lockdowns all but inevitable for the rest of 2022.” He added: “The limitations of medical care, including the low vaccination rate and the insufficient number of hospitals and staff, combined with the policy before the Q4/22 Party Congress, and Xi is closely associated with the current Covid policy, make an end to the strict Covid restrictions unlikely. in 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 the negative economic pressures that are building up in various sectors, with consecutive cuts in its various policy interest rates. Having surprised the market with a 10 basis point (bps) cut in its 1y Medium Term Lending Facility (MLF 1y) and its 7d Reverse Repo Rate (RRP 7d), the PBOC doubled down with a cut deeper (15 bps at 4.30 percent). ) about its 5-year prime loan rate (5y LPR), highlighted SEB’s Victorino. “Deeper cuts in the 5-year LPR reflect lawmakers’ intent to stabilize the real estate sector, and the adjustment will further weigh on average mortgage rates as minimum mortgage rates are set 20 bps below the LPR at 5 years,” he said. “However, even before the latest rate cuts, financial conditions have been easing for months, and the PBOC has been guiding interbank funding lower through liquidity injections. [but] Although lower borrowing costs are designed to support credit demand, liquidity conditions have yet to put a floor on deteriorating confidence in the country,” he added. Of particular concern, in terms of broader financial disturbances in China, is the deleterious state of the real sector. “The drip feed support for the real estate sector has yet to stop the bleeding and the crisis of confidence in the real estate market continues,” Victorino told OilPrice.com. “The latest bank earnings reports have seen state-owned banks double estimates of non-performing loans related to mortgage boycotts, while China’s largest state-owned bad asset management companies have reported falling profits due to credit deteriorations. related to their exposure to the property,” he said.

The likelihood of further lockdown-related oil price shocks in the coming weeks seems high, given that the Mid-Autumn Festival holiday started on September 10 and that Golden Week (which incorporates National Day of China) 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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