The oil industry’s biggest weakness is its reliance on China

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Whenever the commodity cycle reaches a trough, all eyes turn to China. Asia’s biggest powerhouse has through years of explosive growth become the top—or one of the top—importers of many commodities, leading the producers of these commodities to base their own growth strategies on China’s insatiable appetite. Nowhere is this truer than in oil and gas. And now the pandemic has bared the shaky foundation of this dependence. It could hardly be argued that China is an important factor in the oil markets. It is the second- largest consumer of crude oil—most of which it imports—and the second- largest LNG importer in the world. This has turned the country into a natural focus of growth strategies in the oil and gas industry. Every oil demand forecast and every gas demand forecast inevitably has China specifically—and Asia more generally—as the drivers of future growth.

The pandemic has not changed this. Asia, and China in particular, are still seen as drivers of future oil and gas demand growth.

The problem is, this growth will not be as robust as analysts forecast before the crisis. What is more, this growth will be delayed, potentially wreaking havoc with companies’ near-term plans.

China gobbled up millions of barrels of oil when prices fell in March and continued to fall through May. One could say with a decent degree of certainty that if it was not for China, prices would have slumped a lot lower. In that, the country shined as what some have called “the Asian tooth fairy”.

But even this tooth fairy’s storage space is finite and as global storage filled up with unsold—and unsellable—crude, so did China’s, raising questions about how long it could continue to soak up the world’s excess crude.

China’s crude oil imports over the first half of the year rose by some 10 percent from the sale period of 2019. The latest data suggests they have continued to be robust in July, even as they slipped 3 percent from June. On top of that, reports emerged that Chinese state oil companies had booked tankers for at least 20 million barrels of U.S. oil this month and next.

So far, so good. But there is always a but. In July, Bloomberg reported that China had started selling crude oil from its storage. Now, this piece of information had the potential to shake up global markets like nothing else. China, the default buyer of the world’s oil, was now selling it, after having bought it on the cheap in the spring. While the selling can hardly be called the beginning of a trend, it did represent an unforeseen event in an industry already rocked by unforeseen events this year. China is not obligated to keep buying oil at this pace forever. If it suits it, China could take advantage of the higher prices and sell this oil, in competition with the rest of the sellers.

There is a congestion of oil tankers at the moment in Chinese ports. For weeks now, according to a Wall Street Journal report, tankers have been piling up at the ports, waiting to unload in what in some cases are already full storage tanks. According to brokers that the WSJ cited, the pileup is made up of at least 80 tankers, more than half of the Very Large Crude Carriers (VLCCs), each with a capacity to ship 2 million barrels of crude. The world’s top crude oil importer seems to have nowhere to put the oil it ordered earlier this year in hopes that demand for fuel would increase quickly.

“The swift increase in imports in recent months is an optimistic sign for the global economy. However, the pace has been so quick that it has challenged the logistical capabilities of Chinese ports,” said OilX analysts earlier this month in comments on early Chinese oil import data.

Indeed, demand for oil in China rebounded quickly to about 90 percent of its pre-crisis level, but then things began to slow down, as people remained reluctant to spend amid still heightened uncertainty about the future. Although not as vital as it is for the U.S., consumer spending is an essential indicator of any economy’s recovery, so that reluctance to spend was counted towards the downward risks for oil demand.

Then there is the already present fuel glut in Asia, caused by none other than Chinese refineries. Higher oil import quotas, low oil prices, and strong pre-crisis demand led to this glut, and it came back to bite its makers with falling margins and, most recently, a wave of refinery shutdowns across Asia as demand continued to stall.

On the positive news front, there are expectations that an ambitious infrastructure spending program devised by Beijing to jumpstart the economy will push up demand for at least diesel to a record high this year.

Will that be enough to keep Chinese oil imports as strong as they were during the second half of the year? We have yet to see.

So, one of the many unpleasant truths about the modern world that the coronavirus has bared is the oil industry’s dangerously strong reliance on a single source of demand growth. Effectively, oil exporters have gotten used to putting most of their eggs in the Asian basket, and this has backfired. In all fairness, oil demand has been devastated across the world, not just in Asia. Yet the hit from Asia—and specifically China—has been particularly painful.