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Navigating the ‘oil’ uncertainty

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China is the world's largest consumer of oil, therefore an increase in Chinese demand might help oil prices

After decreasing between 6% to 7%, the oil price is now having a domino effect on energy companies, with European and American goliaths feeling the heat. Crude oil prices have reached their lowest levels since December 2021. The United States benchmark price fell by 6% to $67.48 per barrel, the highest since July 2012. The price of benchmark Brent Crude adopted a similar pattern as it dropped to a low of $71.46 per barrel.

Even though paying less for gas may be beneficial, the market impact goes beyond just decreased consumer pricing. The global economy is affected in a rippling manner by changes in oil prices. One of the biggest casualties is the oil industry itself. The stakeholders’ profit margins go down significantly as they sell their products for less money, resulting in job losses, output decrease or possibly bankruptcy. It encompasses both the oil companies and the countries whose economies heavily rely on oil exports.

In response to the failure of two prestigious American banks, Silicon Valley Bank and Signature Bank, oil prices fell in the first quarter of 2023. Investors are in a difficult position too. The fear about the impact of this banking sector crisis spreading to the wider financial sector caused hefty projections for oil demand to be quashed. Analysts are now cautioning that the oil market will be “locked in a surplus for most of the first half of the year” because of persistent “contagion” risks brought on by the turmoil in the banking sector.

The US inflation rate, since 2022, reached its highest level in 40 years as a result of the sanctions placed on Moscow amid the Ukraine war. To combat this, the Federal Reserve increased interest rates to their highest level since 2007. Although the inflation has come down below 4%, there are talks around further rate increases, even though some have projected that the banking crisis would likely end shortly and that the oil price would rebound too. The impact of the interest rate rises is also difficult to forecast and may continue to draw attention to specific financial market segments as well as vulnerabilities brought on by excessive debt and stretched asset valuations.

Low oil prices may be tough for nations that export it, but the phenomenon will be manageable, according to a WEF analysis, because “with price changes, there is a shift in profiting between oil-producing and oil-consuming countries.”

To mitigate the effects on their economies, oil exporting nations will go for options like reducing government spending, boosting taxes, ending subsidies, and implementing measures to tighten the financial system like hiking interest rates.

In addition, the US CPI has significantly grown, placing stress on the economy at a time when the Federal Reserve is already grappling with inflation among banking issues. If the Federal Reserve lowers interest and inflation rates, the oil market may recover. However, it appears that the market is currently either bracing for a future recession or that one or more funds are being forced to raise cash and reduce risk on their books as a result of worries about liquidity in the wake of bank collapses.

Tracing the ‘hope’

Large investors like Warren Buffet, who boosted his investment in the oil business Occidental Petroleum. are drawn to lower oil prices. Buffett’s company Berkshire Hathaway now owns a 22.2% stake in the corporation as a result of the most recent acquisitions. It has purchased more than 200 million shares worth $12.2 billion. The Chinese market will likely be the source of demand in 2023.

China is the world’s largest consumer of oil, therefore an increase in Chinese demand might help oil prices. The International Energy Agency (IEA) predicted a two million barrel daily rise in oil demand by 2023. The IEA Executive Director asserted that “With the Chinese economy now recovering, it will have major implications for oil and gas market balances.” The OECD has also increased its projection for world economic growth by 0.2% points, from 2.2% in November to 2.6% this year and 2.9% in 2024.

China’s recovery

Despite the upward revision of growth projections, the OECD issued a warning that the recovery is still fragile and that the risks are still disproportionately to the downside. According to customs statistics, China’s crude oil imports dropped 18.8% to the lowest daily rate since January in July 2023 as major exporters reduced their international exports and domestic reserves kept growing.

The largest oil importer in the world imported 10.29 million barrels per day (bpd) of crude in July, according to figures from the General Administration of Customs.

The second-highest import volume on record was reached in June at 12.67 million bpd.

However, despite China’s economy being severely impacted by widespread COVID outbreaks and massive lockdowns a year earlier, oil imports were 17% greater than the 8.79 million bpd brought in at that time.

Some 325.8 million metric tons of crude were imported during the first seven months of the year, an increase of 12.4% from the same time in 2022.

“The (month-on-month) decline was led by lower imports from the big-3 crude exporters, namely the U.S., Saudi Arabia, and Russia, which have cut exports amid reduced production targets and/or higher domestic demand,” said Emma Li, a China crude oil analyst at Vortexa in Singapore.

Li pointed out that at the end of July, China’s onshore crude oil inventories were over 1.02 billion barrels, and that the steady increase in those stockpiles would enable Chinese refiners to reduce their imports in the months to come.

Despite the overall decrease in imports, data from consultancy Zhuochuang showed that state-owned refineries increased their processing rates in July to an average of 78%–82%, up 2-3% points from June.

The need for summer travel had been predicted to increase gasoline usage.

According to data from the Longzhong consultancy, domestic diesel inventories increased by around 2% while domestic gasoline inventories decreased by about 3% between mid-June and mid-July as sluggish export volumes and a downturn in the real estate industry continued to dampen demand.

Chinese oil product exports increased in July as a result of better fuel profit margins in Asia, which also supported higher processing rates.

Exports of refined petroleum increased in July 2023 from 4.51 million metric tons the month before by 55.8% to 5.31 million metric tons.

Some 10.31 million metric tons of natural gas were imported into China in July, an increase of 18.5% from 8.7 million a year earlier when importers reduced spot purchases due to high liquefied natural gas prices around the world.

In conclusion, the oil market is currently facing a complex web of factors that are influencing its dynamics.

The impact of the price fluctuations extends beyond the pump. Many oil businesses, especially those heavily reliant on higher oil prices, are grappling with reduced profits, potential job losses, decreased output, and even the threat of bankruptcy. The banking crisis and uncertainty in the financial sector have further exacerbated the situation, leading to cautious projections for oil demand and market surplus.

The broader economy is also feeling the effects, with the US Federal Reserve raising interest rates to counterbalance inflation. This move, however, brings its own set of uncertainties and potential repercussions, including impacts on specific financial segments and vulnerabilities arising from debt and asset valuations.

Amid the challenges, there are glimmers of hope. Key investors like Warren Buffet see opportunity in lower oil prices, and the recovery of the Chinese economy, as the world’s largest oil consumer, holds promise for increased oil demand. The International Energy Agency’s projection of a rise in oil demand by 2023, driven by China’s recovery, suggests a potential positive shift in the market.

However, caution remains. The recovery is still fragile, as evidenced by China’s cautious oil import trends and the ongoing risks associated with the pandemic. The world economy’s growth projections have been revised upwards, yet the OECD emphasises that the downside risks remain significant.

In this intricate landscape, the oil market’s future trajectory remains uncertain. It will likely depend on a delicate balance between geopolitical events, economic recovery, investor sentiment, and government policies. While challenges persist, the interplay of various factors also presents opportunities for adaptation, innovation, and growth across industries and economies.

Despite all the encouraging indicators, there is still a lot of uncertainty over the future of the oil industry, the recovery of China, the implications of the ongoing Ukraine conflict, and the geopolitical environment as a whole. It’s a waiting game, at least for the moment.

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