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China's Oil Demand Not Off A Cliff, US Rate Hike May Have Bigger Pricing Impact

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Downward revisions to oil price forecasts seem to be the order of the day, with decreasing confidence in a quick rebound, a stronger dollar and China spooking the market. It does not help that oil benchmarks remain poster futures contracts of a wider commodities market struggling with its worst erosion of gains in recent memory.

Any hedge fund manager worth his or her investment portfolio would tell you commodities are the worst performing asset class nearly eight months into 2015. Over-assetized black gold is back to summer 2005 levels in dollar adjusted terms, over a short space of 13 months since July 2014, when the oil price decline began.

Several banks and brokerage firms have issued bearish revisions to previously published forecasts in recent weeks. For the sake of reference, I have picked up what ratings agency Moody’s and the US Energy Information Administration noted on 7 August and 17 August respectively.

Moody's lowered its 2015 price assumption for Brent to $55 from $60 per barrel, and for the WTI to $50 from $55 per barrel to “reflect increases in oil production coupled with muted demand.”

Meanwhile, the EIA forecast that Brent will average $54 per barrel in 2015 and $59 in 2016; $6 and $8 lower than its July projection, respectively. It also projected WTI prices in both 2015 and 2016 to average $5 per barrel less than the Brent price.

Both broadly similar projections, along with a plethora of revised forecasts from Wall Street and the City of London, factor in two major influences. The first being a US interest rate hike, with chatter turning to ‘when’ rather than ‘if’ and some opining that a September move was a done deal. Should US Federal Reserve Chair Janet Yellen & Co move sooner rather than later, it would strengthen an already strong dollar – the denomination of choice for the oil markets.

This ‘inevitable eventuality’ is as exciting as it is confusing, but one that both oil producers and consumers can do little about. We were last here was when a financial tsunami was sweeping the world in 2008, the Fed was cutting rates and a demand slump was seen dragging the oil price lower.

Now the Fed is in a mood to raise rates and its oversupply rather than a dramatic demand slump that is largely dragging futures lower. Linear logic is that a stronger dollar would hold the price down longer than many long-callers would like.

Second influence, whether you deem it to be exaggerated or not, is China. The world’s largest importer of crude oil is seeing a correction. Statisticians in Beijing still maintain the country is growing at 7%, but beyond China’s borders not many are buying that. Some in the City reckon Chinese GDP could be as low as 4.5%.

It’s the unpredictability of how much oil China would import that has knocked market confidence to a large degree, especially as the likes of Iran join others, within and beyond OPEC, vying for Beijing’s attention. Some pessimism over China’s oil importation levels is warranted but outright alarm of the kind currently on display is daft.

If for argument’s sake China’s economy grows at 0.0% from here on till the year-end, it does not mean industrial production would come to a standstill. In fact, the country would still be importing at 2011-12 levels. Such a phenomenal growth over the last decade was bound to see a correction.

Anecdotal evidence on why the market is so spooked points to Chinese customs data recorded in May which indicated that oil imports had dropped to a 19-month low. With no movement in sight from OPEC in June, few saw little reason other than to short. Iran’s nuclear settlement further unsettled an oversupplied market which paid little attention to China’s June data pointing to a 31% month-on-month increase to 7.176 million barrels per day (bpd).

This is broadly the level China’s imports are expected to lurk around unless there is a complete crisis of confidence, and we aren’t there yet. Additionally, China is also a major regional exporter of refined oil products and almost always imports more than it needs.

The country’s net exports of gasoline, diesel and jet kerosene rebounded strongly over the first six months of the year, with combined net export volumes up to a record 529,000 bpd in June from 233,000 bpd in January. Beijing also stores crude oil for strategic purposes, data on which is rarely released.

So is the situation really that bad? Not quite, and the yuan’s recent devaluation by China is unlikely to have much of an impact on oil imports if you compare the massive amount by which crude has fallen dwarfing the currency’s staged depreciation.

Barclays macroeconomists predict 6.8% GDP growth for full-year 2015 and 6.6% for 2016. Chi Zhang, an analyst at the bank, said, “On that basis, we forecast that China’s oil demand will grow by 390,000 bpd in 2015 and 310,000 bpd in 2016 on the weakening macroeconomic momentum. Further government fiscal stimulus with a focus on infrastructure investment and some GDP uplift associated with yuan depreciation pose upside risks.”

Whichever way you look at the situation, China was, is and will remain a significant buyer in the oil markets. Concurrently, obsession over what China imports or doesn’t is somewhat clouding what India and South Korea might do. The Koreans have a $10 billion economic stimulus to contend with, while India is growing at 7% and is working on its plans for a US-style strategic petroleum reserve while pressurizing OPEC for more favorable terms.

Few believe in the prospect of an immediate price recovery, though many agree with me that a $60 per barrel average Brent price is around par come the end of the year with the caveat of Fed Sept hike attached, and that 2016-17 futures look undervalued.

Agreed, there is little the oil market can do but brace itself for a stronger dollar in wake of a possible US interest rate hike, but overt short-calling singularly premised on China does not quite cut it for me. Just as the supply correction story has some distance to go, demand side is likely to see a few twists and turns too, and not necessarily for the worse.

Follow the author on Twitter @The_Oilholic

The above commentary is meant to stimulate discussion based on the author’s opinion and analysis. It is not solicitation, recommendation or investment advice to trade oil and gas futures, options or products. Oil and gas markets can be highly volatile and opinions in the sector may change instantaneously and without notice.