Are Analysts Underestimating Chinese Oil Demand?

China's annual session of the National People's Congress (NPC) last week set an annual economic growth target that - at 'above 6 per cent' - looks conservative to many and, as such, it is likely that the country's demand for oil will be significantly higher than is implied in the growth figure. "The soft economic growth target is a really low bar considering that annual growth prints will be boosted by favourable base effects," Eugenia Victorino, head of Asia strategy for SEB in Singapore told OilPrice.com last week. "China's GDP growth is likely to come in around 15-17 per cent year-on-year [y-o-y] in Q1…and we expect output to rise by 8.0 per cent year-on-year this year," she added.

Having recovered from the height of the COVID-19 pandemic in 2020 much quicker than any other major global economy, China is now in a position to scale back its wide-ranging policy support connected to ensuring a sound baseline of economic growth but is unlikely to completely withdraw it. Beijing has already narrowed the deficit for the central government budget to 3.2 per cent of GDP from the 3.6 cap imposed in 2020, although this new target for the budget deficit remains slightly higher than the average historical ceiling of 3 per cent. In addition, underlined Victorino, the quota set for special local government bonds, which supplement the central government deficit, was cut to RMB3.65 trillion from the pandemic-boosted allocation of RMB 3.75 trillion last year. "We estimate the broad deficit in 2021 to narrow to 6.4 per cent of GDP from 8.4 per cent last year but even as the government's monetary stance gradually dials back support it will still avoid a sharp reversal in policy," she concluded.

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Politically, this 'above 6 per cent' economic growth target if maintained for the first two years of the 14^th 'Five Year Plan' that runs from 2021 to 2025 is in line with the leadership's long-term economic goal set in November 2020 to double the size of the economy by 2035, implying annual growth of 4.7 per cent, TS Lombard's chief China economist, Bo Zhuang, told OilPrice.com last week. "By the World Bank definition, per capita income of US$10,410 in 2019 was roughly 84 per cent of the high-income country threshold and this implies that average annual growth of around 6 per cent would enable China to pass the threshold as early as 2022," he said. "The symbolism of this would be significant politically for [China's President, General Secretary of the Chinese Communist Party, Chairman of the Central Military Commission] Xi Jinping at the start of another leadership term at the next Communist Party Congress in 2022," he added. "We think these economic growth goals are achievable, with China likely to achieve high-income status by 2022 as well," he underlined.

This will further feed into China's core policy of being geopolitically and economically independent of all other countries as soon as is practicably possible, as repeatedly stressed during October 2020's Plenum of the Communist Party Central Committee and in line with President Xi's comments on tour in the same month that: "We need to take the road of self-reliance on a higher level." However, it does not mean that China will be either unwilling or unable to fulfil the pledges it made regarding oil and other energy imports in the Phase 1 Trade Deal, as it still needs time to catch-up to the U.S. in key technological areas in which it is still heavily dependent on imports so needs to be seen to keeping its side of the deal. Making good on its promises to increase imports from the U.S. in the key areas agreed last year may also increase the likelihood of President Joe Biden to take a more conciliatory approach to the next round of trade negotiations with China rather than that which was apparent in a U.S. presidential debate when he repeated his description of the leadership in Beijing as "thugs" and vowed to "make sure China plays by the rules".

The consensus of opinion was that China's commitment to buy the additional US$52.4 billion in U.S. energy products in 2020/21 as part of the Phase 1 Trade Deal between the two countries was impossible to achieve but before this became complicated by the effects of the COVID-19 pandemic the consensus was wrong. China was, and is, fully able to purchase such a huge increase in oil and other energy products from the U.S. should it wish to do so and, depending on how the Biden administration resumes its dialogue with Beijing, such increases may be a feature of the oil market for some time. Specifically, China agreed to buy an extra US$18.5 billion of energy products in 2020 over and above the US$9.1 billion baseline of U.S. imports in 2017, and an extra US$33.9 billion in 2021. These quotas represented a doubling in 2020 of China's previous record monthly imports from the U.S. of crude oil, liquefied natural gas (LNG), and coal, and a tripling of it this year. Related: Permian Production Set To Rise Despite Shale Decline

The crude oil element of the Phase 1 deal was regarded as the most difficult of the three new energy products quotas to fulfil for two key reasons. The first was that to reach the volumes of crude oil required in Phase 1 very large crude carriers (VLCCs) would have to be utilised almost daily, which would dramatically increase the freight cost element of the final delivered crude oil price for the Chinese buyers. This final per barrel price of the delivered crude oil would be increased further because the size of VLCCs required would be too large to use the usual route via the Panama Canal for such deliveries from the U.S. Gulf Coast to Asia and would have to travel via the Horn of Africa instead. Replacing the extra 15 to 20 VLCCs needed per month needed to meet the new crude oil quotas with a greater number of smaller vessels that could travel through the Panama Canal would not meaningfully reduce the freight cost element, as each of the smaller vessels would have to pay the extremely expensive transit fee to use the Canal. The second key reason why the new crude oil quotas were regarded as the most difficult to fulfil was that logistical upheaval (and further associated cost) would result from the reconfiguration required in a sizable proportion of the refineries across China that are geared towards processing the heavier, sourer crudes of the Middle East rather than the lighter, sweeter U.S. WTI blend.

None of these considerations, however, were - or are - sufficient to pose a significant problem to the new Chinese power structure that began to emerge when Xi Jinping took over as General Secretary of the Communist Party in China in November 2012, and later as President of the People's Republic of China in March 2013. "Since then, the leadership of China has stressed the virtues of 'self-reliance' and has sought to develop relationships with global partners to make up for the ending of the 'constructive engagement' with the U.S. and its allies of the past four decades," Jonathan Fenby, chairman of the China research team at TS Lombard, in London, told OilPrice.com. In immediate practical terms, this shift in consciousness has been manifested in a broadening and deepening of the Communist Party's role across all key areas of economic management in the country, including the introduction of a directive designed to enhance the political supervision of China's state-owned enterprises (SOEs). Already accounting for 26 per cent of China's total imports, the SOE's have seen their economic role expanded in line with the 'centralisation' ethos of the Chinese Communist Party, as encapsulated in Xi Jinping's statement that: "Government, military, civilian, and academic, east, west, south, north, and centre, the [Communist] Party leads everything."

Within this context, China's approach to securing energy flows is twofold: firstly, to cultivate multi-layered relationships with countries that hold massive quantities of relatively cheap but high quality oil and gas reserves that can absolutely be relied upon for decades to provide China with such energy flows; and, secondly, to develop China's own oil and gas field reservoirs. The latter of these two strategies remains an elusive goal and in the former's case it will take time to fully integrate the oil and gas sectors of Iran and Iraq in line with the broader remit of the 25-year deal with Iran, and to build out their combined capacity to the 10 million barrels per day+ of oil alone that China has been consuming in recent years. Right now for China, then, securing its energy needs in a reliable manner - the prime consideration over and above cost - broadly requires doing just enough to placate the U.S. on the issue of Phase 1 energy imports. This includes simply ensuring that the relevant Chinese state-run - and state-directed - just absorb them as they will be ordered to do by the government, regardless of the costs involved.

By Simon Watkins for Oilprice.com

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