Oil Demand Destruction: A Trade War Reality

Chinese-US trade figures in August came in well below expectations illustrating the negative impact of the ongoing trade war. Chinese exports to the US in August were down 16%, while imports from the US dropped by 22%. Overall, Chinese exports fell 1% year on year, the biggest drop since June, when they slumped 1.3%.

However, Beijing and Washington have agreed to restart trade negotiations in early October with officials already attempting to lay the groundwork.

The problem is we have been here before only to see the talks break down and the US escalate the war with new tariffs, against which China then retaliates. New talks are positive, but only if they produce a positive result.

Another problem is that time has taken its toll.

Already back in June, the World Bank revised down its forecast for global GDP growth to 2.6%, creeping back up to a still meager 2.7% in 2020 and 2.8% in 2021. In early September, BP chief financial officer Brian Gilvary forecast that global oil demand would rise by less than 1 million b/d this year as consumption slows.

In its latest Short-Term Energy Outlook, the US Energy Information Administration has also cut back its forecast for growth in global liquids consumption this year from 1.0 million b/d to 0.89 million b/d. Growth in 2020 is forecast at 1.4 million b/d. This has to be set against growth in non-OPEC supply of 2.18 million b/d in 2019 and 2.21 million b/d in 2020.

Weak demand undermines OPEC's production cuts and accentuates the impact of the expected increase in non-OPEC production this year and next. OPEC is in effect swimming against the tide.

It has also now seen two consecutive monthly rises in its own production. Secondary source estimates showed an overall rise of 50,000-80,000 b/d in OPEC output in August, with Iraq again failing to comply with the organisation's agreed quotas.

Even if optimism surrounding the renewal of trade talks grows, it is increasingly likely that further supply-side restraint or unanticipated disruptions will be needed to keep the oil market steady.

False optimism?

The main reason to hope for an end to the trade war is that both the Chinese and US economies are suffering, but by how much?

US non-farm payrolls rose by 130,000 in August, below expectations and accompanied by downward revisions to previous months' data as well as being boosted by federal recruitment for the 2020 census, but the US economy is still creating jobs. The unemployment rate at 3.7% is holding steady at a very low level and the employment-population ratio is at a ten-year high of 60.9%.

Even so, the forward looking indicators for the US are deteriorating - the World Bank's forecast sees US GDP rising by 2.5% this year, but then slowing to 1.7% in 2020. US business confidence turned negative in April, suggesting that investment levels will not be sufficient to keep non-farm pay rolls on an upward trajectory.

Already suffering in the opinion polls and with the November 2020 presidential elections looming, US President Donald Trump arguably needs to act before his trade war chickens really come home to roost.

But there is little sign that Washington and Beijing are any closer to an agreement. US demands for intrusive enforcement mechanisms are highly unlikely to be conceded by China. Should the talks fail again it will serve only to underline the divisions between the US and China on the latter's industrial policies and lack of intellectual property protection.

A continuation or even further escalation of the trade war remains a plausible scenario, exacerbating the demand-side shock to oil demand of weak global trade.

Alternative reality

The argument for a resolution is that the longer the trade war goes on, the deeper the economic damage becomes and the more likely it becomes that a deal will be done. This logic appears to become increasingly compelling as the US presidential elections approach.

But it ignores the possibility that neither side will make the necessary concessions. The alternative is that US-Chinese trade antagonism becomes an enduring feature of the world economy and Trump campaigns for re-election on the basis that he will not concede on US trade interests.

A return to the pre-Trump status quo looks unlikely. A key difference under Trump is that the US no longer looks for dispute resolution through multilateral rules-based bodies, but pursues a unilateral approach, which is intrinsically less predictable.

If a deal is done, questions will remain over its stability. Either side might form the perception that the other is acting in bad faith. Trump has reshaped US-Chinese relations, making them less stable. Concessions by either side now may be seen as pragmatic, but also as unfinished business to be addressed when the time is right.