By John Richardson
The more oil that China imported the more it was becoming a middle class country by Western standards, was the old argument.
All of us should now understand that the China middle class story was nothing more than a myth. This helps explain the collapse of oil prices since September 2014.
Fortunately, there is some better analysis out there right now. A surge in China’s crude-oil imports up until April this year was viewed by quite a few people as partly the result of strategic stockpiling.
But the strength of oil exports up until April was also explained-away by another over-simplistic theory.
The theory was that whilst diesel demand was falling in response the slowdown in the old industrial economy, thus hurting demand for diesel used in trucks and small-scale generators etc., this did not represent a negative for China’s oil demand. Gasoline demand was said to be more than making up for this weakness as auto sales continued to boom. China’s new consumer-led economy was thought to be very quickly and smoothly replacing the old industrial-led economy.
Since April, though, China’s crude imports have slowed down – and in July they were at their lowest level since February.
Some people are now worrying that demand growth for gasoline might not be that strong after all. Their conclusion is that this means economic reforms are more painful than they originally thought – and that, perhaps, after all, the process of replacing consumption-led with investment-led growth will not be that smooth.
These two latter theories fall into the same category as the discredited myth of China becoming middle class by Western standards, virtually overnight: Over-simplifying what is a much, much complex and uncertain reality.
We instead know from the extraordinary increases in China’s diesel and gasoline exports so far this year that a lot of the oil imported to date has been re-exported as refinery products. China’s overall fuel-product exports rose by 46% year-on-year in January-July 2016.
It was therefore simply never true that you could easily argue-away the strength in oil imports as evidence of China’s booming consumer economy.
What’s the real explanation then?
China’s independently-owned “teapot” refineries have for the first time been given permission to import high quality crude, whereas before they could only import low quality fuel oil.
This has enabled them to make better quality gasoline, raising their ability to compete in the gasoline diesel market.
There were two objectives behind this government’s decision to let the teapots import crude. Firstly, it was to keep them open in order to preserve jobs. And it was secondly about placing more competitive pressure on the big state-owned refineries, which, up until the rule change, had dominated local gasoline markets.
But the state-owned refiners were facing up to this new competitive challenge as demand for diesel, as we said, tanked. Sure, the government wants to reform the state-owned enterprises in general. But it doesn’t want these reforms to inflict too much short-term pain – and it is also keen to boost export revenues across many industrial sectors in order to compensate for a weaker local economy.
The end-result has been a surge in diesel exports, as the state-owned refiners have been given the go-ahead to unload their surplus inventories in international markets.
Interestingly, China’s gasoline exports have also surged during the first few months of this year. This confounds the view of booming, and thus very tight, local gasoline markets.
Confused? If you are this is an excellent start. You have to embrace ambiguity and complexity.
What does this mean for China’s oil markets during rest of this year? Here is one scenario:
- The recent dip in crude imports is simply the result of refinery inventories being more or less full.
- Inventories will eventually be depleted and oil imports might then recover.
- This will quite obviously not be because of a renewed surge in China’s consumer-led economy.
- More crude will instead once again flow China as a means of boosting re-exports of gasoline and diesel. If economic reforms accelerate in H2 now that Xi Jinping has consolidated his political position, raising exports of refinery products could be a useful means of compensating for an even weaker economy.
What is happening in China’s oil markets, and what this means for the global oil and refinery industries, is just one example of why the world must feel that it has been turned on its head.
Regaining the right perspective requires a return to the type of scenario planning that used to be common across many businesses. The Economic Supercycle made this kind of planning unnecessary. But now that the Supercycle is over we need to rediscover these old skills.