Market Forces: China's Evolution

Chinese oil buyers have long pursued a shrewd strategy of leveraging the global oil markets, scooping up discounted barrels when available and pulling out of the market when prices spike. But their tactical purchasing seems to have reached new levels of pragmatism and sophistication, covering a broader gamut of supply sources in response to price variations. Large new refineries starting up this year are expected to sharply increase China’s appetite for medium and heavy, sour crude. Chinese majors have traditionally been astute at switching their crude procurement from one grade to another, taking advantage of arbitrage opportunities and shifting market dynamics. Sinopec’s trading arm Unipec, China’s largest oil buyer, has gone from being a regular Urals buyer to only buying the Russian export blend when it sells at advantageous discounts, as it did in July-August 2020 and again in March-April this year. Refiners have fine-tuned their blending economics and opened trading desks outside Asia. With bases in Europe for more than a decade now, majors like Unipec and Chinaoil became very responsive to market dynamics in the North Sea or Mediterranean, helping to broaden China’s crude regimen. Independent refiners are also now allowed to import crude where they weren’t before, creating more opportunities for traders. From being a buyer of mainstream grades like Angolan medium, sweet or Arabian sour crude, China now routinely buys more discounted grades that its refiners can blend to specification with more expensive feedstock. Some of China's smaller refiners have also been willing to take more risks in availing themselves of cheap cargoes from distressed suppliers like Iran and Venezuela (EC Apr.16'21). The development of its storage infrastructure has, meanwhile, given China unprecedented flexibility in terms of adjusting its oil imports. Unlike other strategic petroleum reserves (SPRs), the Chinese SPR also stores refined products, giving the country flexibility to keep running crude and store products that are not sold domestically or exported. The secrecy around China's SPR makes estimating volumes difficult, but the consensus is that it is full, at around 420 million barrels of oil (PIW Jan.29'21). What is growing is commercial petroleum storage -- crude and products -- added by refiners, ports and private companies. Essentially indistinguishable from the SPR, it could add up to 150 million bbl of crude storage capacity in 2021, more than what is needed from planned refining expansions of 600,000-700,000 barrels per day this year. The Shanghai International Energy Exchange contributed at least 100 million bbl in commercial crude storage for the physical delivery of oil futures. Peak Market Power? Some traders think China is not only using its SPR in a reactive way to mitigate supply and demand imbalances, like the US, but also sometimes to capitalize on market opportunities. China has been smart about filling its SPR when crude prices tumbled, like last year. The country is structurally short by around 10 million-11 million b/d. It is refining about 14 million b/d but producing 3.8 million b/d, meaning it must import the difference. Being the biggest “short” in an oversupplied world gives China a huge competitive advantage. Its sheer market size means the country is a major, sometimes decisive factor in many physical crude markets. When oil prices hit rock bottom in April 2020, China doubled down on its May crude purchases and pursued its buying spree throughout the summer. When the prospects of an effective Covid-19 vaccination emerged in December and prices started to recover, Chinese buyers withdrew, pressing the physical market for deeper discounts. Whether this is a coordinated strategy remains hard to tell, but one thing for sure is that the rest of the market is a hostage to the country's physical buying -- or lack of it (EC Mar.12'21). Even if, historically, China has no tradition of shorting the market, by betting on lower prices, it is difficult to ignore the effects of slower Chinese oil buying: It can force crude differentials down, depress the Brent and Dubai benchmarks, and keep Brent futures rangebound. As a result, Chinese market power, which has grown for years, has only continued to expand. Will the trend continue? Some traders may credit the world's largest oil importer -- the darling of crude producers -- with more market clout than it actually has. Beijing is also pursuing its own energy transition and increasingly buying commodities like copper to support that transition, which forces it to vie harder with developed economies for resources. “Unlike previous recoveries, China is now not the dominant incremental demand force anymore as green demand has broadened the geographical impact of Western demand, too,” says Goldman Sachs. This diversification alone suggests China's market power is not boundless. Julien Mathonniere, London, and Freddie Yap and Maryelle Demongeot, Singapore