Chinese Demand – not Situation in Middle East – Acts as Main Factor Balancing Supply-Demand of Crude

Crude oil futures retested its highs not seen since October 2014 after Saudi Arabia retaliated for yesterday's deadly attack on United Arab Emirates' petroleum facilities and an airport that Houthi forces in Yemen claimed responsibility for. Riyadh's assault reportedly led to at least 23 deaths, including a number of civilians, seemingly causing concern among global oil market participants that the conflict could escalate further and result in more instability in the oil-rich Middle East.

The main question is whether oil has other reasons to be able to continue to rally once this event won’t play its pricing role any longer.

OPEC+ has been maintaining its production cut by 9.7 million barrels per day since May last year due to lower oil demand caused by the coronavirus pandemic. However, since August 2021, the cartel has increased production by 400K barrels per day monthly, hoping to return to previous levels by the end of September 2022.

However, October brought new demand constraints caused by discovery of the Omicron virus of Covid. OPEC+ has been profoundly slow to react to these new challenges and decided not to act preventively, which was a big drag on oil prices. In late December the Brent crude oil declined to its minimum not seen since September, around $68/bbl, but ever since the commodity has been forming a contrarian upward trend.

On Thursday, statistics on EIA weekly oil inventories in the U.S. is expected. During the week to January 7, commercial stocks in the country fell to the lowest level since October 2018.

The key missing component in forecasting oil prices in 2022 is China. China declared a zero Covid tolerance policy recently, which means periods of strict lockdowns when many domestic productions will be temporarily shut down, are obvious to expect. On the other hand, China has been actively rebuilding its oil stockpiles lately, which means any such slow periods could be compensated by increased oil purchases later on.

The data issued by the National Statics Bureau on Monday showed China produced 198.98 million metric tons of crude oil (3.9796 million barrels per day) in 2021, up 2.4% YoY. However, it failed to end the year on a high, with the 16.47 million tons produced in December down 1.7% from the same month in 2020. While output was up, China's crude oil imports fell 5.4% YoY to 512.98 million tons (10.2596 million bpd), which was partly a result of robust oil prices, which has to some extent slowed the influx of foreign oil.

The NSB said that Brent crude was $77.24 per barrel on Free on Board (FOB) basis on December 31 last year, up 9% from the end of November.

The bottom line of the whole story is that significant oil price increases are unlikely, since they result in slowing China’s crude imports. At the same time, protracted price declines seen in 2020 at the peak of the pandemic, aren’t also our base case scenario, because such episodes would resume China’s doubling down on crude imports into the strategic stockpiles.

According to the forecast of Goldman Sachs analysts, quoted by the Wall Street Journal, in 2023 Brent oil prices could average $105 per barrel. Analysts believe that higher prices are necessary to balance the oil market.