Oil Faces Steep Downside Risk From China’s Stock Market

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By Nick Cunningham, a Washington DC-based writer on energy and environmental issues. You can follow him on twitter at @nickcunningham1. Originally published at OilPrice

Oil markets face a lot of downside risk – high crude oil inventories in both the U.S. and Europe, resilient production from U.S. shale, increasing output from OPEC, a nuclear deal with Iran, the turmoil in Greece – but one has not yet percolated through the markets just yet: the possibility of economic cracks in China, the largest oil importer in the world.

China’s economic growth has been cooling in recent years, with 2014 marking its slowest GDP growth rate in a quarter century. But that doesn’t signal anything is amiss. It is entirely unsurprising that the world’s second largest economy cannot keep up such a blistering rate of expansion.

However, deeper warning signs are starting to emerge. Part of that has to do with the extraordinary run up in China’s stock market over the past year, which is increasingly looking like a bubble starting to pop. The Shanghai Composite, an index of all stocks traded on the Shanghai Stock Exchange, had spiked by 40 percent so far this year and has doubled from mid-2014, and the Shenzhen Composite surged by a jaw dropping 90 percent since the beginning of 2015.

But the retreat could be on. China’s Shanghai Composite has plummeted over the past two weeks, falling around 25 percent. Fears that the bubble is popping appear to be spreading. Since June 12, the two exchanges have seen $2 trillion in market capitalization go up in smoke. The government has intervened, cutting interest rates authorizing state pensions to invest in stocks, allowing for nearly $100 billion to flow into the exchanges. That appeared to calm the markets as of June 30, which closed up nearly 5 percent.

Despite the rebound, China’s stock exchanges have suddenly been hit by extraordinary volatility – monthly trading volumes exceed six times the value of China’s $10 trillion market cap. The selloff is likely not over yet, and as concerns that the stock market is becoming detached from China’s slowing economy start to sink in, volatility will likely continue.

What happens next is unclear, but if China leans more towards a “hard” rather than “soft landing,” that would have negative repercussions for energy markets. Cracks that turn into wider fissures in the Chinese economy could lead to weaker demand for oil and gas, pushing down prices.

Dangers from China’s volatile stock market come on top of some warning signs about Chinese energy demand. A new report from the Australian government raises concerns over China’s tepid demand for LNG, of which Australia is one of the world’s top producers. China’s LNG consumption was expected to grow by more than 50 percent between 2014 and 2016, but “downside risks appear to be growing,” the report finds.

Much of that has to do with increased pipeline capacity from Central Asia, along with growing renewable energy, but weak demand stemming from a slowing economy is also contributing. For the first time since 2006, China imported less LNG in the first quarter of 2015 compared to the same quarter in the year prior.

Even China’s level of oil imports have looked shaky, before the latest market turmoil. In April, China’s oil imports hit a record high, but in May it dropped by 11 percent from a year earlier. Moreover, its imports could be temporarily elevated due to the government stockpiling oil for its strategic reserve. Once it stops buying for the reserve, its appetite could abate. China’s growth in oil demand has already started leveling off in recent years.

To be sure, the long-term fundamentals for China are compelling. China’s demand for oil and gas will likely rise steadily in the years ahead. And even in the short-term, the Chinese government could paper over the financial mess, putting a band aid on the problem. It has shown a willingness to actively intervene and further government stimulus in an effort to stop the freefall could inflate prices temporarily.

But the market turmoil in China presents a significant risk to global energy prices.

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  1. Chauncey Gardiner

    View decreasing oil prices as a short-term positive due to lower prices at the pump and ripple effects in the broader economy, but a longer-term negative due to probable effect of causing deferral of development of renewable energy sources.

    WRT to the latter issue, in casual conversation last weekend with the plant manager of a U.S. facility that manufactures materials for solar units, he mentioned that China imposes a 59% tariff on imports of their products.

    1. MyLessThanPrimeBeef

      If demand is persistently weak due to less consumption, the prices will remain down and it’s still not a bad thing long term.

  2. Dan Lynch

    The Sauds set the price of oil, so the price will be whatever the Sauds want it to be.

    But I’m sure the Sauds factor in Chinese demand when developing their price strategy.

    1. Synoia

      And the Saudis want to ruin oil-from-fracking in the US, oil-from-tar-sands in Canada, and probably would like Russia to join OPEC.

      The Saudis may succeed at the first two. How much they offer Russia to join OPEC is a matter of speculation. Russia’s price could be for the Saudi’s to stop funding Jihadists in the Muslim belt across Asia, and in that objective would have the support of the China.

      Otherwise Russia will try to crush the Saudis as reliable suppliers to China.

  3. Fair Economist

    I don’t think the stock market *itself* is going to make a big difference in oil prices. Stock markets are mostly casinos, and they go up and down all the time without much effect on the economy. Now a stock market crash can be a symptom of underlying fundamental problems and those could have an effect on oil prices – and even bigger effects on thing like ore prices where China is the most important market by far.

  4. tegnost

    I’m interested in seeing this play out, seems like the hard/soft landing discussion has been in the background for a while now, years maybe? I still believe demand is soft, the new payroll numbers being meh and lots of part time to boot, i worked part time in high school but i don’t think that is the part time dynamic anymore….

    1. Michael

      Its is not that dynamic anymore. I was watching the news the other day while getting my tires changed. I normally do not watch news from the corporate media. They were extolling the benefits of Amazon moving into the area. It may have been Middleton, NJ. The 1300+ part-time and full-time jobs at the warehouse brought out 10,000+ to their job fair. People reading NC know that Amazon is an abusive employer. Discussing their plant as a boon to the local economy is….not sure how to phrase it with out using foul language.
      Aldi a supermarket chain had a job fair that brought out 100s for a few openings that pay 11.25 an hour. I’m back in school so I went to apply at my local Aldi. Their employees are expected to act as cashiers, stock the shelves, and be janitors during their shifts. It is no surprise that they have trouble keeping employees. The work is hard but they pay more than other local supermarkets. Its owned by Trader Joes which has a similar model but TJ has more employees per store.
      In my area it is hard to find full time employment if you do not have a bio-tech, IT (kind of), or finance background. Mechanical jobs are available but they require years of experience and/or certificates. Landing a part-time to full-time job at a factory is difficult since the employers expect the applicant to cover all shifts. There are a smattering of jobs linked to health care but those are pretty brutal to land unless you know someone at the company. I am not counting retail. I live minutes from one of the biggest malls in America and there are still 2 malls that are close by plus those awful big box store complexes. I do not know anyone working in retail anymore.
      I’m starting to see houses go up for sale in my old neighborhood. I would see maybe 2 per year now I’ll see 3-4 a month sometimes more. I think the cracks in the economy are starting to hit suburban Philly.
      I don’t have data for any of that. Just what I see around town.

  5. Ishmael

    I was reading yesterday that the Chinese govt is letting positions under water to their margin debt be rolled over. I am like WTF! Talk about letting losses snow ball. However, the Chinese govt does not want to trigger a total collapse of their stock market by having margin positions called.

    Margin positions in China are leveraged far more than the US and retail investors could have margin positions on top of margin positions leading to retail investors have leverage of 10 to 1 or more.

    This baby is going to leave a mark.

    So how is that Chinese central planning working out!

    1. MyLessThanPrimeBeef

      Could be another humanitarian crisis unless those 90 plus year old gambl, sorry, investors are rescued.

  6. Larry

    I was rather shocked to read about the government dumping $100 billion of pension money into the stock market to stabliize it. Good lord, that seems like a great way to vaporize some pension money, but hey, as long as it lets the correct class of people maintain their paper wealth/exit the market on good terms. I wonder how much the Communist leadership has tied up in cratering markets?

    1. Synoia

      I wonder how much the Communist leadership has tied up in cratering markets?

      Everything, starting at the last Solyent Peasant.

    2. b

      Leverage on top of leverage, “letting positions underwater to their margin debt be rolled over”, $100 billion of pension money being dumped into the market.

      Hmmmm, aren’t these types of things only done in desperation? Is this all about saving face, not wanting to be the first large country to go down in flames, or are the elite trying to bail themselves out of all their property debt?

      The little serf is going to get crushed.

  7. H. Alexander Ivey

    The problem with this posting, as with most postings about stock markets, is the belief that there is not a market setter, no one or a small group of people who can influence the price of a stock or of a market. The posting acts as if the “stock market” – US, China, HK, whoever, is supported by little old ladies, day traders, widows and orphans, fair to Midland traders, as well as the sharpies in NYC Wall Street.

    But that assumption is just wrong. The stock markets now reflect the influence by “non-fundamentals” – political inputs, insider trading and profiting, and out and out fraud. So my thesis is the ups and downs of a market is due to direct manipulation by financial types, not by the actions of producers and consumers.

    If this is true (and I dare you, dare you, to prove me wrong – snicker), then we should read the markets to show us what the financials and their power brokers think should be happening in their world. And remember, actions in their world has serious repercussions for the rest of the world.

  8. backwardsevolution

    “China is crashing (again); the Shanghai is off another 4+%.

    That’s about a 30% decline, more or less…. and it appears it’s not slowing down either.

    Naw, it won’t come over here; this is a totally-isolated incident……

    Ah, there’s the fireworks!”


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