The oil market has been on a wild ride this year, with crude prices at one point rocketing to highs not seen in three years and in recent weeks, suffering record one-day plunges. The increased volatility has stoked anxiety among major producing as well as consuming countries. Within an already complicated picture, the trade war between the U.S. and China has created uncertainty on oil demand that can be neither properly analyzed nor ignored.
As geopolitical and geological issues in a handful of major oil-producing countries rapidly and unexpectedly tightened oil flows, benchmark Brent crude prices surged toward the psychologically important mark of $80 per barrel in May.
The tables were turned on the group of OPEC and non-OPEC producers, who were in a pact to restrain output till the end of 2018 as part of a continuing effort to remove excess supply.
Just as some of the producers had begun to cautiously open the spigots in June in response to pressure from major consumer countries, crude prices took a far bigger pounding than justified by the incremental flows. A new bearish factor had been suddenly thrust into the limelight -- the bubbling trade wars and their potential to crimp oil demand.
After months of saber-rattling, the U.S. and China descended into the trade battlefield on July 6, levying a 25% duty on annual imports worth $34 billion on each other. On July 10, Donald Trump’s administration raised the stakes further, threatening a 10% import duty on a long list of Chinese products, worth $200 billion in annual trade.
The next day, a shocked administration in Beijing vowed to hit back proportionately. The global financial markets took the escalation as a sign of a prolonged trade war in the making.
Brent crude dived nearly 7% on July 11, recording its biggest one-day plunge in nearly seven years. Oil wasn’t alone -- the bearishness that swept through the financial markets also hit all industrial commodities.
Supply concerns still weigh on the oil market, especially in view of the impending U.S. sanctions against Iran, which could slash the latter’s crude exports from the fourth quarter of this year, and diminishing spare capacity with OPEC as it ramps up output. However, that equation can quickly change if the world’s oil demand in the coming months comes up short.
The fundamental logic for the oil market is simple — a trade war between the U.S. and China poses headwinds for their economic growth and possibly for other countries that suffer collateral damage. In Asia, countries that export components to China that find their way into products exported to the US, such as Taiwan, South Korea, Malaysia and Singapore, are likely to suffer.
A slowing world economy is likely to dampen oil demand. The U.S. and China together consume around 32.5 million b/d of oil, just under a third of the world’s total, and demand in both countries is growing faster than the world average.
U.S. oil consumption rose by 3.3% in the first four months of 2018 versus the same period a year ago, to reach 20.15 million b/d, according to the country’s Energy Information Administration. Chinese oil consumption in the first quarter of 2018 jumped by 6.8% year-on-year to hit 12.36 million b/d, according to Platts data.
It may be possible to evaluate and track the changes in import volumes and trade flows of energy commodities affected by the tit-for-tat tariffs. The $16 billion worth of goods in China’s target list for 25% tariffs, for instance, includes U.S. crude oil.
Though the $16 billion tranche has not yet taken effect, China has already begun to avoid U.S. crude imports. It is still early days, but Japan, South Korea and India were said to have lapped up August-loading U.S. crude barrels that were shunned by China when offered at very attractive prices.
However, assessing the impact of trade wars on oil demand growth is a different story. The dots between shifting trade flows, inflationary pressure, impact on corporate balance sheets and economic growth from tariffs on the one hand and oil consumption on the other are numerous and cannot always be joined up in a straight line. Forecasts for oil demand growth typically set store by projections for economic expansion.
Overall, the global economy, led by the emerging markets, is seen strengthening in 2018 and 2019 compared with last year. Fundamentally, that supports the view of strong oil demand growth.
An average of the latest forecasts for the growth in oil consumption from the International Energy Agency, OPEC and the U.S. Energy Information Administration works out at 1.59 million b/d for this year, almost stable from the rate estimated for 2017.
However, the consensus forecasts for 2019 point to growth slowing down to 1.52 million b/d. What is most concerning for the OPEC and non-OPEC producers is the return of an oversupplied market if an oil demand slowdown catches everyone by surprise.
Equally challenging to factor in is the probability of the US-China trade war blowing over. Despite the growing rhetoric from Beijing and Washington in recent days, the two sides may move toward a rapprochement -- like what happened this week between the U.S. and the European Union.
If the OPEC/non-OPEC partnership wants to remain in control of rebalancing the global oil market, it will need to be extremely vigilant and responsive. It is time to consign the relatively rigid agreement of November 2016, to cut back production by a combined 1.72 million b/d, to history.
Vandana Hari is founder of Vanda Insights, which tracks energy markets. She has two decades of experience providing essential intelligence on the energy commodities sector.