China Production Dynamics and Its Impact on Crude Prices

  • Dec 08, 2019 GMT
  • Team Kalkine
China Production Dynamics and Its Impact on Crude Prices

Crude oil prices over the month of November 2019 have been in a consolidation phase after a weak performance over the previous month. The commodity had been struggling for some time on account of weak demand from China, the second largest economy in the world which is currently experiencing a slowdown and a gloomy global economic outlook was portrayed by the International Monetary Fund (IMF) in its report for the year 2019. However, since the positive news flow of the China and United States of America trade talks began creeping in and the positive news flow from Europe about the Brexit situation, the commodity has started to gain strength.

The Chinese Slowdown - China is today not only the second largest economy of the world but is the largest manufacturer of the world as well. It is the largest consumer of basic raw materials and the largest producer of intermediate and final goods. The energy demand in this country has increased exponentially over the years to be the second largest today only after the United States America. The Chinese market has also grown significantly on account of increasing prosperity among the Chinese people which has led to it becoming the second largest market in the world.

The current slowdown in the Chinese economy has been on two accounts, first it has been on a strong growth mode for several years now which would necessitate a slowdown as a cyclical effect. The second being the trade war situation that had been brewing between China and United States of America for some time now. The Trump administration had been hinting at imposing tariffs on Chinese imports since the time it took office, in order to force China to rework its unfair trade ties with the United States of America as is being alleged by the administration. China, while responding to the same, has also been imposing tit-for-tat tariffs on American goods, leading the dispute into a full-fledged war. The dispute though has a long history and has been on since the time of the China entering the World trade Organization. It got a booster dose of animosity with the Trump administration assuming office.

The theft of intellectual property and the forced transfer of American technological knowhow to Chinese regulators are amongst the major accusations being leveled by the United States on China. China on its part has now been able to establish itself as the worlds cheapest manufacturing base and has also become the world’s largest consumer of basic raw materials, thereby producing basic and intermediate products and exporting the same to the rest of the world. On this account, the United States of America and the rest of the world are a worried lot on account of these cheap Chinese imports which are hurting their local manufacturing industries, which in turn have been pressing their governments to take corrective measures to protect them. The United States in particular has been accumulating an ever-increasing trade deficit with China on this account which has now assumed a massive proportion and has been desperate to fill the gap with the latest measure of increasing tariffs on Chinese goods in an attempt to bridge the same. These measures from both sides has not only damaged Sino-American trade to a great extent but has also been impacting the diplomatic relations among the two economic giants.

The impact of this trade war on the world economy has also been significant. The trade war has depressed business sentiments across the world as both of these countries are the largest consumers of basic commodities and the largest markets. A weakness in the demand, supply and a tweak in trade tariffs between these two countries disrupt the demand supply equilibrium of the world markets. This not only impacts commodity markets but also has a cascading effect on the world currency and equity markets. The IMF in its world economic forecast report published in 2019 has painted a not so encouraging picture of the world economy and has held China - United States trade war a major factor resulting in the same. This is in addition to the slowdown of the Chinese economy and the Brexit situation unfolding in UK and rest of Europe.

Crude oil prices have a very high positive correlation with global news factors. These volatilities are also often exacerbated by the Organization of Oil Exporting Countries (OPEC) decision to cut production in order to influence the pricing on this commodity globally. But given the size and scope of the Chinese economy, even the OPEC has also not been able to arrest much of the downward slide in the prices of this commodity. Another important factor that is often forgotten is the new capacity addition of crude oil resources entering the market in the recent past. These new resources are significantly downgrading the ability of OPEC and other major oil producing countries to regulate and influence prices of crude oil.

Towards the fourth quarter of 2019 however good news has been filtering in from all quarters. The Brexit situation in United Kingdom and Continental Europe has improved significantly. The Chinese economy will see some prospects on the back of continuing negotiations between the Trump administration and their Chinese counterparts and as a cascading effect there will also be an improvement in the prospects of countries whose economies are dependent on the Chinese economy. The prices of crude, however, may not rally very strongly as a number of other factors are also having their say on the prices of this commodity. Currently significant changes are taking place in the dynamics of this industry in the likes of additional discoveries, increased production capacities and increased investment in electric vehicle technologies which are sure to cast a dent on the prices of crude in the mid to long term business cycle. In the short run however, the prices are likely move strongly up to at least the January 2020 Brexit deadline, after which, of course, the ensuing situation will dictate its direction further.

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