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A renminbi threat to oil?

A major Chinese currency devaluation probably wouldn’t hurt Chinese oil demand as much as some think

Oil demand and stockpiling in China will remain strong this year as speculation, particularly in the West, that Beijing will do a massive 15-20% devaluation of its currency, appears to be just that.

Chinese oil consumption and imports are sensitive to price changes – so a renminbi devaluation that made crude more expensive in the local currency would hurt both. But domestic oil demand, in particular, also reacts to GDP. A weaker renminbi would be expected to make exports of Chinese goods more competitive, boosting manufacturing activity. In turn, this would lift demand for diesel (used in manufacturing) and offset any weakness in gasoline.

Financial markets have for months been humming with speculation that a significant renminbi correction is on the horizon. Beijing surprised currency watchers earlier twice in the past year, with unexpected devaluations first in August 2015 and then in January 2016. As a result confidence has been dented both at home and abroad. But while small fluctuations in the renminbi’s value may continue, China is unlikely to devalue abruptly or significantly, because its economy needs relatively stable exchange rates to grow and prosper, wrote Lawrence Lau, an economics professor at the Chinese University of Hong Kong, in a recent paper.

He argues that since the currency is not overvalued, and a devaluation is not in the best interests of China, and that the country has the ability to stabilise the renminbi, a deliberate weakening is simply not going to happen.

Progressive state

Moreover, any devaluation aimed at boosting exports, which would need to be 15% or more to make a meaningful impact, would not make sense. “It is not really in the best interests of China to return to making garments, shoes and stuffed toys all over again, with the low standards of living that implies for its workers,” added Lau. A profound adjustment in the Chinese economy is underway, moving from manufacturing and exports to services and consumption. A reversal is not in the cards.

China’s leaders want to remain in power – and so want to avoid major shocks to the financial system. Indeed, the focus of the government and People’s Bank of China has shifted towards stabilising the renminbi in the coming months rather than planning for a significant devaluation of the currency, by reassuring financial markets and stemming capital flight, says Rajiv Biswas, Asia-Pacific chief economist for consultancy IHS Global Insight.

This should increase Chinese oil imports during 2016. These have soared in the first quarter, reaching a record level of 8.03m barrels a day in February as China continued to top up its strategic petroleum reserves (SPR). It marks a big jump from January’s 6.3m b/d and from last February’s 6.68m b/d, especially considering that most of the Chinese economy ground to a halt in early February for the week-long lunar new year celebrations.

Partly explaining the surge were rising imports from independent refiners – the so-called “teapots” – as well as strong refining margins. Slowing domestic oil output, which has been falling since November, will continue to support crude buying too. Domestic production averaged 4.16m b/d over January and February, down 75,000 b/d compare with a year earlier.

Production declines should accelerate through the year as capital expenditure cuts bite. Chinese offshore producer Cnooc has said it will cut output by 40,000 b/d, while Sinopec will reduce flows by 34,000 b/d. But the most significant cuts will come from CNPC, which is expected to shut down some 90,000 b/d.

In fact, storage constraints are more likely to slow oil imports than a currency devaluation. China continued to fill its SPR when oil prices were at $70/b, so a 5-10% rise in the today’s prices would not significantly discourage further buying. But China can only fill empty capacity and the second phase of its SPR is nearly full.

A fall ahead

Li Li, a Beijing-based oil specialist at consultancy ICIS expects only 18.87m to 31.45m barrels will be channelled to the SPR this year. Based on her calculation, the fill rate would be 51,697 to 86,161 b/d, much less than the estimated 250,000 b/d fill rate last year. Still, if domestic production falls some 100,000-200,000 b/d in 2016, oil import levels may not be drastically affected.

Expanding the SPR is less urgent than before. The latest full-year plan released by Beijing downplays the priority given to building the third phase of the SPR. Policy makers believe world oil markets remain well supplied and relatively open. “They seemed to realize that the SPR might not be a panacea for oil security and that oil security might become a false proposition,” says Li.

Despite the recent record import numbers, however, overall oil-demand growth remains anaemic, reckons Amrita Sen, chief oil analyst at Energy Aspects, a consultancy. Over the first two months of the year, Chinese data are typically distorted by the lunar new year. But official figures show combined January-February actual demand was flat year-on-year: hitting 10.34 b/d in January, up 3.8% year-on-year, but just 10.01m b/d in February, down by 2.9% compared with that month in 2015.

In its March oil-market report, the International Energy Agency cautioned that the outlook for China remains restrained by lingering economic weakness. Oil-demand growth would come in at just 300,000 b/d in 2016, with industrial oil particularly lagging. The agency estimates demand for the first quarter at 11.3m b/d and 11.6m b/d for 2016, or 3.5% year-on-year growth.

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