Crude oil faces some very specific risks in the coming months as the Chinese decision to devalue the yuan is likely to weigh heavily on demand for the commodity.
Over the past year, China has been a key participant in the global crude oil market as the Asian powerhouse sought to build up a strategic reserve of the commodity. However, this week’s decision to devalue the yuan will significantly impact the country's near term appetite for crude as demand falls based on the increased import cost. Considering China's role as the world’s largest buyer of global commodities, such a development poses a real risk to crude oil in the short term.
Source: Blackwell Trader
The Chinese devaluation is likely to provide a hit to global crude oil prices in the short term. A significantly weaker Chinese currency implies diminished demand for a range of commodities, including a particular focus upon oil. What this means in the short-term is further bearish momentum for crude oil, and prices potentially challenging the psychological $40.00 a barrel level.
In fact, forecasting from the Energy Information Administration (EIA), has revised overall U.S. production downwards from 750,000/bpd to 650,000/bpd on the back of waning demand and a rout in the benchmark price. Modelling from the World Bank also shows the significant fall in world oil demand, which is subsequently mirrored in the overall decline in price of the commodity.
It is also apparent that the fall in crude oil prices is not solely based on the supply glut but also about diminishing world demand for the commodity. Subsequently, the real story about the yuan devaluation is less about a grab for exports and more to do with slowing aggregate demand.
The devaluation is a clear signal that everything may not be well within the Chinese economy. It is clear that the intent of the move is to seemingly prop up Chinese exports in an attempt to shore up what could potentially be a deeper slow-down than reported. In fact, Chinese Industrial Production just fell to 6.0% from 6.6% YoY. Considering the continuing question over the veracity of the Chinese data, the results may in fact be far worse.
Regardless of the economic indicators emanating from China, the bulwark for global economic activity, crude oil prices, is signalling that all is not well within the global macro-economy. Successive rounds of quantitative easing and currency depreciations represent a concerted race to the bottom and have failed to buoy demand for anything except on a short term basis. Subsequently, crude oil faces the very real prospect of further falls and we may just see some levels not seen since the height of the financial crisis.
Overall, crude oil might not be facing a rout just yet, but watch out for the Chinese finger trap effect as the dominoes of currency depreciations start to fall across Asia.