- China’s zero-COVID policy has had a very negative impact on oil demand in 2022.
- Whether or not Chinese authorities relax COVID measures, both steps carry a huge political risk for China’s President Xi.
- Softer economic growth in China and an evaporating Ukraine war premium could result in further downside for crude.
Since the late 1990s, China has been the big beast in the global oil markets, driving demand for oil and other commodities that it used to power double-digit economic growth every year for many years and then high single-figure growth for years after that. As late as 2017, China’s high economic growth rate still allowed it to overtake the U.S. as the largest annual gross crude oil importer globally. It became the world’s largest net importer of total petroleum and other liquid fuels in 2013.
From 1992 to 1998, China’s annual economic growth rate was basically between 10 to 15 percent; from 1998 to 2004, between 8 to 10 percent; from 2004 to 2010, between 10 to 15 percent again; from 2010 to 2016, between 6 to 10 percent, and from 2016 to 2022 between 5 to 7 percent. From this point, no one knows precisely where it will go, except that it is likely to go lower, and the key reason it will go lower is the country’s handling of COVID – specifically its ‘zero-COVID’ policy.
However, each choice for China in where it goes from here in terms of this policy – whether to stick to it or relax this policy further – carries huge risks for the country and its leader, Xi Jinping, with whom the policy is personally associated. Whichever choice Xi makes, it is almost certain that it will result in an extended period of lower oil prices. This, although unwelcome for oil companies and net oil-producing countries, will be extremely welcome for several major developed economies and their citizens who have seen high oil prices over the past few months play a key role in destroying their savings, their pensions, and their quality of life.
To briefly recap, China’s zero-COVID policy is based on ultra-tight lockdowns introduced across entire areas, including major cities, immediately after identifying a relatively minuscule number of COVID-19 cases. December 2021 saw a refinement of the zero-COVID strategy into one incorporating the idea of ‘dynamic clearing,’ which provided local governments more flexibility in imposing restrictions, allowing daily increases in symptomatic cases to be capped at around 200 on a national basis.
On Nov. 11, the Chinese government unveiled 20 minor changes to the zero-COVID policy, including travelers from abroad requiring only one negative PCR test within 48 hours of boarding a flight to China instead of two. Another was that foreign travelers would only have to quarantine for eight days rather than 10, and another was that inside China, people considered ‘close contacts of close contacts’ of COVID-19 carriers would no longer need to quarantine. The new guidelines also forbade mass testing unless ‘it is unclear how infections are spreading’ in an area.
Despite this slight relaxing of the rules, China’s President Xi is now facing a wave of public protests against the still-tight COVID-19-related restrictions across the country of a seriousness not seen since those of the mid-1980s that culminated in the 1989 massacre in Tiananmen Square. The latest round of these protests began after at least ten people burned to death in an apartment fire in the city of Urumqi, the capital of eastern Xinjiang province, with many blaming COVID lockdown rules for delaying any response from the emergency services.
According to several live television reports, the protests spread to several big cities, including Shanghai and Beijing, with protesters shouting, “Step down, Xi Jinping! Step down, Communist Party!”. It would seem to be that in just the same way that the protests of the 1980s were in large part driven by the breaking of the understanding between the people and their government – that the former is content to go along with the controlled regime of the latter provided that prosperity is given to them – so the current protests are too. For prosperity, though, economic growth is needed, and the more there is, the better it is for the government, and this is where its problem is right now.
President Xi is caught between a metaphorical rock and a hard place. On the one hand, if he sticks to anything close to zero-COVID restrictions – at this point, basically any meaningful restrictions – then China’s economic growth will continue to deteriorate. Additionally, the scale and scope of the protests against him and his regime will likely increase. On the other hand, if he meaningfully loosens China’s COVID-19 control measures, it is highly likely that vast numbers of China’s people will die, resulting in the same appalling scenario that China would face if it stuck to tight control policies for COVID-19.
The reason vast numbers of deaths would result from any meaningful lifting of COVID-19-related controls is that China still does not have an effective vaccine against the disease or any variant thereof, despite offers from all major vaccine-producing countries to make such supplies available to it. China also does not have an effective post-infection anti-viral, and it still refuses to buy in such supplies from foreign suppliers, despite offers from several Western countries to make such anti-virals and post-infection treatments available.
Because of China’s initial response to the outbreak of COVID-19 in 2019 – draconian lockdowns across all areas – the country still has vast numbers of its people without any vaccination against any variant of the disease, even China’s vaccine (CoronaVac), and it has a critical shortage of intensive care units (ICUs).
“There are 263 million people in China who are over the age of 60 and 35 million people over 80 and the susceptibility of the elderly to severe cases of COVID-19 is well known,”
Rory Green, the chief China economist for TS Lombard in London, exclusively told OilPrice.com last week. He added,
“Of the over-80s, only 66 percent are vaccinated and only 40 percent have had three shots, and we know from detailed medical analysis of the Hong Kong outbreak that the CoronaVac shot has the equivalent efficacy of mRNA vaccines only after three doses, so this leaves approximately 37 million of the over-60s vulnerable to a widespread COVID outbreak,”
After vaccinations, the key consideration in dealing with COVID-19 outbreaks is treatment for those severely affected by the disease, which means ICU capacity in hospitals. Still, China has a major problem here too. He went on to add,
“Various studies put the number of ICUs per 100,000 people at between 3 and 6 in China – this compares with 2.3 in India and 34.7 in the U.S. What the national level analysis misses is the regional variation in ICU coverage: the majority of ICUs in China are in the wealthier eastern provinces, which tend to have higher vaccination rates and better demographics, and local estimates factoring in city-level demographics and medical capacity posit that the most vulnerable city – Lijiang in Yunnan province – would need a 6000 percent increase in ICU capacity to address an Omicron outbreak adequately,”
So, how bad could things become for China? Data from Hong Kong’s February 2022 outbreak is likely to offer the most relevant comparison, thinks Green. He concluded,
“Returning to China CDC [Center for Disease Control] micro-estimates of city-level healthcare provision, if we use the Hong Kong February 2022 outbreak as the baseline for community spread and severity of cases, it is estimated that just 7.3 percent of China’s population lives in cities with sufficient ICU capacity, with the other 92.7 percent living in areas where ICU resources would be completely overwhelmed by the epidemic.
The shock to a relatively unvaccinated population could be substantial: based on Hong Kong’s mortality rate, China could experience 50,000 deaths per day at the height of an uncontrolled outbreak,” he highlights. In economic terms, then: “In short, China remains well and truly stuck and we think real GDP, as measured by TS Lombard, this year will come in at 1.6 percent year-on-year,”
The removal of much of the economic potency behind China’s big bid in the global oil markets would mean a much softer true demand backdrop to oil prices going forward, particularly with any concomitant diminution in the Russia-Ukraine War premium. This premium began last September when savvy market players began to buy oil based on observations from U.S. intelligence officers of highly unusual Russian military movements on the Ukraine border after the conclusion of the joint Russia-Belarus military exercises that had taken place.
Before this, oil had been trading consistently around the US$65 per barrel of Brent level. This level reflected the equilibrium price that factored in China's already evident weaker demand. As this Russia-Ukraine war premium declines as Europe continues to substitute energy from Russia with energy from other sources, as it will, this US$65 per barrel level is likely to be the base point for oil prices from then.