Exploring the Reasons Behind China's Reopening Not Having an Immediate Impact on Global Oil Markets

It's been a tough start to the new year for oil investors. Prices have fallen sharply, and there's no end in sight to the decline. It's a painful reminder of the volatile nature of the oil market, and the risks that come with investing in it.

Although China has managed to get its Covid-19 outbreak under control, a significant resurgence in energy consumption is still weeks or even months away. This is according to some of the market's biggest names, who are predicting a demand boom in the wake of China's recovery.

At the start of the year, global oil markets looked similar to how they did at the end of 2022 - oversupplied due to a combination of weak demand and strong supply, while also dealing with thinner trading volumes than usual.

The oil market is prone to big moves, making it challenging for traders of physical oil barrels to predict which way prices might be headed. This is due to a spate of unexpected outages.

Gary Ross, a veteran oil consultant turned hedge fund manager at Black Gold Investors LLC, believes that the market is oversupplied by at least 1 million barrels a day. He predicts that large stock builds will occur in the coming weeks, potentially reaching 10 million barrels a week. Ross wonders how the market will be able to handle such an influx of oil.

There are several reasons why the oil market isn't yet seeing the benefits of China's big reopening. One is the near-term oversupply of oil. Another is that a number of U.S. refineries have been closed following a recent deep freeze.

A cold snap hit the US shortly before Christmas, forcing many refineries to shut down. At its peak, about 40% of Texas' crude processing capacity was shut down, with some of that remaining offline into the first week of 2023.

"We've seen these big freeze-offs in the US and that has meant that the crude balance has actually weakened," said Amrita Sen, chief oil analyst at consultant Energy Aspects Ltd. in a Bloomberg TV interview.

There are still concerns that the latest surge in infections will lead to further economic slowdown, both in the US, Europe and China. On Tuesday, manufacturing figures showed the Chinese economy was in steep decline in late-2022. While mobility has improved in recent days, the worry over the health of worldwide consumption continues to linger due to the risk of a synchronized deceleration.

In the United States, manufacturing figures for December showed a continued contraction, missing expectations. European figures also showed a pullback for December.

The first quarter of the year is typically a time when stockpiles build. The most recent forecast by the International Energy Agency estimated oil supplies at about 600,000 barrels a day above demand in the first quarter. This was before the impact of the US cold snap and resultant refinery closures were known.

According to Ross, the stock build in the first quarter will be a reflection of first quarter activity, which is likely to be sluggish.

Afterwards, milder weather in a lot of the West has also lessened some tension across energy markets to meet heating demand. Most of the US is now supposed to experience warmer-than-normal temperatures from Jan. 10-16, according to the National Oceanic and Atmospheric Administration.

Earlier, crude demand had received a boost as some power generation units switched from gas to oil amid a shortage of natural gas.

The oil market has been struggling with low liquidity for months, as high volatility and margins have pushed open interest to multi-year lows. This retrenchment has made prices more susceptible to sharp swings on days when technical traders known as commodity trading advisors (CTAs) dominate trading.

This week, US crude futures briefly rose above their 50-day moving average, before falling back below that level. This spurred additional technical selling by CTAs (Commodity Trading Advisors). People involved in the market said that momentum-driven selling is also contributing to the rout.

FGE has noted that the sudden lifting of Covid-19 restrictions and testing requirements in early December, followed by a strong resurgence of infections, has caused demand destruction for gasoline and gasoil in recent weeks. This is especially apparent in China.

Although major cities such as Beijing, Shanghai and Guangzhou have passed their Covid peak, rising cases in inland and rural areas will limit the demand for travel in the near term, according to an industry consultant.

Beijing has also granted a generous allocation of fuel export quota to refiners this year, prompting traders and analysts to forecast that much of the demand boost from China will come in the later months.