Pacific Money | Economy | East Asia

The Commodity Craze Creates a Supply Gap for China

While China benefits from buying cheap Russian oil, weak demand and expensive oil globally is creating a large commodities supply gap for China.

The Commodity Craze Creates a Supply Gap for China
Credit: Wikimedia Commons/ N509FZ

Pain at the gas pump has become commonplace across the globe. Hit hard by geopolitical tremors and sanctions on Russia, crude oil prices have begun to soar. Brent crude oil prices, an international benchmark for oil, closed at over $120 per barrel on March 23. Traders are busy estimating the true loss of oil supply from Russia; Western leaders are looking for options to meet demand with imports from other major producers. Nonetheless, any loss in oil production will be met with rising prices in the current high-demand post-pandemic market.

While China continues to buy Russian oil and other products, despite U.S. and European warnings, inflation is showing no signs of slowdown in China. According to the National Bureau of Statistics, China’s factory-gate inflation index, the Producer Price Index, clocked in at 8.8 percent growth year-over-year in February. Although the PPI showed its slowest year-over-year growth in many months, this was due to base effects. In fact, the PPI exhibited 0.5 percent month-over-month growth, the quickest monthly growth since October.

The PPI for industrial goods saw price growth beyond 11 percent, implying that raw materials, such as fossil fuels and metals, saw prices grow at a much faster rate than consumer goods. Consumer goods prices rose just 0.9 percent year-over-year.

Despite China’s tremendous buying power, its support for Russia cannot prevent global supply shocks, which increase prices for all buyers. These soaring prices have dampened demand and, in turn, caused a gap in China’s oil supply as Chinese fossil fuel imports have shrunk. As of the end of February, Chinese imports of liquefied natural gas (LNG), for example, dropped by 12 percent year-on-year. However, Russia’s share of those imports rose to 8 percent, poignantly as Russian energy dealers sell at a steep discount. Crude oil imports also fell 4.9 percent year-over-year, while coal and iron ore imports also suffered.

In the near term, factory-gate inflation is expected to continue to rise as Russia continues its invasion of Ukraine. Since China will have to make up for a supply loss in February, it may continue to increase its share of Russian oil imports and enjoy some high margins. Similarly, officials may call for increases in domestic production. At the end of February, though crude oil imports dropped by 4.9 percent year-over-year, domestic crude oil production increased by 4.6 percent. Similarly, while natural gas imports dropped 3.8 percent, domestic production rose by 6.7 percent.

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However, the domestic COVID-19 situation in China may also be enough to put a stop to the commodity craze of recent weeks. China’s latest COVID-19 wave is recognized as the worst since early 2020, and China has begun to clamp down through large-scale quarantines. Many analysts have attributed the cooldown in global oil prices from their peak of more than $130 per barrel in early March to the onset of China’s latest coronavirus wave. Given China’s status as the second largest oil consumer in the world, a significant slowdown in economic activity could put downward pressure on oil prices.

With supply shocks and demand shocks both in play, the commodity craze could go in many of ways in the remainder of March and April. However, more signs are pointing south than north. Some European nations have begun to consider all-out embargoes on Russian oil, while the United States is considering additional sanctions on Russia. Either way, it is expected that commodity prices will get worse before they continue to get better.