At the end of July, we wrote an article titled "Oil Bulls Beware: Crude Demand Is About To Slide As China's SPR Is "Close To Capacity"" which explained why what until recently had been a record hoarding of oil by China, was starting to fade. The reason: according to JPM China's Strategic Petroleum Reserve was filling up.
As we said then, "as many speculated, a big source of China's demand in the past 5 months was Beijing's decision to stockpile oil for its SPR. However, that is now over as China is likely close to filling its strategic petroleum reserves after doubling purchases for it this year as prices plunged. JPM estimates that China's SPR demand was equivalent to approximately 1mm bpd. More importantly, stopping shipments for the reserve would wipe out about 15 percent of the country’s imports, according to the bank."
For context we said that "Chinese crude imports had risen 16% this year, and the country was rivaling the U.S. as the world’s biggest oil purchaser. That demand, along with supply disruptions from Canada to Nigeria, has helped boost oil prices about 80 percent since January. Chinese imports surged to a record 8.04 million barrels a day in February. The nation may surpass the U.S. as the world’s largest crude importer this year with average inbound shipments of 7.5 million barrels a day, according to Zhong Fuliang, vice president with China International United Petroleum & Chemicals Co., the trading arm of the nation’s biggest refiner. However, if JPM is right, China's imports are about to hit a brick wall."
Yet while Chinese imports have indeed slowed down, the rate of decline has been less than what JPM may have envisioned. That said, the slowdown may hit any moment.
In its June calculation, JPM said that the implication to China’s oil imports from a nearly full SPR is that "our base case assumes China continuing high volumes of (1mbd) SPR builds through August, while factoring in 7% domestic crude production decline and 2% refinery throughput increase. This means 15% mom decline in China’s crude imports in September, or 1.2mbd loss from the China inventory demand. China’s net oil imports ytd has expanded 16% yoy, versus a flat consumption growth."
We'll find out very soon if JPM was right.
Meanwhile, as attention turns to what is finally perceived as the biggest wildcard in global oil demand, one which could directly lead to the evaporation of up to 1 mm bpd in demand, Bloomberg writes that "the world is puzzling" over China's oil hoard, and with good reason: if 1mm barrels of oil demand were to disappear, the price of oil would plunge as the already oversupplied market would find itself with an unprecedented glut of excess production.
One part of the mystery is that while China outlined in 2009 its plans to build reserves equivalent to 100 days of net imports, since then it’s only provided sporadic scraps of detail on its strategic petroleum reserves.
A big reason for this is that unlike the US, in China stockpiled oil does not have one defined, centralized location. As a result, "from underground caverns by the Yellow Sea to a scattering of islands in the Yangtze River delta, the government has been stockpiling crude for emergencies in a network of storage sites dotted around the country."
That's the unknown - what is known, and what we reported two months ago, is that China's record purchases of oil this year "have helped oil prices recover from the worst crash in a generation. What the country plans to do next could determine where they go from here. "
As Bloomberg writes, "the difficulty is that nobody outside China really knows for certain. The government won’t say how much it’s holding or when the tanks will be full. Energy Aspects Ltd. says the country will probably keep buying and fill up commercial tanks if it has to, while the likes of JPMorgan Chase & Co. say the purchases may soon stop. The difference in opinion is equivalent to about 1.1 million barrels a day, or more than the Asian country buys from Saudi Arabia."
“China seems to feel no obligation to report on its strategic stocks, and that might confer a genuine advantage in its favor,” said John Driscoll, the chief strategist at JTD Energy Services Pte, who has spent more than 30 years trading crude and petroleum in Singapore. “The scope of their purchases The can dramatically affect fundamentals and prices. However, since they will likely be shrouded in secrecy, it will remain challenging to quantify the impact.”
The chart below is BBG's calculation of the amount of crude oil that China imported over the what it has used in recent years.
According to a statement on the website of the National Bureau of Statistics in December, the Asian country had about 191 million barrels of crude in its SPR as of the middle of last year. But China also said at the time that total combined capacity of seven above-ground sites and one location with underground caverns was the equivalent of only 180 million barrels. The figures haven’t been updated since. Additionally, China has pushed back completion of its SPR stockpile to beyond the 2020 deadline, according to a Five Year Plan released in March 2016.
What adds to the mystery is that the government has also said it has leased space in commercial sites, signaling it could buy additional oil while more of its own tanks are constructed.
This has forced watchers to estimate China's daily SPR-filling needs. “SPR has been a China mystery due to the lack of government data disclosure,” said Ying Wang, a Hong Kong-based analyst at JPMorgan. The bank estimates the amount of crude China is putting into stockpiles by calculating how much more oil the country is buying and producing than it’s using. As we reported in June, that amounted to about 1.2 million barrels a day over the first half of the year, according to JPMorgan. The bank estimates the country built up a total of about 400 million barrels by mid-2016 out of a targeted 511 million barrels.
Energy Aspects has provided a different interpretation, suggesting that there is no true limit to SPR buying: "the government may be able to increase purchases even if it runs out of its own space", said Michal Meidan, a London-based analyst for the industry consultant. "Another 150 million barrels of commercial storage space is coming online by the end of next year that can be filled," she said. That means that while reserve buying may slow, it won’t fall significantly.
“Even if SPR tanks only come online later in the year, more commercial tanks are starting up,” Meidan said. Energy Aspects sees demand for the reserves dropping by only 100,000 barrels a day in the second half of the year to 300,000 barrels daily. In other words, with consolidated US oil stocks at record highs, China merely continues to copy what the Obama administration is doing, and filling up every possible storage facility, public or private, in hopes prices will eventually turn higher while taking advantage of lower prices to warehouse as much crude as it can store.
Considering that China’s oil imports have averaged an unprecedented 7.5 million barrels a day so far this year, the portion going to the SPR is as much as 15% of the daily demand, which is why the current state of China's SPR is so very critical.
China's record purchases, along with temporary production outages in Nigeria and Canada, helped rebalance supply and demand in the market, leading Brent crude to jump almost 90 percent from mid-January to June.
However, now that the recent outages have been largely resolved, with key OPEC producers pumping at or near record levels, and with both Nigeria and Algeria gradually resuming oil exports, it is all about demand. To be sure, earlier today the EIA delivered an unexpected announcement when it reported that it overestimated US demand by as much as 16% in the first half of 2016.
Which is why should roughly 15% of Chinese oil demand be about to hit a wall, it's all downhill from here for oil prices.
Finally, how will the market know if China is indeed at SPR capacity? Recall from JPM's calculation:
Based on our base case of assuming another high SPR builds through August and the following three assumptions listed below, our model suggests a 15% mom decline in China’s crude oil net imports in September, or a loss of 1.2mmbbl versus August and 0.8mmbbl less from the 12-month average.... We do not believe the 16% growth in oil imports ytd is sustainable despite a domestic oil production decline, as demand is weak (2% expansion in oil processing with gasoline an increased risk), if inventory capacity reaches the limit.
In other words, we should know the answer soon. For now, however, judging by today's sharp, 4% drop in the price of oil, the market appears to already be making up its mind.