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Simon Watkins

Simon Watkins

Simon Watkins is a former senior FX trader and salesman, financial journalist, and best-selling author. He was Head of Forex Institutional Sales and Trading for…

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China Could Cause The Next Massive Crash In Oil Prices

  • China has been one of the main drivers of the 2000-2014 commodities supercycle
  • Slower economic growth and a huge debt bubble pose a tremendous risk to oil markets
  • China’s Evergrande crisis shows the fragility of the Chinese debt market

Given the extreme disconnect between China’s huge economy-driven oil and gas needs and its minimal level of domestic oil and gas reserves, the country’s influence over oil prices has long been profound. As a result of this imbalance, China almost alone created the 2000-2014 commodities ‘supercycle’, characterized by consistently rising price trends for all commodities that are used in a booming manufacturing and infrastructure environment. This was a product largely of the 8 percent-plus annual GDP growth recorded by China over that period, with many spikes well above 10 percent and only a relatively short move down in economic growth at the onset of the Great Financial Crisis. Aside from huge quantities of imported oil and gas, this massive economic growth was fuelled by enormous debt piled up but then hidden away in various financial mechanisms that China believed it could simply pay off eventually through its rapid economic growth. Developments in the last week or so hint that both of these bubbles may be set to burst, taking the big bid in oil out of the market.

“Despite some easing in the energy market, downside risks to growth persist, and we continue to expect GDP growth to ease to 5.2 percent in 2022 from an estimated 8.2 percent growth in 2021,” Eugenia Fabon Victorino, head of Asia Strategy for SEB, in Singapore, told OilPrice.com last week. “Easing in financial conditions will not spare the property sector from further pains, and bond defaults will continue to test investors’ nerves,” she said. The country’s Manufacturing PMI (purchasing managers’ index) for November unexpectedly surprised to the upside, coming in at 50.1 (anything above 50 indicates an expansion) for November (compared to 49.2 in October), while its Non-Manufacturing PMI for November registered 52.3 (compared to 52.4 in October) but official figures from China relating to its economy should be taken with a dose of skepticism. Looking ahead, highlighted Victorino: “The uncertainty surrounding the omicron variant will likely strengthen the resolve of the authorities to stick to its zero-tolerance policy towards COVID-19, even if it remains a dampener on private spending.” Meanwhile, she added: “Investment continues to deteriorate, [and] although fiscal policy turned marginally supportive as Beijing urged local governments to speed up mature projects, the impact on infrastructure activity is unlikely to become evident until the first quarter of 2022, in our view.” 

Added to this macroeconomic uncertainty is increasing unease that China’s long-disguised bubble of debt will finally explode. Originally brought to light by the then-Fitch analyst, Charlene Chu, China had long been hiding vast quantities of debt that it had accrued through a multitude of state-related businesses through a range of difficult-to-examine schemes, most notably back then ‘wealth management products’ (WMPs). Typically, these offered a high rate of return and were up until recently effectively unregulated and were mainly sold to the public. More latterly they were also sold increasingly to banks and other financial institutions. In practical terms, they were an amalgam of layers and layers of liabilities built upon the same underlying assets, much as was seen with subprime asset-backed securities that the Western banks had in 2007/08 in the lead up to the onset of the Great Financial Crisis.
Related: Saudi Arabia Hikes Oil Prices Despite Omicron Fears

Combined with the corollary bubbles in China’s housing and other asset markets that have been inflating over the past few years, as analysed in depth in my new book on the global oil markets, the situation in China right now is very similar to the one in the West in 2007/08 to which nobody paid attention until there started to be bankruptcies, which then snowballed into the full-blown Great Financial Crisis.  Although officially China’s debt-to-GDP ratio is currently just under 70 percent, in reality, it is much higher. Even according to the People’s Bank of China’s own data, outstanding ‘total social financing’ (which measures overall credit supply to the economy) stood at CNY284.83 trillion (USD44.1 trillion) at the end of December 2020, up 13.3 percent from a year earlier, with an increasing share of this being used to pay debt servicing costs. 

Even back when China’s economy was growing at an average of 8 percent-plus per year, year in year out, it was mathematically not possible for it to grow its way out of this debt burden, and with GDP set to fall to around 5 percent or lower next year and likely beyond that, the concerns over China’s mountainous debt position have only increased with recent news of debt-related troubles at Evergrande. Originally a real estate developer – therefore, at the center of the Chinese government’s previous initiatives to fuel economic growth by huge infrastructure building projects, including new towns and cities – Evergrande took on even more debt (including through extensive bond issues) expanding its business portfolio. Overall, at a minimum – and these are just the known figures – Evergrande’s expansion in real estate (it owns more than 1,300 projects in more than 280 cities across China) and into wealth management, electric car production, and food and drink manufacturing, among others, cost it over US$300 billion in borrowing. Unsurprisingly, it is struggling to pay this debt and to service its bond payments, just like those who have known about China’s hidden debt pile for years were warning.

“Although concerns of contagion beyond the property sector have pulled back, risk appetite for China’s offshore bond markets remains weak,” Victorino told OilPrice.com last week. “The real estate sector accounts for only 2.2 percent of the incoming bond maturities in the onshore market in 2022, but the share of real estate bonds maturities in the offshore bond market is substantially higher at almost 18 percent,” she said. “In the coming year, refinancing needs of the real estate sector in the offshore market will rise by around US$10 billion to almost US$57 billion, and total offshore maturities are expected to peak in March and April,” she underlined. “Considering that hawkish policy on the real estate sector will remain, defaults will continue to test investors’ nerves in 2022,” she concluded. 

By Simon Watkins for Oilprice.com

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  • Mamdouh Salameh on December 07 2021 said:
    When in the 1980s and 1990s China’s annual economic growth ranged from 10%-12%, many in the west cast doubts about China’s growth figures until China emerged as the world’s largest economy based on purchasing power parity (PPP) which is the only reliable measure of GDPs of the world. In fact China’s GDP in 2021 is almost 18% bigger than the United States’ on PPP basis.

    In 2013 China overtook the United States to become the world’s largest importer of crude oil. This achievement was the outcome of its fast-growing economy. If the world has already accepted this as a fact, it has also to accept China’s data on economic growth and debt/GDP rates as well.

    In 2021 China’s debt to GDP (debt/GDP) ratio was estimated at 68.95% compared to the United States’ 133.28%. By 2026 China’s debt/GDP ratio is projected to grow to 80.1% compared with the United States’ 133.46%. If there is a risk that China bubble of debt could explode, then the United States’ risk is at least twice that of China.

    In 2020 the US economy declined by 22% as a result of the pandemic while China’s was the only economy other than Qatar’s to end the year with a growth of 2.3%.

    Therefore, western analysts and sources including the author of this article should stop casting doubt on China’s economic data and judge them by the expanding gap between the economies of China and the United States. Then they won’t be surprised when the time comes soon when China will tell the United States to stop meddling with Taiwan and get out of the Asia-Pacific region.

    Dr Mamdouh G Salameh
    International Oil Economist
    Visiting Professor of Energy Economics at ESCP Europe Business School, London
  • George Doolittle on December 09 2021 said:
    There hasn't been a "commodity super-cycle" since the 1970s and certainly there is not one now in the USA anyways. With the Turkish Lira in free fall that hardly has anything to do with China as well...nor did the collapse of the Russian Ruble back in 2014.

    Anyhow if US equities at these levels continue to deflate anyone still long commodities will continue to get annihilated as there are only so many US Dollars in the World and the US economy continues to forge ahead with truly awesome amounts of innovation going on since the Tesla Model S first hit the US Highways.

    The USA has rapidly become near the World's largest exporter of natural gas now as well...if not the World's largest in point of fact. Indeed at some point the USA will become an exporter of any number of goods if domestic US natural gas prices plunge back towards one US Dollar per mcf if not below even that. Yet another brutal day for palladium by way of example...hardly an unimportant metal with in fact the exact opposite being true.

    The Upper Midwest is now being flooded with refined energy product as a consequence (Indiana, Ohio, Michigan and soon Upstate NY.) This mass of product will only intensify once the massive ethane cracker in Western Pennsylvania from Royal Dutch Shell becomes fully operational.

    Already a 3 *MILLION* square foot Wal Mart Distribution Facility here in South Carolina has pushed forward its operational date to January of next Year, 2022. That one facility alone will *FLOOD* the entire Eastern Seaboard with retail product and excludes what Amazon.com is already doing in Virginia let alone everywhere else.

    Plus Amazon is pushing an all electric pure BEV delivery Fleet.

    Wal Mart is already running driverless trucks as well in Arkansas...soon to spread to Texas.

    I think the US Federal Reserve has been proven spot on when calling inflation "temporary" although I agree that was a poor choice of words.

    The battle between Microsoft and Apple for "largest Company on Earth" is quite remarkable to see and yes 5g is a really really really big deal.

    Compared to battle over 5g the entire oil market seems rather small in point of fact and I think China understands that.

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