TWS: Aug. 6, 2020

Graph of the Week | Economics

China’s record-setting oil binge continues to turn heads as June figures confirm the third consecutive month of frenzied imports for the world’s largest importer. China’s imports alone have supported the industry’s recovery after oil prices reached historic lows in April.

TCG’s long-term followers will remember our jaw-dropping bewilderment when crude oil traded at negative values in a rare event that saw sellers paying buyers to offload inventory through oil futures. China jumped on the opportunity, as the country took advantage of unprecedented pricing to fill strategic reserves cheaply.

Fast forward to today and tankers carrying stock from earlier orders are arriving at Chinese ports in baffling numbers – a spectacle likely to persist throughout the remainder of the summer and into the fall.

With China’s massive purchases, the question remains: ‘What’s the oil being used for?’

Option 1: Domestic consumption
Transport typically drives China’s domestic oil demand. But, Chinese traffic levels plunged to new lows as travel plans were cancelled and work from home became the norm. Although commutes have largely resumed, passenger traffic still sits at about 56% of last year’s heights. So, with sluggish gas consumption, option 1 is a no-go.

Option 2: Storage
At peak levels in June, China was storing around 2 million barrels per day. But, while the price shock offered an opportunity for Beijing to fill strategic oil reserves cheaply, storage takes space and China lacks the capacity to hold all the oil it purchased. So, that leaves us with…

Option 3: Flip it like a flapjack
China has been flipping oil in offshore markets like your uncle flips iPhones on Craigslist. Over the first five months of 2020, fuel exports jumped to 1.57 million bpd, making China a pretty penny by buying low, driving up the price, and selling for cash money.

Bottom line: China has been on a quest for self-sufficiency – particularly for economic and militaristic independence. As a common denominator between the two, oil imports present a very real threat to China’s ability to minimize global reliance. With China’s oil binge winning on all fronts, Beijing’s opportunistic approach has placed an ace into its back pocket at a time when the country is challenged by an increasingly hawkish international environment.

Economics | Markets

China’s Foxtrot with Fantasy

China’s top leadership is donning their dancing shoes once again. The politburo unveiled the ‘dual circulation strategy’ – the latest step in Beijing’s gavotte towards self-reliance through economic reform. The initiative seeks to turn export-facing factories inwards to service the Chinese market.

Our more capitalist-minded readers out there may have already noticed a few questionable areas in the strategy:

  1. As the world’s production center, China’s production capabilities far surpass domestic demand, and with one of the world’s largest wealth gaps, there is a smaller market than initially meets the eye to absorb excess supply;
  2. While China leads the coronavirus recovery charge, Chinese consumers are marching out of beat with spending down 5.9% in the first half of 2020;
  3. How does China plan to counter the fallout of increased competition in an already overly saturated market?

Bottom line: China’s dual circulation plan sounds great in theory. But last we checked, alchemy is still impossible, and demand cannot be created out of thin air. Further smudging China’s dance floor is its traditional state-led economic model that is now at odds with its ambition to grow domestic demand – two pursuits that are unlikely to step in beat anytime soon.

Further Reading


Blasting Off on All Fronts (Almost)

To pre-virus levels…and beyond! China’s manufacturing sector is blasting off at rates unseen since 2011. Caixin’s Manufacturing PMI hit 52.8 in July, up from June’s 51.2. The increase is particularly encouraging given the smaller manufacturers that the Caixin Index surveys – a sector heavily burnt by the outbreak.

The outbreak had stalled the engines of the Chinese economy earlier in the year, resulting in its worst three-month period in decades. Manufacturing in parts of China freefell amid lockdown measures and factory closures, with SMEs particularly impacted. Now, production is skyrocketing past pre-coronavirus levels as stimulus and reform-driven foreign inflows boost domestic demand and manufacturing.

Bottom Line: We already mentioned that we see serious flaws in Beijing’s strategy to turn towards the domestic market to fill excess production capabilities. Regardless, while certain economic indicators should be viewed with the utmost skepticism (employment *cough *cough), domestic manufacturing has indeed recovered nicely, preparing the Chinese economy to launch upon clearer skies.

Further Reading

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Economics | Markets

Chipping Away at the Status Quo

Black Friday came early for Chinese companies as they go on a shopping spree for chips before US tariffs and other trade restrictions spike prices on goods passing through Hong Kong.

With the city’s special trade status revoked, Mainland companies expect that punitive trade restrictions will complicate supply chains – particularly in sensitive industries like telecommunications that rely on Hong Kong’s relaxed import-export laws to source chips. IF (IF we could caps, bold, AND underline that, we would) sensitive technologies are still allowed to pass through Hong Kong, you can bet that Chinese firms will have to pay a premium to import the same goods from other countries.

Domestic companies aren’t waiting around smelling the plum blossoms, but instead shopping with a frenzy, as re-exports to China jumped by 11% in the first half of 2020.

Looking forward: It concerns Beijing to no end that Chinese supply chains are so dependent on foreign chip suppliers, which has driven a hard push over recent years to quickly develop domestic precision manufacturing capabilities. But, until there’s a breakthrough in these technologies, Chinese firms must resort to the next best option – buy, buy, buy like there’s no tomorrow.

Further Reading

Finance | Industry

A SWIFT Departure from the Conversation

China’s pivot away from the West continues as domestic banks are forced to plan for a reality without access to the SWIFT financial communication network. Under the looming threat of US sanctions, Chinese banks are beginning to plan for a switch to China’s own homegrown Cross-Border Interbank Payment System.

The sanctions would target banks that service any officials that played a role in passing Hong Kong’s national security law, isolating Chinese banks – and their clients’ money – from the global grid.

While capital controls already limit the outbound exposure of Chinese institutions to broader global financial system, abandoning SWIFT could impair China’s ability to charm foreign capital into Chinese borders. The CIPS network is also a far cry from mature, processing a mere US$19.4 billion against SWIFT’s US$5+ trillion per day.

Bottom line: The transition will force the CIPS network to scale – QUICKLY. The initial plunge would sting – like ripping off a band aid – but just as the outbreak forced companies to innovate or die, a forced transition to CIPS with the full support of the country’s resources could ultimately speed up the timeline for Beijing’s dream of a Chinese alternative to the US-led financial system.

Further Reading

Economics | Policy

Zigzagging in a Zugzwang

The EU seems to be the latest nation to toe China’s clear line approach to Hong Kong. The bloc will be slapping sanctions on China over the not-so-autonomous semi-autonomous region’s National Security Law, with new restrictions limiting the distribution of equipment and sensitive technologies for end-use in the city, while also considering easing visa rules.

The sanctions aren’t likely to have a significant impact on China – though they’re more representative of the zugzwang that the EU currently faces. The EU is like a child stuck in the middle of a messy divorce: on one side is the US, urging the EU to follow its lead towards the lofty cause of democracy; on the other end is China, who promises economic opportunity in exchange for autonomy in its handling of ‘internal affairs.’

Bottom line: Though these sanctions are more symbolic in nature than anything, the gesture will still not sit well with China – a nation that finds itself at increasing odds with much of the Western world. It’s unlikely that the EU will join its ally across the pond in full out rivalry against China, though these sanctions likely signify the first small step towards a shift in EU-China policy.

Further Reading

Economics | Trade

Chinese Trade Lays a Path Forward Without the West

China is considering a new series of free trade agreements to rebalance trade objectives with its national interests. Two of the largest agreements in history, the RCEP and TPP11, may not only help China expand its economic footprint, but also act as a backdoor should old trade relationships fall apart.

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