China economy concerns weigh on oil prices

Concerns over China’s economy hit oil prices as both Brent and West Texas Intermediate fell on Tuesday following the release of more disappointing data from the world’s second largest economy.

Industrial production in China rose by 3.7% in July from a year ago. However, it was below the 4.4% increase analysts had anticipated.

Retail sales also rose by 2.5% in July, compared to the year before, but this was also below market expectations.

Meanwhile, urban unemployment rose to 5.3% last month from 5.2% in June and real estate investment fell by 8.5% from a year ago, as of July.

The latest data follows a recent official survey release showing exports in China were down 14.5% year-on-year in July and factory activity also contracted for a fourth consecutive month.

Oil prices reverse gains

West Texas Intermediate (CL=F) declined 0.17% to trade at $82.39 (£64.81) a barrel, while Brent crude (BZ=F) lost 0.08% to trade at $86.10 a barrel.

The crude losses follow seven weeks of gains for the commodity on tight supply concerns following Saudi Arabia’s decision to extend production cuts into September. Russia has also extended its crude cuts.

Susannah Streeter, head of money and markets at Hargreaves Lansdown, told Yahoo Finance UK: “Concerns swirling about the health of the world’s second largest economy are putting pressure on commodity stocks amid expectations of weakening demand for crude, oil metals and minerals. China’s increasingly sluggish growth indicators are a nagging worry with retail sales numbers, industrial output and investment data coming in lower than expected.

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“The triple disappointment immediately prompted the People’s Bank of China to cut a key medium term loan rate, but it failed to stem a fresh weakening of sentiment. Policy action overall has underwhelmed, and investors are looking for a lot more welly before being more confident that the economy may have more insulated from the downturn.”

Worries about deeper cracks appearing in the Chinese property sector are exacerbating concerns, after real estate giant Country Garden (2007.HK) defaulted on key interest payments and flagged multi-billion pound losses for the first half of the year.

“Fresh uncertainty about what lies ahead for the Chinese economy and expectation of lower demand for energy in the vast country has prompted falls in oil prices, with Brent Crude dipping below $85 a barrel this week after a run of gains since late June, putting pressure on oil giant BP (BP.L) and Shell (SHEL.L),” Streeter said.

Stronger USD weighs on oil

The US dollar (USD) has also been weighing on oil prices with the index extending gains after a slightly bigger increase in US producer prices in July.

The data lifted US treasury yields despite expectations the Federal Reserve is at the end of a campaign of hiking interest rates.

A stronger USD tends to put downward pressure on oil prices as it makes the dollar-based commodity more expensive for buyers holding other currencies.

Crude cuts supporting price

Despite concerns over China’s recovery from COVID-19 pandemic restrictions, supply cuts by Saudi Arabia and Russia are expected to erode oil inventories over the rest of the year.

This could potentially support oil prices or drive them higher, the International Energy Agency (IEA) said in a monthly report on Friday.

Longer-term perspective

Russ Mould, investment director at AJ Bell, said second-guessing daily movements in anything, especially a liquid asset like oil, is difficult, because in the short-term positioning and leverage (whose positions are funded by debt and thus most of risk of being closed out by chief risk officers) can be the most important factors.

“It is only over the long-term that more fundamental influences such as supply and demand, sanctions and geopolitics, environmental issues and technological advancements will really shape the price of crude,” he said.

“Oil prices are dipping just below $86 a barrel after a strong run since early June and one explanation traders are offering is the rash of weak economic data from China. It is quite possible the disappointing data from the world’s second largest economy is tempting some to lock in any near-term profits that they have.”

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OPEC+’s latest monthly report forecast that China will consume an average of 15.8 million barrels of oil a day in 2023, roughly 15% of global demand.

“If China’s economy weakens, there could be a chance that forecast proves too optimistic and that global oil supply and demand are not quite as tightly balanced as some may think even if coal is still China’s primary source of energy,” Mould added.

Moreover, Mould pointed out how OPEC’s supply-side strategies, ongoing American economic strength, Western sanctions on Iranian and Venezuelan supply and America’s need to replenish its Strategic Petroleum Reserve at some stage could yet help to underpin the oil price, especially as global demand continues to grow and rig activity remains relatively subdued.

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