Oil prices have had a spectacular run, rising by nearly 50% since last July, thanks to a potent mix of OPEC discipline, geopolitical risk and strong demand. The rally has moderated in the past couple of weeks, thanks to concerns OPEC’s resolve on supply cuts is weakening just as U.S. oil production is showing renewed signs of vigor. What investors may not appreciate is that demand growth is also poised to slow in the world’s largest net oil importer last year, China.
Chinese petroleum demand still appears fine. Growth bounced back to a healthy 9% on the year in April, twice the rate in March. April’s petroleum burn was flattered, however, by exceptionally weak demand in the same month the year before—and probably by the official end of the government’s winter pollution controls, which had given a temporary shot in the arm to Chinese industry this spring.
Unfortunately the overall trend for the industrial and transport sectors—which together account for about 70% of Chinese oil demand—looks shaky. Growth rates in freight traffic and electricity production both peaked in the third quarter of 2017, excluding January and February figures distorted by the Lunar New Year holiday. Freight tonnage growth is now running at barely half the 11%-12% rate it reached in mid-2017. Weakening global trade, driven partly by the slowdown in Europe, will put further downward pressure on those numbers. Given that background, sustaining Chinese oil-demand growth at close to 10% in the second half of 2018 looks unlikely.
The weakening yuan, which makes oil more expensive for Chinese importers, isn’t likely to help. In yuan terms, Brent crude is up 20% in the past three months alone. But Chinese benchmark diesel prices are only up 12%. Unless China’s state-set benchmarks are adjusted higher in the weeks ahead, Chinese refiners may start to feel the squeeze and cut back on crude purchases.
Oil-supply growth—Venezuela and Iran aside—is suddenly looking a bit bubblier. If Chinese demand goes pop, oil prices and shares could be in for a rocky second half.
Write to Nathaniel Taplin at nathaniel.taplin@wsj.com