Tight global oil supply conditions and firming global growth suggest that even as the Chinese economy continues to slow, energy prices will trend higher.
E arlier this week, we highlighted that one downside risk to metals prices is that import demand from China could relapse if the current metal inventory accumulation phase in China ends before Chinese final demand picks up. But this is not the case for oil prices: a soft landing in China is not a barrier to further gains in petroleum prices and related assets.
True, a combination of higher energy prices and a tighter policy stance cooled China’s appetite for new car purchases and slowed oil consumption growth. But this is not enough to alter the global supply-demand balance. Although overall car purchases have flattened from a very high level, SUV sales in China are robust and the share of SUVs in total vehicle sales doubled over the past two years, despite a similar increase in oil prices.
This supports our view that oil prices are not yet “too high”.
Furthermore, Chinese oil import growth has accelerated to make up for a slowdown in domestic production. This will continue to put pressure on global oil balances, despite a slowdown in Chinese growth.
Indeed, global spare oil production capacity is below what is required to fuel a global economic upturn. The average draw of spare capacity over the business cycle is about 4-5 million barrels per day. Current available capacity is only 2 million barrels. OPEC could potentially produce about 3.5 million more barrels of oil per day but oil prices tend to come under strong upward pressure when spare capacity approaches the 1.5-2 million barrels per day level.
This implies that higher oil prices will be needed to ration demand and encourage substitution.