By Gao Jinghui, Li Haiyang, Sun Guangmei
Key summary
● China's Petroleum and Chemical Industry Prosperity Index recovered to a normal range on expectations that inventories will see replenishing activities on the approach of a peak season
In the first quarter of 2023, the whole domestic industry faced heavy destocking pressure on the back of capacity expansion and weak demand. At the same time, international oil prices remained high. Accordingly, under the dual pressure of cost and inventory, the petroleum and chemical industry saw profits decline sharply, which pulled down China's Petroleum and Chemical Industry Prosperity Index to a relatively cold range in March. In April, with the rising expectations of a recovery in demand, the destocking pressure in the whole industry was eased. The rebounded oil prices at the beginning of the month drove up the prices of petrochemical products, so the industry regained profits significantly and China's Petroleum and Chemical Industry Prosperity Index returned to a normal range. In the sub-indices, Prosperity Index of Chemical Raw Materials and Chemical Products Manufacturing Industry rebounded month on month, but was still in the overly cold zone, as the chemical raw materials and chemical product manufacturing industry remained oversupplied in line with the onset of start-up of new capacities.
● OPEC+ decided to significantly reduce production from May to defend with expectations of weak demand
OPEC+ announced a surprise cut to production on April 2, 2023. Both Saudi Arabia and Russia reduced production by 500 000 barrels per day, while the whole organization cut output by 1.66 million barrels per day in total, effective in May. Affected by this news, the international crude oil futures prices rebounded by about US$7 per barrel. The production cutback is likely to result in supply shortage of crude oil in the second half of the year as the United States Department of Energy has postponed the replenishment of strategic oil reserves to the third quarter of 2023. OPEC+ unveiled that the production curtailmentis a measure taken in advance to combat the lower-than-expected demand in case of an economic recession. This round of production reduction plan will be effective till the end of 2023.
Suggestions and notes
● Market forecast
The restocking activities may be delayed because of unstable long-term recovering trend.
● Risk alert
The rising risk of an economic recession has led to a sustained deviation of international oil prices from the supply-demand fundamentals. In addition, we should keep an eye on energy supply risks in the summer.
● Overview of China's Petroleum and Chemical Industry Prosperity
China's Petroleum and Chemical Industry Prosperity Index returned to a normal range as it rebounded to 98.85 in April 2023, up by 6.18 percentage points month on month. The Index fell by 4.89 percentage points year on year, indicating that the year-on-year decline was widened (see Figure 1).
Figure 1 Movement of China’s Petroleum and Chemical Industry Prosperity Index (historical average level = 100)
Economic data was relatively stable in April 2023 after China's economic recovery was in a smooth state. According to the National Bureau of Statistics, the manufacturing PMI decreased to 49.2 in April, down by 2.7 percentage points from March, indicating a narrowing trend and hence when to kick off the restocking activities was yet to be decided. The traded volume in China’s real estate market has shifted from an increase to a decrease, with a more significant decrease in supply than in demand, indicating a drop in the supply-demand ratio and hence heavy destocking pressure faced by the real estate market. In March, social financing increased by RMB707.9 billion year on year. New medium and long-term loans for enterprises was at RMB2.1 trillion and long-term loans for residents at RMB634.8 billion, both registering positive year-on-year growth and indicating rising credit confidence. International-wise the tightening of US dollar liquidity kept sweeping the global market. Commodity prices rebounded following the news of OPEC+ production cutback in earl April, but the prices fell in the middle of April. The downtrend continued till the end of the month. The expectations of an economic recession are weighing on the pricing of commodity.
Industry-wise, China's Petroleum and Chemical Industry Prosperity Index increased significantly month on month (see Table 1) because the domestic petroleum and chemical industry saw a significant comeback in the profits on expectations of recovering demand in the peak season. Prosperity Index of Fuel Processing Industry rose by 8.67 percentage points month on month as the demand for travel and freight was increasing in line with higher temperature, reporting the biggest increase among the sub-indices. Prosperity Index of Petroleum and Natural Gas Extraction Industry rose by 3.05 percentage points month on month, with the smallest increase among the sub-indices, and the prosperity index returned to the overly hot zone. Prosperity Index of Chemical Raw Materials and Chemical Products Manufacturing Industry and Index of Rubber, Plastic Products and Other Polymer Products both rebounded by over 6 percentage points month on month, which were consistent with the seasonal characteristics.
Hot spot analysis and future prospect
1. The pricing of international oil will deviate from the supply-demand fundamentals as affected by the expectations of an economic recession
Affected by the news of OPEC+production reduction, international oil prices rebounded by over US$7 per barrel in early April. As for the supply-demand fundamentals, the crude oil market remained in a tight equilibrium state. The United States Department of Energy resumed the regular release of strategic petroleum reserve (SPR) inventory in April (buyers should return the same volume of crude oil), spurring up the inventories of crude oil and refined products recovered in the last week of April, but the increase was very limited, much lower than the decline of strategic petroleum reserve inventory.
However, international crude oil prices fell continuously from the middle of April amid the expectations of an economic recession and tightening financial conditions. At the end of April, Brent crude oil futures fell below US$80 per barrel. The pricing international crude oil has deviated from the supply-demand fundamentals and factored in the risks of economic recession in advance. To put it from another perspective, the pricing deviating from the fundamentals will cause oil companies to reduce the investments in development and research, thereby fewer efforts in shale oil drilling. This will be not conducive to increasing production and refilling inventory, and hence make the crude oil supply chain more fragile.
2. There will be more uncertainties in long-term recovery
The global economic growth is losing some momentum, which will be the headwind for to long-term recovery. In China, a month-on-month decline in the real estate supply and demand data in April indicates that the market will shift from rebounding to long-term growing. It is expected that the year-on-year increase of social financing will remain positive, but the upward room will be quickly narrowed. The manufacturing PMI returning to the contraction range also indicates the uncertainty of recovery, which will further delay the kick-off of the refilling cycle of manufacturing inventories. In the global market, the initial GDP growth in the United States in the first quarter was 1.1% quarter on quarter, a significant slowdown from the previous quarter-on-quarter growth of 2.6% and lower than the expected 1.9%. The core CPI in the first quarter was above 5%, featuring obvious stagflation. The continuously tightening US dollar monetary policy has resulted in higher risks in the US dollar financial system. The unresolved issue of the United States government debt ceiling has led to a significant increase in Credit Default Swaps (CDS) of the federal debt. The United States economy has also showed obvious signs of recession: the month-on-month retail growth rate has turned negative, and the consumption of durable goods has significantly declined; the manufacturing PMI has been in a contraction for six consecutive months.
3. Future prospect
China's Petroleum and Chemical Industry Prosperity Index gained a bigger-than-expected rebound in April. However, from the perspective of the prosperity indicators, the main reason was that the destocking pressure was eased on expectations of strengthening demand for the upcoming peak season. In addition, a rebound in the prices of petrochemical products in line with the rise in international oil prices in early April improved profits in the whole industry and injected confidence to the market again. In other words, the rebound in China's Petroleum and Chemical Industry Prosperity Index in April was still more driven by the cost side rather than the demand side. It is expected that China's Petroleum and Chemical Industry Prosperity Index will be flat or a little lower in May.
