U.S.-China Trade Issues Loom Large for Oil

Mohammed Barkindo, Secretary General of the Organization of Petroleum Exporting Countries (OPEC), is worried about the U.S.-China trade war. Even though oil prices seem to be stabilizing, Barkindo told CNBC News that OPEC was “concerned about the lingering trade disputes.” Last week, it was reported that China’s car sales fell by 6 percent in 2018, the first annual decline seen in more than twenty years, amid signs that China’s economy could be slowing down and consumer sentiment turning more pessimistic.

Chinese oil demand, which represents over 12 percent of total world demand, is a linchpin to global oil markets. When China’s economy slows significantly, the effect on oil prices can be dramatic, potentially leading to single digit prices, which has happened in the past. Typically, an economic slowdown in China has historically sent shockwaves through the rest of Asia, weakening oil demand across the region. Oil traders, OPEC, and just about everyone else is hoping that Beijing’s planned stimulus will be sufficient to turn trends around, staving off what is feared to become broader global recessionary pressure. But this time around, the situation is more complex than what a Chinese stimulus could be able to address. Larger, more geopolitical issues are looming. These geopolitical factors will be harder to resolve and could easily become structural.

Bruce Jones of Brookings argues that U.S.-China relations are at a turning point which he defines as the “closing of an era of expanding cooperation.” Jones argues that President Xi Jinping’s more assertive global and military strategy, combined with his crackdown on domestic dissent and internment of Xiajiang Muslims, is prompting a reevaluation of China, not only by the Trump administration but by a larger cross section of American political leaders, academia and business leaders. The previous American assumption that the deepening of commercial, diplomatic and cultural ties between the United States and China would transform China into a status quo power and liberalize China’s internal political development is now being seriously questioned. China’s flirtation with consumerism has not produced a society trending to openness and its nascent local environmental movement has not spurred on democratic principles, as previously supposed. Rather, what was ten years ago a decentralizing political culture has snapped back to central authoritarian rule revolving around a strongman leader who has removed term limits for his post.

In a sign that progress on trade issues is not moving in the right direction, the U.S. Department of State and Canada’s Foreign Ministry recently issued a travel warning for China due to arbitrary enforcement of local laws and possible special restrictions on U.S.-Chinese dual nationals. The warning comes in the wake of the arrest of Meng Wanzhou, the chief financial officer of the giant Chinese tech firm Huawei, in Canada, at the request of the United States. The Chinese firm, China’s largest telecom equipment maker, has been under U.S. investigation for alleged violations of American trade control laws with Iran. China issued a similar warning to some of its state-run companies to avoid business trips to the United States, Britain, Canada, Australia and New Zealand.    

The arrest of Meng Wanzhou is just a small part of a larger policy afoot to rein in China’s voracious appetite for sensitive American technologies. The Trump administration is giving high priority to the U.S. national security implications of China’s push into artificial intelligence, automation, and information technology as well as Beijing’s willingness to gain sensitive U.S. technology by a variety of means, including outright intellectual property theft. Last year, the Trump administration blocked Broadcom, the Singapore-based chip maker, from taking over American firm Qualcom, citing Broadcom’s relationship with foreign entities such as Huawei. The U.S. Commerce Department also banned Chinese telecommunications equipment firm ZTE from using U.S. components amid accusations that the Chinese firm had violated U.S. sanctions against Iran and North Korea. The ban was lifted after ZTE paid a hefty fine, replaced its leadership and agreed to U.S. compliance inspections. 

But the U.S. administration’s views on U.S.-China trade are wider than the specifics of telecommunications technologies like 5-G. At issue is a broader view on the security of globalized supply chains. Some louder voices inside the administration’s internal U.S. trade policy debate argue that the United States should shrink dependence on China for U.S. and global supply chains. They argue that China’s massive Belt and Road Infrastructure Initiative (BRI) and its industrial policy, China 2025, could threaten the U.S. ability to maintain reliable and cost competitive cross border trade on which the U.S. economy and the military rely. Disruption to U.S. international supply chains could have serious consequences for the U.S. economy, jobs and the competitiveness for U.S. companies, for example, as became apparent for businesses that relied on components produced in Fukushima, Japan when it was hit by a tsunami back in 2011. The U.S. military is also vulnerable to supply chain disruptions involving materials and products from China, especially strategic minerals. Conservatives are starting to beat the drums regarding these risks.

China’s BRI has proven an effective mechanism to get Beijing preferential access to investments in ports and other transportation infrastructure. Almost 70 percent of global container traffic flows through Chinese owned or Chinese invested ports, according to a survey by the Financial Times.  But China’s investment in logistics businesses include more than sea ports and warehouses. It also covers energy infrastructure and pipelines, trucking, railways, airports, and shipbuilding. The United States has been forced to respond with an infrastructure fund of its own, despite President Trump’s previous distaste for foreign aid programs. But it is unclear if the U.S. will be able to counter the pernicious financial devastation that can be wrought when a major Chinese infrastructure project goes badly in the developing world, especially in oil for loan deals in Latin America and Africa.

It is important to understand this wider context when evaluating how U.S.-Chinese trade negotiations could progress in the coming weeks. Temporary hiatus in conflicts has been seen as good news for oil exporters but it could belie larger problems ahead.

If the United States is thinking about how to dismantle its reliance on Chinese supply chains, it is safe to assume Chinese strategists are doing the same. That’s bad news for American oil and gas firms that were counting on China as a steady customer for rising exports. China’s imports of U.S. crude oil averaged 377,000 barrels a day (b/d) in the first seven months of 2018 but were zero by September of last year. That’s out of over 2 million b/d of total U.S. crude oil exports and 9.6 million b/d of Chinese imports. U.S. sales of liquefied natural gas were only 4 percent of China’s total 1.53 million tons of LNG imported in 2017, but tellingly, were the third largest market for U.S. sellers. Going forward, U.S. oil and gas exporters alike were expecting their sales to China to be much higher. Access to the Chinese market was also considered critical for the success of future natural gas export projects in terms of financing and end-demand. Lingering uncertainties about U.S.-China trade issues are making it harder for American LNG export promoters to push forward credible deals to beat out Qatari and Russian gas sales ahead of looming multi-year contract renewals.

It’s not just the threat of more tariffs that could plague U.S. industry in the future or even the slowdown in Chinese demand for oil and gas more generally, though these would be a problem for U.S. producers as well. It is also that the rougher the U.S.-China divorce over technology supply chains and logistics infrastructure, the less likely China will feel comfortable relying on American oil and gas supplies. The days when U.S. and Canadian energy to China could have seemed like among the most secure sources could well be over, at least for now, reducing the value to Chinese firms of a 5 year or 10 year contract with an American firm, even if backed with an invitation for an upstream or export facility equity investment. A temporary truce in the trade war could produce an immediate home for some U.S. spot cargoes in China, but it’s going to be hard to inspire confidence for lengthier contractual commitments.  American oil and gas will have to shift to other markets.

At first glance, this could seem like good news for Russia or Saudi Arabia who will have an easier time selling energy to China. But the longer process of dismantling of intensive trade links between the United States and China could eventually produce major headwinds to both the U.S. and Chinese economies. As markets start to wake up to such risks, it will be harder for the price of oil to rally, even with supply cutbacks. OPEC Secretary General Barkindo expressed "cautious optimism" on U.S.-China trade disputes being favorably dispensed because both countries “want to see these issues resolved.” But chances are it will be a long, drawn-out process of recalibration.