Why the crude oil shipping industry could bottom

Part 4

China’s manufacturing activity is essential to world oil demand

China’s manufacturing activity

Since manufacturing has been a large part of economic growth in China over the past decade, the country’s economic activity plays an important role in the world’s tanker demand. When manufacturing activity rises, China will import more oil as the country gets wealthier, buys cars, and uses more oil, which would be positive for tankers because more ships haul oil from the Middle East and West Africa. In 2012, China’s oil consumption per capita was only about 24% of major developed countries’.

China Manufacturing State PMI & Oil  Consumption 2013-11-06Enlarge Graph

Purchasing manufacturers’ index

China’s manufacturing PMI (purchasing manufacturers’ index) is an indicator widely followed by money managers, policymakers, economists, traders, and analysts. Because of its timeliness—reported at the beginning of every month for the previous month—it’s highly regarded as a leading indicator for the future demand of dry bulks.

China’s PMI rose to its highest level since April 2014. The PMI, which stood at 51.5 in September, slightly rose to 51.4 on October. Figures above 50 indicate solid expansion, while those between 42 and 50 show possible growth, and levels under 42 signal a potential recession. As the chart above shows, year-over-year growth in oil consumption has historically followed movements in the manufacturing PMI. So you should take the October data as a positive.

Lacking demand momentum

While October’s data was positive, investors should note that last month’s manufacturers’ sentiment wasn’t particularly great. The largest increase in the headline figure—which is comprised of indexes for new orders, production, raw-material inventory, employment, and suppliers’ delivery time—shows only production strength, rising from 52.9 in September to 54.4 in October. While new orders were still above 50, they fell from 50.7 in September to 50.4 in October. So you could say domestic and external demand still lacks momentum.

A period of transition

After falling for much of 2011 and 2012, manufacturing sentiment in China turned up in 2012, as inflation and growth slowed, prompting the central bank to ease monetary policy and provide some juice to the economy. PMI, however, remains weaker compared to historical standards because the new government isn’t eager to provide large stimulus like previous governments did as it tries to rein in shadow banking (think of making loans in the black market with high interest rates) to steer the economy away from public infrastructures to private consumption, and to craft and enact reforms.

Weak growth is not bad

This isn’t all negative, of course. Demand for crude oil has risen at a decent pace over the past few months. While it’s unlikely that we’ll see China’s manufacturing PMI hit above 52 in the short term, or for China’s oil import to surpass United States’ in the short to medium term, it nonetheless helps. As long as we see China continue to grow at a stable pace, consumption should grow and tanker stocks like Tsakos Energy Navigation Ltd. (TNP), Teekay Tankers Ltd. (TNK), Nordic American Tanker Ltd. (NAT), and Frontline Ltd. (FRO) will benefit. The Guggenheim Shipping ETF (SEA) will be a safer way to ride China’s economic growth, as it’s less influenced by falling U.S. crude oil imports that negatively affect crude tanker rates.

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