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How China Is Creating a Big Crack in the Global Crude Oil Market

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China’s stock market 

Chinese large cap stocks (FXI) fell by 5% in yesterday’s trade. Chinese equities fell by 16% in 2016. The slowing Chinese economy and the devaluation of the Chinese yuan are weighing on the global oil market. Why is China devaluing its currency? Chinese manufacturing is contracting, and the stock market is crashing. Thus, the Chinese government is trying to boost its export-driven economy by devaluing the yuan. The yuan is pegged with the US dollar, which means the People’s Bank of China controls the movement of the yuan within a narrow range. The yuan has appreciated against the US dollar by 50% since 2005, which has led to lower margins for exporters.

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Chinese yuan and crude oil

If the Chinese government lets the Chinese yuan depreciate to 7.7 with respect to the US dollar, China’s exports would increase by 10% in 2016 compared to 2015. This would add 0.7% to China’s economic growth, per data compiled by Bloomberg. This would also put more pressure on the oil market.

Weaker demand puts pressure on Chinese oil producers such as CNOOC, PetroChina (PTR), and Sinopec (SNP). These stocks also fell in yesterday’s trade. Morgan Stanley estimates further depreciation of the yuan could push crude oil prices even lower. Read the last part of this series to learn more about the latest crude oil price forecasts.

China’s foreign reserves

The devaluing of the yuan will lead to a reduction in Chinese foreign reserves and an increase in capital outflow from China. It is expected that $670 billion could flow out of China. However, China’s foreign reserves are above $3.4 trillion, which means the marginal drop of $670 billion may not have a big impact. Negative sentiment from investors is weighing on the Chinese economy and leading to panic selling around the globe.

Impact 

China-focused ETFs like the iShares China Large-Cap ETF (FXI), the iShares MSCI China ETF (MCHI), and the SPDR S&P China ETF (GXC) are affected by the roller-coaster ride in the Chinese stock market. The record-low crude oil prices also affect upstream players like ConocoPhillips (COP), Anadarko Petroleum (APC), Whiting Petroleum (WLL), and Continental Resources (CLR). They also affect energy ETFs like the PowerShares Dynamic Energy Exploration & Production Portfolio (PXE), the Vanguard Energy ETF (VDE), and the ProShares UltraShort Bloomberg Crude Oil ETF (SCO). The depressed energy market continues to put pressure on broader indexes like the S&P 500 Index (SPY).

 

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