China is downside risk for oil prices as OPEC meets: Analyst

Key Points
  • OPEC meets today amid expectations of an extension of output cuts
  • Major importer China could present downside risk for the oil market, said an analyst
Here's what to expect from OPEC's meeting in Vienna
Here's what to expect from OPEC's meeting in Vienna

All eyes are on the Organization of the Petroleum Exporting Countries ahead of a highly-anticipated meeting later Thursday when the oil group looks set to extend their crude production cuts, but the big downside risk comes from China, an analyst said.

The OPEC and 11 non-members will be negotiating whether to extend an agreement reached in December to cut oil production by about 1.8 million barrels a day in the first half of this year.

"If you wanted to know where the downside risk is, it is not in OPEC's decision or in U.S. driving demand or in global inventories rebalancing. I think China is the big source of concern," said Prestige Economics President Jason Schenker.

Worries about slowing Chinese growth will affect the market, he told CNBC's "The Rundown". The world's second largest economy is also the second largest importer of crude oil behind the U.S.

"If China weakens further, that poses downside risk. But if we see the rebound in the (China Caixin Manufacturing Purchasing Managers Index) and we see Chinese manufacturing PMI as a proxy for global growth improve, then we see some upside potential here," Schenker added.

Crude oil prices were higher on Thursday in Asia on hopes of an extended production cut. U.S. West Texas Intermediate was up 0.7 percent at $51.74 a barrel while European Brent was up 0.8 percent at $54.38 a barrel at noon SIN/HK time.

IHS Energy vice president Victor Shum told CNBC that supply and demand will be balanced for the rest of 2017 with no sharp drawdowns in inventories even with the production cut extended for another six to nine months. Longer or deeper cuts will take "a lot of time and a lot of diplomacy," he said.

OPEC supply cuts this year won't be enough to drawdown inventories
OPEC supply cuts this year won't be enough to drawdown inventories

Moody's Investors Service on Wednesday downgraded China's credit rating to A1 from Aa3, changing its outlook to stable from negative, citing concerns efforts to support growth will spur debt growth across the economy.

That could be problem for the oil industry that has been propped by the East Asian giant.

"Without China, the oil market cannot survive," said industry consultancy FGE's founder and chairman Fereidun Fesharaki at a Center for Strategic and International Studies discussion in Washington D.C. on Tuesday.

Asian demand for crude has grown he added, even as Middle Eastern demand growth has fallen due to reduction in energy subsidies across most countries.

Meanwhile, production has been falling in China, spurring greater imports, he noted.

China imported 34.39 million tons of crude oil in April, about 8.4 million barrels a day and up 5.5 percent from a year ago, Reuters reported.

This is as China's domestic crude oil production fell 3.7 percent in April from a year ago to 15.99 million tons, or 3.89 million barrels a day. Output for the first four months was down 6.1 percent from a year ago, Reuters reported.

Fesharaki said China is likely to import a additional 900,000 barrels of oil a day this year over 2016.

OPEC logo at its headquarters in Vienna, Austria.
Heinz-Peter Bader | Reuters

On Sunday, China announced new guidelines for the oil and gas industry that will allow for more private participation, but the regulated environment will still present headwinds against the backdrop of a challenging macroeconomic environment.

In a report on Tuesday, BMI Research noted headwinds for independent refiners or "teapots" in China, including limited storage and pipeline capacity in the Shandong province, where around 70 percent of China's independent refiners are located.

"Onshore crude stock levels in Shandong are reportedly at a multi-month high, and the volume of crude cargoes stored in floating tankers is on the rise, which points to the need for additional storage and distribution infrastructure to remove supply bottlenecks," said BMI.

"A slew of other policies , including tighter scrutiny of tax compliance could further hamper teapots ' operations, and pose downside risks to teapot imports," the house added.

OPEC's meeting is expected to start at 10 a.m. local time in Vienna (0800 GMT) and will end with a press conference starting at 5 p.m. local time.

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