Oil and Gas

China's Covid resurgence is part of the reason oil prices plummeted from record highs

Key Points
  • The Russia-Ukraine war, now into its third week, has caused oil prices to be volatile in the past week or so.
  • Crude prices fell back drastically in the beginning of this week, dropping more than 27% below recent highs to less than $100 a barrel.
  • China has started to clamp down on the Covid spike – the worst since 2020 - ordering lockdowns and a pause in manufacturing in some cities.
  • Markets probably also took into account Russia's Foreign Minister Sergei Labrov indicating that Moscow would allow the Iran nuclear deal to go ahead — that would allow the resumption of oil supply into the market.
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China's recent Covid wave and subsequent lockdowns have helped oil prices ease from record highs reached roughly a week ago, according to analysts.

"We have the re-emergence of Covid in China, which is throwing another spanner into the works when we're trying to assess what the demand will be," said Richard Gorry, managing director of JBC Energy Asia.

He also said markets are still grappling with the disruption of oil supply caused by the Russia-Ukraine war.

Oil prices have been volatile in recent sessions, spiking to record levels not seen since 2008 just a week ago, reaching above $130 per barrel. But crude prices then fell drastically, dropping more than 27% below that recent high to less than $100 a barrel earlier this week.

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"The OPEC in their monthly reports have not changed their demand forecast, which suggests that it is business as normal," Gorry said. "I would tend to believe that that will probably change in the months ahead, because if we look at China, for example, right now, we have 45 million people under lockdown, like it was in 2020. And we know from history that this does have an impact on oil demand."

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In the last few days, China has clamped down as it grapples with its worst Covid spike since the pandemic began, ordering lockdowns and a pause in manufacturing in some cities. Manufacturing hub Shenzhen ordered businesses to suspend production, which affected companies like Apple supplier Foxconn.

China is the world's biggest oil importer and any reduction in demand would have an impact on energy prices.

While "it's tempting to attribute the fall-back in oil to optimism towards an early cessation of hostilities in Ukraine," it's more likely a combination of reasons, according to Ray Attrill, head of foreign exchange strategy at National Australia Bank.

"[The fall in oil prices] more likely reflects a combination of some speculative froth being blown off, alongside fears of weaker China demand as more Chinese cities are put into lockdown amid record high Covid case numbers — as tiny as these are relative to most other parts of the world," he wrote in a Wednesday note.

Recent outbreaks have infected more than 15,000 people and stem primarily from the highly transmissible omicron variant, China's National Health Commission said Tuesday, according to state media.

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Furthermore, Russia's Foreign Minister Sergei Lavrov indicated Moscow would allow the Iran nuclear deal to go ahead, which would lead to the resumption of oil supply. Talks to revive the deal were previously stalled by demands made by Russia, one of the core participants of the deal, according to Reuters.

"There are hopes a nuclear deal with Iran may soon be concluded, which may bring some stability to the Middle East and shore up oil supplies," said ANZ Research analysts Brian Martin and Daniel Hynes.

Bob McNally, president at Rapidan Energy Group, however was less optimistic.

"The Shenzhen lockdowns and Lavrov saying that Russia could live with the Iran nuclear deal, and there's talk of a deal between Ukraine and Russia. So I understand why we took out all the risk, but I don't think it's over yet," he told CNBC's "Street Signs Asia" on Wednesday.

"So I'm afraid we probably have to go higher before we go much lower," he said, of oil prices.

— CNBC's Evelyn Cheng contributed to this report.