Dynamic clearing’ turns China’s economic indicators to red
China’s relentless battle against Covid-19 continues, with the country’s ‘dynamic clearing’ policy requiring all local governments to implement strict containment measures as soon as local cases climb into double figures. Shanghai has grabbed global headlines, but the current outbreak has spread widely across China.
GDP growth had already decelerated to 4.8% year-on-year in Q1. But with both full and partial lockdowns ramping up since March, China’s economic indicators have plunged further into the red. We now expect China’s GDP to slow further in Q2.
What is the prognosis for China’s economy through the rest of 2022? How is ‘dynamic clearing’ impacting China’s demand for energy? And what does the slowdown mean for global energy prices? To understand more, I spoke to Yanting Zhou, our Head of APAC Economics.
How serious is the Covid situation in China?
In terms of actual numbers, the current outbreak remains modest The difference, of course, is China’s ongoing commitment to its zero-Covid policy. Almost all provinces in China have imposed lockdown measures at some level, with many local governments still cautious about easing containment measures even as case numbers fall. By last week, provinces with active measures in place accounted for around 70% of China’s GDP.
Which sectors of the economy are hit hardest?
Logistics, services, and manufacturing are bearing the brunt. Under huge pressure to deal with outbreaks, local governments have taken aggressive measures including preventing drivers from crossing provincial or city borders. At its peak on 10 April, over 6% of China’s highway exits were closed, and according to AutoNavi’s highway traffic data, mobility on China’s highways fell by almost half between 15 March and 19 April.
In this environment, China’s households have tightened their purse strings. Retail sales registered the first year-on-year decline of 3.5% in March since the pandemic broke in 2020. We expect retail sales to remain in contraction in April as lockdown continues.
Manufacturing is also impacted, with industrial production slowing to 5% in March from 7.5% in January and February. This sounds bad, but the worst is still to come as more factories will likely reduce operations through April and May.
As a result, in our latest China Economic Focus Insight we now see full year GDP growth looking more like 4.8%, well short of the government’s target of 5.5%. Uncertainty in China is also contributing to our downward revision in global GDP for 2022.
How is ‘dynamic clearing’ impacting Chinese energy demand?
Demand fundamentals have inevitably been weakened by ‘dynamic clearing’. The most immediate impact has been on China’s oil demand, with lockdowns cutting to the quick of domestic transport fuel demand. Long-distance trucking is an obvious casualty, though intra-city transportation and domestic air travel are also taking a hit as residents stay put. Gasoline and jet fuel demand fell by 9% and nearly 40% year-on-year in March, and we anticipate demand to fall by 18% and just over 50% respectively on the same metric in April.
China’s electricity demand has slipped in line with the slowing economy. China saw flat demand in March compared to growth of over 8% in 2021. Faced with record coal and gas prices, thermal generation output fell by almost 6% in March. But at the same time, China continues to boost domestic coal supply to ensure energy security, easing pressure on domestic coal prices.
Chinese gas demand – and LNG in particular – has had a torrid start to 2022. Already squeezed by slower economic growth and record LNG spot prices, gas demand barely grew in Q1. Chinese LNG buyers, clearly spooked by high prices, are now reeling from lockdowns. From our previous expectation of China’s LNG demand rising by 10 Mt of LNG this year, imports will fall by 4% over 2021. Bad, but could still get worse – LNG imports have fallen a whopping 16% so far this year.
What does this mean for commodity prices?
In combination with the Russia/Ukraine conflict, inflation fears and supply disruptions, lockdowns in China are contributing to commodity price risk. In this environment, oil market volatility is set to continue, with the potential for more widespread and prolonged lockdowns into May and beyond, skewing the near-term risks for China’s oil demand – and prices – to the downside.
For LNG, weak China LNG demand has resulted in a long Asian balance, forcing price parity to Atlantic LNG, though prices remain volatile and are trending downwards as abundant piped gas and LNG imports are pushed into storage in Europe.
Softer thermal power generation and increasing domestic coal production is gradually feeding through into prices. China’s benchmark Qinhuangdao price, currently around RMB1100/t, is expected to cool to RMB1000/t in May and fall further to around RMB700/t by late summer.
When can we expect recovery?
We do see reasons for optimism, but much depends on the confirmed case count data. In Shanghai, the government recently announced plans to resume industrial production after three weeks of lockdown, with manufacturers receiving approvals to restart. However, with strict protocols in place, progress will be slow. Assuming the current wave of the pandemic is under control by mid-May, we expect material improvement in manufacturing activity.
Further out, much rests on the government’s commitment to dynamic clearing. While proving effective at reducing transmission, the Shanghai lockdown has eroded support for hard lockdowns. With rising public opposition, we now see a greater possibility that the government will relax its current Covid control protocols before the November Congress of the Communist Party.
Source: Wood Mackenzie