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Last week (June 22-26) I again fielded a ton of questions from several media sources on oil. This is my recollection of what I was asked, how I responded, and some support for my thinking.

Question: I'm seeing at least two reports that said China consumption is up a second month, up much more than a year ago and at record levels. Platts recently reported that China consumed 33.23 million metric tons of oil in May, up 6% from a year earlier.

Answer: Demand from China may be up, however, according to the International Energy Agency, global demand for crude is off 2.9 percent year over year; US demand is down 4.9%. Although it might be popular and trendy to talk about China being the “next big thing” the reality is that the tail cannot wag the dog no matter how much it tries. The United States is still the world’s largest consumer of oil by far and should hold this position for the foreseeable future. Unfortunately for China, at least for now, the laws of nature will not be rewritten.

According to the most recent CIA Fact Book figures on Oil consumption the United States currently consumes nearly as much oil per year as the entire European Union and China combined. As a result, based on these figures, when demand from the US is off nearly 5% China’s increases don’t mean much. When looking at the math, a 4.9% decrease in US consumption equates to 1,013,320 (BBL/Day) lost. When that figure is contrasted against China’s consumption gain of 6%, an increase of 472,800 (BBL/Day), the disparity is easily recognizable.

Question: Can Chinese consumption, if it continues to increase, boost oil prices in the near term? Make them significantly higher? Why / why not?

Answer: China is not “really” increasing consumption, and as a result will not be able to affect oil prices indefinitely. Over the past several months (since March) China has been attempting to hoard commodity resources through speculative buying. This heavy buying is being led by Chinese stimulus money which has been flowing into its banking system. Once at the banks, due to lending law differences, this stimulus money is able to be lent out for use within the broad commodities markets. More specifically, Chinese banks are able to book physical commodities as allowable collateral assets and can lend on commodity purchases with physical delivery; this cannot be done by many other places in the world.

Since lending on commodity investment is allowable, Chinese banks and investors have little reason to pour money into expanding export infrastructure which is already far too large for current global demand. As a result, the standard in Chinese lending has changed for the time being. With nowhere else to lend, this type of commodity borrowing has become lucrative for struggling banks and investors alike. To put it quite simply: What is the point in developing more export infrastructure that’s not needed? The recession will eventually end, so rather than increase capacity, existing exporters are trying to deal with the prospects of future; increased input costs and / or inflation.

Besides artificial Chinese demand, it is also important to remember that as a net exporter China still needs the European Union, the United States, and all other industrialized nations to drive its expansion. Therefore, if oil prices were to increase beyond what these economies can currently handle, demand from China would drop off even more significantly.

This phenomenon is very similar to what I wrote about previously in “Oil, OPEC, and Super Contango.” To get back to your question I think demand from China can only grow if the global economy comes back online. At some point speculative purchasing in China will end as stimulus money runs dry and commodity stockpiles grow too high. It’s a global economy now and no one country can efficiently exist without transacting with outside nations. China must know this and I would guess will be very aware of its impact on global oil prices.

Question: What does all of that mean for the oil market? Why is oil still below $70 or just not able to get past $75

Answer: Weak underlying fundamentals for oil and excessive speculation suggest to me that crude may be ready to turn hard between now and July. Around mid summer to early fall I expect to see oil trade between $40 and $55 per barrel. Again, for a more detailed discussion of my long term forecasts please see "Oil at $25 a Barrel? Gas $1.50? The Time Is Coming Soon". From the date of that material we are at the “Medium Term Forecast” point and I don’t see any reason to materially revise my estimates at this time.

Question: Even with all the turmoil in Iran and Nigeria of late?

Answer: The turmoil in Iran and Nigeria are unlikely to materially affect oil prices in my opinion. I feel this way as current global supply, capacity, and demand all suggest that oil production is nowhere near “maxed out”. Since we aren’t at maximum production I feel that small disruptions are unlikely to materially damage current pricing.

When considering the two situations, the unrest in Nigeria is more likely to hurt supply in the near term due to the militaristic nature of those events. However, Nigeria as a global player is less significant to the oil market than Iran. In addition, Nigeria is less likely to get involved in a global conflict as its situation is primarily a civil one. Further, since supplies from Nigeria are unlikely to be completely wiped out, it is probable that other producers will be able to pick up the slack if a Nigerian supply disruption were to occur.

When looking at Iran, although political protesting has been borderline revolutionary, I do not see it resulting in a destruction of oil infrastructure. Iran, as the second largest OPEC nation, would certainly damage global supply more significantly than Nigeria if it went offline. It also has a significantly higher probability of creating a global conflict due to its political positioning. However, since the protesting in that nation is now subsiding, it is unlikely things will escalate further without provocation from the Iranian government.

To summarize, since neither country looks like it will go completely offline as a result of its respective problems and the world is not running at full oil capacity; it is not likely that supply and demand will be materially affected. This of course should hold unless an all out war were to break out in Iran or Nigeria which had global implications.

Disclosure: No positions

Source: China, Iran, Nigeria, and Oil