What China's Stock Market Implosion Means for Oil

The last time I revisited the Chinese stock market, it was in the throes of a major bear market. Fast forwarding to now shows things have only intensified with the Shanghai composite trading at less than half of its top in October 2007:

While we quibble about a percentage point here and there to see if our market decline fits into the classic definition of a bear market, there are no qualms regarding that in China.

Support?
The scary thing is that even after falling so much, the index is still far from major support areas. If you look at the link above, you’ll see a long-term chart of the Shanghai composite going back to its founding. According to that chart, significant support is somewhere in the vicinity of the 2000 level. That would put a potential fall to almost 70%!

I have no idea if that will happen but the Chinese stock market certainly has precedent. It is not for the faint of heart. The Shanghai Composite can go ballistic: rising as it did going tenfold in the span of a year (1991-1992) but it can also lapse into deep stagnation, as it did from 2000 to 2007, treading sideways.

Dire Portents
But what interests me more is the portent of such a dramatic decline for the price of crude oil. From what I read, China holds significant responsibility for the current price of oil because of its voracious appetite. But if the stock market is a forward discounting mechanism, that means that the Chinese economy is about to decelerate or even go into a tailspin.

The corollary of that is lower demand for oil and, if I remember Economics 101 correctly, that would mean a lower oil price - all things being equal.

Comments

[Peter Martin]

Does this analysis account for the capped prices that Chinese consumers pay for oil?

[mkreisel]

"Does this analysis account for the capped prices that Chinese consumers pay for oil?"

You assume the Chinese government will subsidize the gas prices forever, huh?

I'm wondering how long they can still hold out.

[logicalthought]

Capped prices or not, if people are suddenly (at least for a few years) buying far fewer cars and trucks...

[Sophisse]

I don't think the wealth effect is going to have too much of an effect on the average chinese citizen. Most people don't own any shares at all. What matters to them is economic growth, which is still strong in china. As long as their economy grows, they will burn more oil. That will be true even if the government ends their subsidies, though I'm sure that would cause a slowdown in oil usage growth and very likely a short-term contraction of usage.

[Dogcrap]

"Most people don't own any shares at all."

No kidding and SO WHAT...

If 5% of the population owns a car this year and 6% of the population is projected to own a car next year. Then you had 20% growth!!!!!! The minority of people that experienced an explosion of wealth is what created the explosion in consumer consumption - IN TERMS OF PERCENT.

The Chinese wealth effect from the stock market is the same as the American Wealth effect from the housing boo. Take it away and you take away the growth.

[Woz2000]

How much has high oil prices affected Americans? The answer is not much, mainly because there is so much wealth here. The same is happening in China. As more Chinese discover the luxuries that wealth brings, there will be an abundance of Chinese moving up the economic scale and consuming more goods including oil.

[Alex_G]

China is very inefficient in converting energy use into GDP, the USA being 4x and Japan being 9x as efficient. Right now, their government is subsidizing energy costs, to what degree is anyones guess. The net effect of this is transferring a portion of their foreign reserves to energy exporters.

High energy prices will affect China far more than the US or Europe. Manufacturing based economies are more energy intensive. As long as oil and coal prices stay at sustained levels, I believe this stock market will face continued downward pressure.

Watch what happens to energy subsidies in China after the Olympics. There might well be energy price protests.

I don't have the time to delve into the hard numbers and quantify the exact effects to their economy with any accuracy, so if anyone else has done the work, please share!!

[James V]

The smart money exited the stock market a long long long time ago.
Currently the losers are as normal the dumb money consisitng of un-eductaed gamblers from all over China who are stuck in the market.
There are no margin calls because no one can buy stock on leverage. There are also a number of companies that used their companies cash-flow and borrowing facilities to purchase cross holdings to gamble on the market in the name of business diversification.

The markets drop will affect some people but not broadly. The middle class hold more property than stock and because of revelent strenghth of property prices there net worth has not fallen. It is actually this property net worth and inflation expectations that is driving rise in consumer spending in China.

I disagree that there is no support technically in the market until 2000. There is very strong support at circa 2550 (2007 low). At levels around this the amrket is a buy.

Remmeber the main drag on the amrket is Petrochina because earnings are being destroyed by the government subsidy actions in the fight to control inflation rather than deal with route cause of rmb undervalution. If they do raise price of oil, then we will see a very good rally in petrochina.

In terms of efficiency - everything about China is very inefficient.
This is the reason that they need to undervalue the Yuan and subsidise everything in sight to compete.

[E.D. Hart]

The end of subsidies may be offset by the revaluation in a proportionate amount of the Yuan. Higher Yuan and the prices rising from the end of subsidies dont mean so much.

[Alex_G]

Eric,

Yes, China could immediately cut energy costs by letting the Yuan float higher, but that would also make their products less attractive on the world markets. A bit of a catch-22, I would say...

[Anguished]

I think we should worry more about american oil consumption and its impact on oil price when the Us stock market crashes in the coming quarters, rather than somewhere else. So far, Us subprime has barely hit 20% and US is in recession, imagine what happens when the Alt-A, ARMS, credit cards and corporate bonds start to default in the coming quarters.

Americans consume 30% of global oil production, china accounts for less than 5%. Oil prices would really feel the pain when US enters the second phase of the credit deleveraging.

Its a bit the wrong question, but correct answer.

[Alex_G]

Joe L,

You said:
"Americans consume 30% of global oil production, china accounts for less than 5%. Oil prices would really feel the pain when US enters the second phase of the credit deleveraging."

Pardon me for saying so, but what the hell does that mean?? Does credit de-leveraging mean the USA will be using more oil? What? It's a bit the wrong question, a lot the wrong answer and basically the wrong dimension.

Sorry for being a bitch, but really...

[User 212090]

BABAK,
Is there any etf which tracks the SSE Index (Shanghai Composite Index)? There are ETFs from Powershares/ishares and SSGA but none of these track the SSE

[paultaut]

The only way Oil, in terms of the light grade, will fall sufficiently is if the US grinds to a virtual stop.

The growth of the BRIC plus other underdeveloped and emerging countries will be able to accelerate unhindered. Think in terms of the Eurozone but subsitute BRIC+ for EURO. Include Bartering instead of cash (China is already doing this in Africa) for some of the poorer nations.

Europe doesn't try to impose its will on these countries and will fare far better than the USA.

Instead of trying to renegotiate trade treaties with resource rich countries to benefit ourselves, we should strive to accomodate ourselves to the new world order where WE do not really have much to offer but need all the resources they can provide. 70% of our GDP is Service.

We used to be 40% of the worlds GDP, we are now around 20%. We will have to catch pneumonia rather than a cold to serious affect the rest of the world.

[bigtoe]

It seems like everytime oil prices fall a report comes out on shortage of supplies, unrest in Nigeria, or something else, and oil prices go back up. I don't know a lot about finiace other than to check my 401k and to balance my check book, but there has got to be some other answer to the oil problem than just the possible implosion of another countries stock market. I do understand how that could possibly bring oil prices down but that's not a complete answer to our problems here.

[eplurbisunum]

sounds good all markets will correct

[Itsonlymoney]

Yes bigtoe, you may not know much about finance but your sense about market manipulation by big producers is right on. Iran and Venezuela in particular are highly dependent on high oil prices and are poking us in the ribs every time oil prices soften. And our Cowboy-in-chief is practically falling out of his saddle when this happens. Look for more trouble from both of them if oil prices start to decline. Lets hope our next administration has it's feet on the ground in international relations.

[gashouse gorilla]

>> China is very inefficient in converting energy use into GDP, the USA being 4x and Japan being 9x as efficient.

Recent implosions in structured finance should be a lesson to be skeptical about accounting and what it does or doesn't hide.

For instance, do those calculations back out the fictitious contributions from the USA's FIRE sector? If most US revenue (and profits) come from manufacturing that's been outsourced to China, how "efficient" are we really?

Sorry, but each time I read figures like these, I hear "we're #1" and visualize foam fingers on the people doing the calculations.

[Mile]

This is the time to go into china - big time. The reason? The Olympics. The Chinese Gov is not going to let the little people lose more money as the prepare for the biggest celebration in Chinese 5000 years of history. The eyes of the world will all be looking at China with a 24 hours coverage of the Olympic games. Again and again we will hear how China IS the future and how the market is down 50% in the last few month, meaning this is the time to buy. They will go on and on about if you are not getting into China now, you will miss the train forever. That's why I say this is the right time to go into the Chinese market, and big time. From here an up until at least the end of August there is only one way - up!

[wowser]

anyone here been to china? on the real people level there is gas shortages all over the country ...like 1/2 mile lines to wait for 10 gallons(equate to liters of course)the average chinese person i know has a gambling problem either with games or buying realestate that they only own for 70 years ...this kills the appreciation that resale used to do in USA no nest eggs here...fuel will kick chinas butt ours also ...the guy with chavezzzzz and others like him on his mind is dead on ...new crusade ..with oil not bullets

[User 142738]

I beg to differ, Mile. Let's put the politics and supremacy complexes aside.

The majority of the Shanghai composite's moves lately have been led (up and down) by China's domestic major oil producers. They have to sell their oil to producers at an artificially low price by the Chinese government. When oil prices rise, they lose money; that explains the drama (2% losses or more daily) in the past few weeks. The minute a rumor surfaced about allowing domestic oil prices to rise, the SSE jumped 5%. Imagine what the U.S. stock market would look like if the Dow or S&P 500 were dominated by flaky banks and airlines other than Southwest: it would look horrible as well.

The parallels between the Chinese oil companies and the American airlines are strikingly similar: they are being thrown back and forth by their respective governments' regulations and they are dependent on subsidies.

I've seen this scenario unfold before. Several people are expecting SSE to follow the Nikkei circa 1990. That probably explains the various support levels being as low as 2000 (67% from their high, much like the bubbly Nikkei back in the day).

[gashouse gorilla]

>> The parallels between the Chinese oil companies and the American airlines are strikingly similar: they are being thrown back and forth by their respective governments' regulations and they are dependent on subsidies.

Yes. And this is one of the worst things a government can do: keep changing the playing field. How is an oil company supposed to decide on the best level of investment? C'est impossible.

It's like the tax code: I wish people would just leave it alone. The biggest beneficiaries of "constant change" are H&R Block, Intuit, etc.

>> anyone here been to china? on the real people level there is gas shortages all over the country ...like

Heh heh...They have Nixonian price controls -- and its effects!

I wonder: if they were to eliminate price controls, are Chinese willing to pay a lot more per gallon? Would the availability of more fuel at higher prices actually result in *more* rather than less consumption? That could be a surprise to people -- such as myself -- who expect eliminating subsidies/price-contro... to reduce consumption. I'm eager to see what happens here...

[mkreisel]

Hehe, China is raising fuel price by 18%, today!

As I said a few days ago, they couldn't take it much longer.

And for those who think China and India are invulnerable juggernauts, I can only shake my head.

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