The script was simple: OPEC and its allies would reach an agreement on future supply and in doing so pave the next leg higher for oil prices. Alas, the reality turned out to be very different. Although the new OPEC+ agreement provided some clarity on the group’s near-term production path, the fact that baseline production levels were raised for several members means more oil supply will be coming back than expected. To make matters worse, this comes at a time that an increase in Delta-variant cases is threatening to stymie the global economic recovery and is hence putting a downer on the oil demand outlook.

The prospect of higher OPEC+ supply in the coming months coupled with fresh uncertainty over the demand recovery from the pandemic is making for a potent bearish cocktail. Yesterday’s initial bout of unwinding quickly triggered a domino effect that eventually morphed into a full-blown selling frenzy. Such was the fierce nature of the sell-off that it bore all the hallmarks of a sharp speculative liquidation. By the close, Brent and WTI were nursing losses of around $5/bbl in what was their worst session since March. Both crude markers are now back below the $70/bbl level for the first time since the end of May. The only saving grace for battered oil bulls is that the prompt timespreads held up reasonably well.

Yesterday’s onslaught will raise the question as to whether it was a knee-jerk reaction or the start of a sustained pullback in prices. Some market participants believe OPEC+ is being overly optimistic about supply and demand balances. Yet, the oil market is still facing a supply deficit over the remainder of the year. This should limit the downside for oil prices. That being said, the market is clearly unsettled about the demand outlook. And rightly so. The rise in Delta variant cases is raising questions about the sustainability of demand. As things stand, it is hard to see prices staging a comeback unless virus jitters are brought back under control.

China loses its mojo

Demand uncertainty has overtaken oil markets amid the rapid spread of the Delta coronavirus variant. But there is another, less publicised factor also at play, namely signs of slowing growth in the world’s biggest oil importer. China’s latest GDP data suggest the nation’s V-shaped economic rebound from Covid-19 is cooling. More worryingly, recent customs data out of China is giving the market some mixed signals that are tilted to the bearish side.

China’s crude oil imports fell to 9.77 mbpd June 2021, down 2% in May and the lowest monthly level since the start of the year. Over the first half of the year, China imported 10.51 mbpd. This was a 3% drop compared to the first half of 2020 and the first such contraction since 2013. At the same time, Chinese refiners processed a record amount of crude oil in June, at 14.8 mbpd, up by 3.9% from May when run rates also broke records, statistics data showed. The average daily run rates for the first half of the year were even higher, at 15.13 mbpd—up by 10.7% from a year earlier, the data also showed.

In short, Chinese refiners are curbing oil imports but boosting fuel exports. This suggests that they are dipping ever more into crude stockpiles. Indeed, they appear to have done so for a third straight month in June, with calculations based on official data showing a likely inventory draw of almost 1 mbpd, according to JBC. The logic behind this behaviour is sound. China’s crude inventories swelled over the second half of last year and provide an affordable alternative to costly imports.

Going forward, China’s destocking activity is expected to continue, which in turn will weigh on future crude imports. This is especially true given that the import outlook for private refineries has become skewed to the downside due to import quota shortages. Independent refiners are expected to curb crude imports in the second half of 2021 after China slashed by 35% the import quotas for the teapots in the second batch of oil buying authorizations this year. What’s more, the government also recently launched inspections over Chinese teapot refiners as part of a crackdown on illicit fuel trade and tax avoidance. This intervention sets the stage for China’s independent refiners to slash their run rates and crude imports over the next few months as well.

Echoing the softening outlook for China’s crude imports are forecasts from Refinitv Oil Research. They show China’s July crude imports fell to 9.55 mbpd. All in all, it appears that the world’s biggest oil importer is consuming less – which would be a bearish signal that the market. Questions are being asked whether the recently announced increase in OPEC+ supply will overwhelm the recovery in demand. Currently, this seems unlikely, although the evidence from the world’s top oil importing nation appears to favour the bearish narrative.