China’s Worsening Virus Threatens Commodities Supply and Demand

(Bloomberg) -- Almost 80% of the Chinese economy has been affected in some way by the worst outbreak of Covid-19 in two years, straining the supply of commodities and posing an increasing threat to demand.

China’s restrictions to contain the fast-spreading omicron variant have primarily hit travel over both short and long-distances, which is a direct drag on fuel consumption and a complication for supply chains.

The longer that Beijing persists with its Covid Zero policy, the greater the impact will be on the consumption of commodities as purchases are deferred -- think copper for electronic goods or steel for cars. Production is also at risk as inventories of raw materials dwindle and workers stay at home. 

Widespread outages at metals processors, for example, could further lift markets that have already hit record highs in recent weeks because of the war in Ukraine. That would set the inflation-hawks at the central bank and economic planning agency on edge. Still, demand is also likely to shrink at some point, which would leave the net impact on prices uncertain.

Oil Demand

Independent oil refiners clustered in Shandong province have been forced to resell crude cargoes and cut operating rates as demand has slipped. Industry consultant OilChem estimates these refiners, dubbed teapots, have reduced processing to around 50% of capacity. That’s the lowest level in more than five years if you exclude the plunge caused by the pandemic in early 2020.

Dongying, a refining hub in Shandong, imposed traffic controls on some highways on March 16 for an indefinite period, slowing the delivery of fuel. Crude inventories at 20 sites in the province -- where half of China’s teapots are based -- have risen over the past two weeks, compared with the overall national trend of falling stockpiles, according to Ursa Space Systems.

Goldman Sachs Group Inc. trimmed its forecasts last week for Brent crude prices and Chinese oil consumption in the second quarter due to the lockdowns afflicting centers from Shanghai to Shenzhen.

Metals Supply

This week’s lockdown of the key-steelmaking hub of Tangshan has resulted in the idling of some blast furnaces due to tight supplies of vital inputs like iron ore and coking coal. Traffic controls are disrupting operations at some mills in the northern city, which has long played a pivotal role in the world’s biggest steel industry. Tangshan churned out over 130 million tons of steel last year, some 13% of China’s output. 

All of the major steel-producing provinces have some level of trucking restrictions, and mills could soon face a shortage of raw materials, according to Lange Steel Information Research Center, an industry group in Beijing. Tight supply of those materials will be the main driver behind a production drop if Covid-19 restrictions aren’t eased next week, it said.

In base metals, the main impact so far has also been on the supply-side as travel curbs hinder the flow of raw materials and finished products. There haven’t yet been reports of output losses at major smelters, where production is usually protected by local governments to ensure security of supply and given their importance to regional economies.

Still, cuts could be looming. One copper and aluminum fabricator has temporarily reduced output at its plants in Tangshan because of a lack of raw materials caused by the controls there.

Coal Disruptions

The epidemic is disrupting coal production by slowing mining activity and stalling transportation from mines to factories. Queues of trucks waiting to pick up and deliver the fossil fuel are growing longer as they’re forced to navigate lockdown requirements.

That’s posing difficulties at a time when China is pushing for a massive increase in domestic coal output as it prioritizes energy security to limit disruptions to economic growth. Beijing has ordered power generators to sign long-term supply contracts with miners and build up inventories to last at least 15 days of consumption, but the strict virus measures are frustrating those efforts to replenish stockpiles.

There’s also a flow-on risk for other commodities markets. Coal is China’s mainstay fuel and a key determinant of metals prices, which will only strengthen if the cost of production rises because of scarcity of the fuel.

China’s imports and exports of commodities could also ultimately be at risk as ports become more congested because of the logistical disruptions caused by the lockdowns. The backlog of goods in the major ports of Shenzhen and Hong Kong has risen to its highest level in five months. Rising infections in Shanghai, meanwhile, have spurred fears that measures to combat the virus could affect the transport of goods to and from the world’s biggest port.

©2022 Bloomberg L.P.

With assistance from Bloomberg