China's Oil Demand? It's Gonna Bounce Like a Bunny

September 9, 2022

I’m cracking up. I don’t know where on the internet I saw this, but to me, it’s delightful.

The caption? Every bunny is kung-fu fighting.

LOL. Dad jokes, ah so good.

I needed a chuckle this week. Well I’m sure most oil investors did because how could you not after oil decided to free fall $10/barrel in less than 2 weeks.

It made no sense, even to the great Pierre Andurand. In an Energy Aspects interview conducted this week, he shared his views that fundamentally the market looks tight and crude prices were poised to go higher. Yet, with the low liquidity caused by high uncertainty and high volatility, it’s increasing forcing market participants to the sidelines.

It’s something Grimlock helped explain last week, and undoubtedly the factors are all intertwining to create their own vicious cycle. Despite the market’s uncertainty, though, we’re increasingly convinced that what you’re seeing printed as the price for oil, isn’t the right price. As paper market forces overwhelm the physical market (remember it’s >30x larger), it’s exacerbating the price movements to the point where price discovery has become nearly meaningless. So when will uncertainty abate? When will fundamentals force prices higher?

Soon.

How soon?

By year-end.

How?

China.

China because again here’s one of the world’s greatest oil traders articulating his thoughts on China . . .

“. . . and if we look at China, a bit bearish, relative to expectations because of the Covid policies lasting longer than most people expected, the question is when will they get out of it . . . as soon as they do, I think when they do, demand will jump when they do, 2 months away, 1 year away, 2 years away, nobody knows.”

“Nobody knows” . . .

Nobody knows because this is China today . . .

First off . . . someone is actually named Nectar in this world, fascinating.

Second (off?). . . what in the world is China still doing? Remember, the first cases of Covid was discovered in China, in December 2019. It’s been almost THREE YEARS! Initially, China’s strict quarantine measures and wholesale lockdowns were lauded. We marveled at the efficiency and mastery of central planning. Good, great, fantastic they should be commended. Back then, the novel Coronavirus was something to be concerned with as cases and hospitalizations overwhelmed our local healthcare systems.

Like the rest of us, China staggered at first, but then slowly wrestled the public health crisis under control. During the dark days (i.e., pre-vaccines) we operated largely on incentives and hope.

“Government institutions, public/private companies, NGOs, healthcare providers, innovators and thought- leaders worldwide are almost singularly focused on developing treatments and vaccines to combat the virus. Their motivations to do so and attendant rewards are immense. Many have argued with certainty that no current treatment is a panacea and that a vaccine will take 12-18 months, fair enough, but breakthroughs and advances are much more likely when timelines accelerate as regulations relax. Some treatments are already showing clinical benefits. Although full clinical data is still pending, keep in mind that we are two months into this pandemic. Politically there’s an effort to manage expectations, but the private reality is pushing everyone to exceed them. We simply don’t know, but if our options are to trust in the innumerable scientists who do and who are working tirelessly on corralling this virus then our money is firmly on the scientists. Blind optimism? No. It’s an asymmetrical bet on human incentives, and in incentives we trust.”

That bet proved prescient as the vaccines soon appeared. From AstraZeneca’s first version to Pfizer/BioNtech’s & Moderna’s highly effective mRNA ones, the vaccines only got better. Soon the world regained control and the pandemic faded.

Yet, not in China, and not in the past three years. As the New York Times recently reports . . .

Currently, about 65M Chinese are under some form of lockdown. Chengdu, the city noted above is a city of 21M people. Even if your city isn’t under lockdown, Covid restrictions (movement/travel restrictions, mass scale mandatory testing, general uncertainty) means the economy has been greatly disrupted in China. Undoubtedly those in China understand that the lockdowns likely do more harm than good, but local officials frightened by the repercussions of central authorities (i.e., being sacked or worse) continue to adhere strictly to the dictates sent from above.

So why does China retain these policies? It’s can’t be that they don’t know that such practices are ineffective and disruptive. Claiming so would be too simplistic. It certainly isn’t scientific or logistical as efficacious Western mRNA vaccines are readily available, but the National Medical Products Administration (“NMPA”) (the regulatory agency responsible for approving medical devices and pharmaceuticals in China) has yet to approve any of them.

The economic arguments (i.e., they are intentionally slowing the economy to lower commodity prices and inflation) are weak and unconvincing. The damage done has far exceeded any economic benefit forced austerity would’ve bestowed on the people from cheaper goods. Just take a look at the collapsing GDP growth, and you begin to appreciate how much of an economic friction all of these policies create.

No, that can’t be it. Thus, what remains must be political, which makes sense to some extent. Some of this stems from the authoritarian nature of the regime.

Some of it stems from techno-nationalism . . .

Although the West has effective mRNA vaccines that can end the pandemic in China, none of them are approved there. Instead, China continues to develop its own mRNA based vaccines. As you may recall, mRNA is a novel platform technology, it teaches our cells to make proteins (or pieces of proteins) that can trigger an immune response (in the case of vaccines). The delivery platform, however, can be modified to target all manner of viruses (e.g., malaria, cystic fibrosis, certain types of cancers, Hepatitis B, tuberculosis, etc.).

You know that phrase “this isn’t rocket science?” Well this kinda is because think of mRNA as a rocket, a delivery platform, that can deliver different satellites, treatments, into our system. As the technology develops, it can actually revolutionize the biotech field, and for once that description isn’t just a vacuous statement in some investor slide deck. Still, to lock-down an entire economy just to force China’s domestic pharmaceutical sector to catch-up with the Western world seems like overkill. Hence we come back to the real reason . . . politics. Specifically, party politics.

October 16.

That’s the date the Chinese Communist Party has set to begin its 20th National Congress in Beijing and when Xi Jinping will secure his third leadership term. Like in the movie Frozen, it’s coronation day. Given what we know about Covid, when it was spreading uncontrollably like wildfire, from the onset of infections to the peak, and back down again, took about 3 months. Infections, rising hospitalizations, and deaths numbering in the millions (likely, given China’s low immunity and ineffective vaccines), would’ve been politically unacceptable for its leaders, especially as the anniversary approached. If they hadn’t didn’t soften the zero-tolerance policy after Q2 lock downs in Shanghai, there was no way they’d do so as we neared the Party’s party. China’s leaders simply couldn’t tolerate a loss of control and court controversy in the opening acts of their political theater.

So hence the lockdowns continue.

For how long though?

For frustrated commodity bulls, macro-fund managers, and investors in general, when does China come back is a key question. Finding the answer will go a long way towards lifting the veil of uncertainty. When does the senseless zero-COVID policy end?

Soon.

Why?

The Vaccines are Coming

China’s unwillingness to import mRNA vaccines from the West (beyond Hong Kong and Macau) means that the only way out of its Covid quandary is to develop and approve its own mRNA based vaccines. Fortunately, it’s looking promising so far.

According to Goldman Sachs, here’s a list of vaccine candidates and their R&D status. We’ve noted the ones that are mRNA based (see black arrows), and if similar Western vaccines are a guide, they should prove to be much more prophylactic than the “first generation vaccines” (using inactivated viruses) developed by China.

The first mRNA candidate we’re focused on is CSPC’s SYS6006. In another recent update, Goldman writes:

“CSPC Pharm: SYS6006 has completed phase I clinical trial in China with data on safety and immunogenicity expecting in July / August. Phase II clinical trial (600 participants) will initiate shortly and target to complete in September. The company is also looking for partners in 5-6 southeast Asian countries to conduct phase III studies. The Emergency Use Authorization (“EUA”) application for China will be based on data from phase I and II clinical trials and investigator initiated booster trials, if no extra phase III data is required by CDE.”

The second candidate we’re keeping an eye on is ARCoV made by Abogen Biosciences, a Suzhou based biotech start-up. Interestingly, Abogen is founded by Bo Ing, an American-trained scientist who once worked for Moderna. Arguably, the ARCoV vaccine is the furthest along, as it’s now in Phase III clinical trials in Mexico and Indonesia. A smaller/earlier ArCoV trial, involving 300 adult participants, showed much higher immune response when given as a booster than the control group which was given a first generation booster. Although adverse events (“AE”) were noticeably higher, the symptoms didn’t appear to be out of ordinary for people who’ve received other mRNA based vaccines (e.g., Pfizer/BioNTech and Moderna).

Ultimately, the researchers in the small study found that after a shot of ARCoV, levels of neutralizing antibodies that target the Omicron variant, which can correlate to the strength of protection, were 4x higher than after a booster with CoronaVac. The results are encouraging, and if early read from Phase II trials are positive, the approval process could be expedited by the CDE (Center for Drug Evaluation, an office under the NMPA) via an EUA.

Lastly, human trials for Sterna Therapeutics SW-BIC-213 are also ongoing with a PhaseI/II clinical trial with 640 participants. That trial is scheduled to be completed by December 30, 2022.

Put it Altogether Now

So there’s light at the end of the tunnel you’re saying?

Yes.

. . . and it’s not a train?

Yes.

If you surmise that China’s leaders didn’t want to “lose face” and witness an explosion of infections, overwhelmed hospitals and overfilled morgues before their 20 year CCP celebration, you’d be correct. You’d also be correct that the domestically developed mRNA vaccines are progressing well. If so, a less politicized environment coupled with a highly effective vaccine can quickly turn things around.

Our base case is that after October 16, China will announce the emergency approval of its first mRNA vaccine and vaccinations (i.e., boosters) will begin shortly thereafter. China’s reopening doesn’t come merely because the political spotlight dims after October 16, it comes because like our recovery, scientific progress finally catches-up to our political/societal aspirations. Within 2-3 months, more than half of the Chinese population will likely be boosted. Thereafter, we anticipate China will begin relaxing it’s zero-tolerance COVID policy by the year-end, setting the country up to claim triumph over the pandemic three years after initial cases were discovered. The timeline also allows China to fully reopen by Chinese New Year, which falls on January 22, 2023.

So don’t count China out just yet. Things will turn there and demand for all kinds of commodities will return when it does.

After all 2023? It’s the year of the rabbit, and we all know . . .

Every bunny’s kung-fu fighting . . . Hoo Yah!

Gotta love dad jokes.

Please hit the “like” button and subscribe below if you enjoyed reading the article, thank you.