Mind the Gap: China's Reopening & Oil

November 25, 2022

Did you like the UCLA game buddy?

“I don’t know . . . .” his voice trailing off.

Hmm maybe he’s tired since he looked like he was having fun.

“I thought you were having fun watching the game?”

“I was, but . . . they’re so good, they make me think . . .

“what?”

“. . . that I’m so bad at basketball.”

There it is. The gap between expectation and reality. Your own perspective vs. what you see. I had that conversation last night with my son. He’s a sensitive kid. Smart, kind and slightly bashful. He loves doing things well, absolutely hates being wrong, and dislikes being uncertain, and loathes . . . and I mean loathes . . . veggies. The little man is single-handedly waging a just war against crops. Except corn. Corn is . . . acceptable. You may plate it.

He also loves basketball. 8 years old and he’s in the gym. “Club basketball” they call it. It’s ridiculous. It is the professionalization of youth sports. He’s on two teams, so we’re talking 5-6 hours of practices every week, and 1 to 2 games on the weekend depending on the season.

Without perspective, it can be physically and mentally unhealthy. Hence why we have no delusions or illusions that he will “turn pro” or “get a scholarship.” We do it because he loves it. We do it because he loves his teammates, he loves the coaches, and he just loves basketball.

I say “we” because like many parents these days, I sit there. No I don’t sit in the car, or go run errands during his practices . . . I sit there. I grab a chair, prop open my laptop and I just watch. Sure I’m doing work, updating models, reading notes, or writing these missives, but I’m there watching him. Watching all of them, improving here and there, tweaking their shots, altering their dribbles, pivoting faster. Watching the grind of practicing, making those tiny, incremental, and almost imperceptible improvements that are needed to get better. It’s often not pretty. Psssst here’s a secret . . . 8 year olds? Not that physically coordinated. Lots of bruised knees, many wayward basketballs, and some crying . . . but give it some time . . . and over time . . . you start to see some pretty dramatic improvements.

China

So I bring these things up because I was thinking about China the other day. The “reopening” that’s not, or was, or will be. We obviously had an optimistic scenario that a vaccine would be introduced shortly, and China would dose/vaccinate, and would gradually unlock its frozen Zero-Degree-COVID-Policy economy as 2022 came to an end and the Lunar New Year approached. That timeline . . . that forecast is turning out to be delayed.

You could say a gap between our expectations and reality is forming.

Mind the Gap

As COVID cases surge in China, the oil markets have been thrown into uncertainty again.

As of today, COVID cases are higher than they were in April when Shanghai locked down, and inevitably, analysts and pundits begin saying . . . surely the country will lock down again. Cases today are higher than before, how can they not? For us, we think restrictions are possible, but wholesale lockdowns? Doubtful.

Here’s why.

The government just recently introduced its “dynamic zero-COVID” policy with “20 measures” on November 11. In many ways, this was seen as an easing of the overly strict Zero COVID Policy (“ZCP”), which effectively quelled the pandemic, but at great cost to the economy. The introduction of the new policy, many of which are actually quite sensible from a public health standpoint, meant that the government has been planning this shift for quite some time.

No one throws together a 20 point plan without passing through a seemingly endless series of reviews and consultations, not in the US and certainly not in China. The tonal and policy shift was necessary because the 3-year ZCP plan was simply economically, politically, and socially unsustainable. The Chinese populace have by and large willingly traded individual freedoms for economic and social prosperity. It’s why Xi promotes “common prosperity,” because enabling it means cementing the CCP’s political legitimacy. So long as the country was steadily moving forward, the political machinations, the clamp-down on free speech, and the corruption was tolerated. All of that patience has evaporated as people grapple with losing their life’s work because of the economic fallout caused by the ZCP. Protests in Zhengzhou, the world’s largest iPhone assembly plant, followed after a similar riot occurred in Guangzhou. Lives vs. livelihood, and after three years of trading one for the other, it’s obvious the Chinese are more concerned with the latter.

So we’re barely 2 weeks into this dynamic policy, and the investment community is now concerned that rising case counts will lead China to reinstitute a deeply unpopular ZCP plan and abandon it’s new policy? Hmmm unlikely. We highly doubt that the new policies were implemented without careful consideration about their implications, nor were they done so without extensive modeling as to how quickly cases could rise. No, we believe allowing case counts to rise and exceed prior highs was an expected outcome of relaxing the stifling ZCP. After years of warning the population about the dangers of COVID, allowing the virus to spread, and allowing the population to readjust their “fear” levels for the virus, would actually help in the ultimate effort to reopen. Understanding that COVID poses a smaller risk to those younger and healthier, could actually ease the uncertainty around living with the virus. Conversely, fearing an infection, vaccination rates (i.e., boosters) may actually increase as people opt-in for booster shots.

We’ve long known that Hong Kong was China’s testbed for relaxing COVID healthcare restrictions, and the city was able to unwind and reopen once a high percentage of its population received a third dose of vaccines. Recent studies in Hong Kong, published in the Lancet medical journal, showed that a third booster (whether it was BNT162b2 or CoronaVAC) offered significant protection against severe or fatal outcomes (98%). This is an astonishingly high protection rate. What’s equally surprising for us is that even the CoronaVac vaccine, which showed lower efficacy against Omicron, conferred almost as high a protection rate for the elderly when given as a third dose.

As of November 4, 90% of China’s total population had been fully vaccinated, but only 63% have received a booster. For people over 60 years old, 86% were vaccinated and 69% were boosted. For the elderly over 80 years old, 66% were fully vaccinated and 40% had received a booster.

So think about those figures for a bit. COVID disproportionately affects the elderly in terms of high hospitalization rates and deaths, and if only 40% of the elderly over 80 have been boosted, there’s a large part of the vulnerable population group that’s at risk (protection falls to around 60% for only 2 doses of CoronaVAC (87% for 2 doses of BNT162b2)).

So in steps the National Health Commission.

Through all of the noise, what we’re really paying attention to is the rollout of a broader vaccine campaign. Not only with a domestically developed mRNA, but also any third or fourth booster. After the promulgation of the 20 measures on November 11, China’s National Health Commission held a press conference on November 17 and in response to a Bloomberg reporters query about vaccines said

“ . . . the choice of vaccination needs to comprehensively consider factors such as safety, effectiveness, accessibility and affordability, and adhere to the principles of compliance with laws and regulations and respect for science. At present, relevant departments are formulating a plan to accelerate the promotion of COVID-19 vaccination. After the plan is determined, the relevant information will be released to the public in time. Thank you.”

No . . . thank YOU. Well, at least when you finally publish those plans. So that’s the hiccup. It’s the hold-up. The data for certain domestically developed mRNA vaccines are close to being finished and/or already submitted and should be done by YE. What’s uncertain is how the government plans to roll-out the vaccination recommendations/requirements and approvals. If a plan were to be released shortly, booster penetration could rise significantly.

In Hong Kong, efforts to to increase vaccine/booster uptakes helped nudge the percentages up (e.g., reducing the duration of dosing for care-home residents, extending vaccination clinic operating house, deploying vaccine outreach teams to care homes, housing estates and residents with limited mobility). So we anticipate similar measures to be announced shortly. If booster penetration were the main focus, 85% of the elderly population over 60 years of age could be dosed within a few months. If booster rates stagnate? We can even imagine a scenario where China mandates vaccines for the elderly because remember . . . 98% efficacy.

Afterwhich?

The pandemic is largely over as China reopens. Sure case counts will rise as they did in the US in 2021, but eventually it’ll subside, or inevitably people will stop paying rapt attention as this subsides to an endemic. So keep watch. This is what reopening in China looks like. Yes, it’s messy and uncertain, but you don’t introduce a 20 point plan only to abandon it 2 weeks later, you don’t build quarantine centers only to lockdown harder, and you certainly don’t prepare more hospitals beds if you’re maintaining status quo.

Disappointment in our daily lives arises when there’s a gap between our expectations and our reality. Those two points, however, are never static. As investors, our energy thesis has never been about the next month or two, it’s a much broader/longer-term structural theme. That China is seeing headline risk because cases are rising isn’t surprising. It was inevitable. You can’t emerge from three years of darkness without feeling a bit unbalanced and unsteady, but those first few steps are important.

China will reopen, it is on the path to reopening, and it won’t be easy. Though difficult, there’s a path to follow, one trailblazed by Hong Kong, and one based on sound public health policies and the approval/distribution of vaccines and therapeutics.

While China is taking slightly longer than we anticipated, we’re looking more at a delay of a month/few months, instead of years. So stay patient, keep your expectations in check, keep working the issue, monitor the government announcements, and look at the broader picture.

“Whoa, buddy, those are college players, they’re some of the top players in the country. You’ve only been playing basketball for a year, you just keep working at it, and you’ll be really great. Just have fun.”

“Okay.”

“Now time for bed.”

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