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Pricey Oil May Be Boon for China

With energy stocks key to the Shanghai Composite, investors could rejoice if crude rises. Still, inflation will remain a worry.

Just when global markets look like they may be about to take another hit on the rising price of oil, investors in China may get a pleasant surprise if black gold goes back to triple digits.

Whereas most indices are weighted in companies that use oil as a cost stream, nearly one-third of the Shanghai Composite Index is made up of those deriving earnings from crude prices. For example,

PetroChina's

(PTR) - Get PetroChina Company Limited Sponsored ADR Report

weighting accounts for 18% of the index, while

China Petroleum & Chemical

(SNP) - Get China Petroleum & Chemical Corporation Sponsored ADR Class H Report

constitutes 5.9% of Shanghai's exchange.

China Shenhua Energy

(CUAEF)

, the mainland's largest coal and power conglomerate, which also benefits from rising energy prices, weighs in at 4% of the exchange.

"Whether $100 oil will materialize again is the question of the year," says Steve Rowles, a commodities analyst at CFC Seymour Securities in Hong Kong. "Oil at $100 has not been the chaos we potentially thought it would be. In China the price is heavily subsidized."

Rowles adds that another uptick in the price of oil could also produce a bump in government bond markets in Asia, as countries such as China and India issue more debt in order to offer further subsidies to consumers.

Oil has been rising in recent days, most recently to $93.04 in Asian trading Wednesday, prompted by Venezuela's suspension of commercial relations with

Exxon Mobil

(XOM) - Get Exxon Mobil Corporation Report

after the U.S. oil giant won permission to freeze $12 billion in the country's state assets days ago.

Venezuela's Energy Minister Rafael Ramirez most recently commented on the fight as potentially escalating to "economic war."

Previously, when the price of oil has surged, the Shanghai Composite Index has reaped the gains, as the news has cheered investors of China's big oil producers.

The last time oil reached triple digits, in early January, PetroChina jumped 3.6% from its December low, while China Petroleum & Chemical and China Shenhua Energy surged around 16% from the same period. The impact lifted the Shanghai Composite Index around 12.5%, to a peak last month of 5443.78.

Since then, as the oil price has suffered in the wake of fears of a U.S.-led economic slowdown, the Shanghai Composite Index has dropped 21% to 4490, dragged down by the major oil companies that dominate the exchange.

China's largest oil companies -- PetroChina,

TheStreet Recommends

Sinopec Shanghai Petrochemical

(SHI) - Get Sinopec Shanghai Petrochemical Co. Ltd. Sponsored ADR Class H Report

and

CNOOC

(CEO) - Get CNOOC Limited Sponsored ADR Report

-- together have a combined market capitalization of nearly $1 trillion.

But while a rising oil price may mean short-term gains for equity investors, it's likely to have a negative longer-term impact on economic growth, says Zuo Xiaolei, chief economist for Galaxy Securities in Beijing.

Like most mainland polarities, the conflict between potential capital markets growth and an economic slowdown as a result of more expensive oil comes from China's size. While the country is currently the world's second-largest importer of oil, it is also the sixth-biggest global producer.

"China is increasingly importing oil, so rising oil prices increase everyone's costs and push up inflation, which is not a good thing for the Chinese economy," says Zuo.

Also, not all oil companies in China may benefit in the event of another rally, she adds. She expects oil to fall back a little from current levels, which, while bad for the likes of PetroChina and China Petroleum & Chemical, would be a positive for gas station owners like Sinopec Shanghai Petrochemical.

And playing China based on oil may be risky, some observers warn. Even if the price of crude does usually boost Shanghai's index, investors should be aware that the focus of Chinese mainland retail investors hasn't been on blue-chip stocks so far this year, so the gains may be minimal, says Alex Wong, a director of Ample Finance Group in Hong Kong.

"Even though China's markets benefit from rising oil because most of the large caps are tilted that way, the force this time may not be too strong," says Wong. "People are not too optimistic or enthusiastic about equities, so sentiment may not be too moved."

Still, slight gains in PetroChina in December as a result of a rising oil price contributed to overall buying as investors viewed the market as oversold after a late-November correction. Even companies who consume oil and record it as a cost rose in the event of the triple-digit liquid energy.

Air China

(AIRYY)

, for example, soared 25% from December to January, while China's largest insurer,

China Life Insurance

(LFC) - Get China Life Insurance Co. Ltd. Sponsored ADR Class H Report

, earnings of which are unrelated to the oil price, rose 7% in the same period, as investors viewed the oil increase as a proxy for a repeat of double-digit growth in the country.

That may just be enough, say some, to prompt another sharp uplift soon in China's recent ailing markets. On Wednesday, when the exchange opened for the first time in the Chinese New Year, it fell 2.4% to 4490.

"China is such a speculative market that it's difficult looking at the exchange all together, but the fundamentals indicate that we'll see an abundant supply of money continuing to drive the market," says CFC Seymour's Rowles. "We still expect to see double-digit growth."

Daniel M. Harrison is a business journalist specialising in European and emerging markets, in particular Asia. He has an MBA from BI, Norway and a blog at

www.theglobalperspective.biz

. He lives in New York.