How China and 'currency wars' are fuelling oil's plunge

A combination of factors has conspired to create a perfect storm for oil since mid-2014, but analysts are now contemplating how major currency fluctuations are fanning the flames for the commodity's latest lurch lower.

"The worries from China are leading the fall (in crude on Thursday) and with the devaluing (Chinese) yuan traders sense a currency war into the bargain," Malcolm Graham-Wood of Hydrocarbon Capital said in a morning note.

The equity free fall in China has many moving parts but traders have been focusing on the surprise yuan depreciation that the central bank has engineered at various points over the last few months.

On Thursday, the bank facilitated the yuan's biggest fall in in five months. The People's Bank of China (PBOC) set the official midpoint rate on the yuan 0.5 per cent weaker at 6.5646 per dollar, the lowest since March 2011, according to Reuters. The news agency highlighted that it tracked record losses in the more open offshore market for the yuan currency and was the biggest daily fall since last August, at the height of the last equity market storm in China.

There have been discussions in the last few years over whether countries are purposefully debasing their own currencies -- a concern that was termed "currency wars" by Brazil's Finance Minister Guido Mantega in September 2010. A weaker currency can help a country's export-focused companies and - in the case of China - can alleviate greater concerns about stalling growth. Central banks often stress that exchange rates are not a primary policy goal and can be seen more as a positive by-product of monetary easing.

However, if one country devalues its currency it can lead to others following suit. In the case of the US it can lead to a wave of deflation coming from cheaper goods produced in foreign countries. For oil, which is traditionally denominated in the greenback, it can dent demand by making it pricier for domestic consumers.

Gemma Godfrey, the founder and CEO of investment firm Moo.la called Thursday's unannounced move from the PBOC the "yuan yell."

"China is the largest importer of oil and the move will make the dollar-denominated commodity more expensive domestically. Therefore whether indicating a lower demand or not, it may have that very impact," she told CNBC via email.

Graham-Wood added that worries about China's economy are "really hitting oil hard" while Societe Generale's commodity analyst Jesper Dannesboe told CNBC that the currency move was making investors nervous that the Chinese economy is "perhaps weaker than previously thought or about to weaken further."

"If Chinese demand were to weaken this would be problematic for the global oil market as it is already severely oversupplied," he added.

China's apparent oil demand rose 1.5 per cent in November from a year earlier to 10.95 million barrels per day, according to a Platts China Oil Analytics report, released on Wednesday, which is based on the latest Chinese government data. It was the slowest growth since February 2015, but comes after Chinese demand growth for oil was generally solid for the whole of last year.

Barclays oil analyst Miswin Mahesh predicted that oil sellers could start to offer Chinese consumers the commodity denominated in their own currency.

"Especially given the current state of the oil market - being that of a buyer's market. And suppliers, from Russia to the Middle East competing for market share in Asia," he told CNBC via email.