China relies on imported energy and may face disruptions to oil and LNG supply from the Middle East, including risks linked to Iran. China imports 73% of its oil, with about 40% of those imports coming from the Middle East, mainly Saudi Arabia and Iraq, and about 10% coming from Iran. Around one-third of oil and around one-quarter of LNG passing through the Strait of Hormuz is destined for China. Chinese officials have called on ‘all sides’ of the Iran war to reduce military operations, avoid escalation, and ensure safe passage for ships through the strait. China has built buffers by stockpiling energy when prices were lower, with total oil reserves estimated at about 80 days of consumption. Its import mix is also spread across suppliers, and it may be able to raise oil imports from Russia. China also uses more non-fossil power, with renewable electricity rising to almost 40% in 2025. In response to the Middle East conflict, the government told large refiners to suspend exports of diesel and petrol. Higher oil and gas prices could raise inflation, though China’s starting point is lower than the US or Europe. A firmer inflation path could lead the People’s Bank of China to be more cautious about further piecemeal monetary easing. Given the persistent Middle East tensions from last year, we see energy costs directly constraining the People’s Bank of China. With Brent crude holding stubbornly above $95 a barrel this month, the risk of imported inflation is very real. China’s February CPI data confirmed this trend, coming in at 1.8% and marking the third straight monthly rise. This sustained price pressure suggests the PBoC will be very cautious about further monetary easing in the coming weeks. Unlike the broad-based easing we saw after the 2022 energy crisis, the current environment seems to be tying the bank’s hands. We should therefore adjust expectations for rate cuts, which will be reflected in yuan-denominated interest rate swaps. For currency traders, this limited scope for easing provides a floor for the yuan, making bets on its significant weakness a risky proposition. The interest rate differential with the US dollar is unlikely to widen substantially from here. This may lead us to consider strategies that profit from a stable or slightly strengthening yuan against the dollar. This scenario is also a headwind for Chinese equities, which often rely on policy support to move higher. The ongoing uncertainty is reflected in the market, with implied volatility on Hang Seng Index options climbing 15% since the start of the year. We are likely to see traders hedge their stock portfolios by purchasing put options on key Chinese indices.

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