China's cheap fuel underpins global spike in oil prices

Business Times 20 Jun 08;

(BEIJING) To find out why global crude prices are at historic highs, look no further than Christina Lu and her silver Honda Odyssey.

A beneficiary of China's artificially cheap gasoline, she drives as though the world's energy resources are limitless.

'The current price of gasoline has no influence on my use of the car,' said the 40-year-old, who works for a foreign company in Beijing. 'The price could even go a bit higher as far as I'm concerned. It would limit the use of cars - there are just too many of them on the streets.'

China and other emerging economies have recently accounted for the entire growth in global oil demand as more mature economies have cut consumption.

This is partly expected, since China is in the middle of what looks set to be its sixth year of double-digit economic growth. But price caps on gasoline and other oil products also play a huge part, insulating China's consumers from the real price of energy.

The nation's oil majors, Sinopec and Petrochina, suffer under price caps as they cannot pass the costs on to their customers. In turn, they get subsidies from the government to cover most of their losses.

Observers see it as a classic example of how government interference covers up the actual state of the market, leaving people with little direct sense of the value of the goods they consume.

'The money is paid from the tax revenue, so people actually wind up paying the same price,' said Li Youcheng, an analyst with Hong Yuan Securities.

This is not just China's business. Since it is a power with growing global clout, economic developments such as this have repercussions far beyond its borders.

'A reform in the energy pricing system will not only benefit China itself but the whole world,' the China International Capital Corporation (CICC), an investment bank, said in a research note. 'The international crude oil price largely depends on China's energy pricing policy, because China accounts for around 40 per cent of the increment of global oil consumption.'

CICC cited a simulation which showed what would happen if China raises its oil product prices by 50 per cent around mid-2008 to put the domestic refining gross profit margin in line with international levels.

Under this scenario, international oil prices would decline to US$110 per barrel by the end of 2008, and US$90 one year later. If China continues to control oil product prices, international crude oil price will hit US$200 per barrel, the CICC's simulation shows.

According to Lin Yixiang, general manager of TX Investment Consulting, the Chinese system has brought about a litany of social ills. 'The measures have led to waste of energy, chaos in the market, queues of consumers, corruption of those in power and losses of producers. Moreover, it has exacerbated the supply shortage and inflation,' he said. 'Curbs on energy prices are policies favourable for the rich, putting the unprivileged at a disadvantage and endangering social harmony.'

However, the government may be reluctant to change, as a rise in the cap on fuel prices could boost inflation.

The question is how much longer the government can afford to subsidise energy use.

As late as 2007, the value of China's direct and indirect subsidies was a manageable 0.9 per cent of GDP, lower than the 3 per cent seen in many other economies. However, if crude oil prices hit US$200 per barrel at the end of 2009, the ratio will reach 6.3 per cent of GDP, according to the CICC.

This is more than the state can afford, since it is higher than the sum of state-owned enterprise profits and fiscal surplus combined, it said. 'The subsidies are not sustainable in the long term.' - AFP