China's demand

2008-07-02

China’s price hike for fuel has created demand for more oil, which may be just the opposite of what the government planned, experts say.

BOSTON—A price rise that was supposed to curb China’s demand has only boosted its appetite for more oil, experts say. While the government has allowed oil companies to charge more, it has also urged them to produce more before next month’s Olympic Games.

On June 19, China’s National Development and Reform
Commission (NDRC) surprised analysts by announcing price
hikes of up to 18 percent for gasoline, diesel, electricity,
and aviation fuel. The first increases since last November
came under pressure from soaring world energy costs and
despite a decision in January to freeze prices due to
inflation concerns.

The price hike cheered China’s refiners like Sinopec, which have been losing 3,000 yuan (U.S. $437) on every ton of fuel sold because of government-controlled retail prices, according to the NDRC.

Unhappy drivers

The government has been paying the companies billions of
dollars in subsidies to make up some of the difference. But
China’s drivers were less pleased as they lined up for hours
at gas stations, trying to beat the increase to 6.25 yuan per
liter (U.S. $3.45 per gallon) for the cheapest grade.

Outside the country, some analysts voiced hope that the
long-awaited increase would help to ease the relentless run-
up in world oil prices, which have been driven in part by
China’s surging demand for cheaper fuel.

“This could change the psychology of the market
completely,” said one trader quoted by the Associated Press.
But after a one-day dip of U.S. $4 per barrel, world oil prices
continued their climb, adding nearly U.S. $10 per barrel in less
than two weeks.

One reason is that government officials such as Vice Premier
Li Keqiang urged China’s refiners to produce more. Refiners
also jumped at the chance to sell fuel at higher prices and
cut their losses, experts interviewed by Radio Free Asia
said.

But the result is the reverse of what economists might
have expected. Higher prices are stimulating China to use
more oil rather than less.

“When you raise prices, it gives the refiners an incentive
to increase production,” said Mikkal Herberg, research
director for the energy security program at the Seattle-based
National Bureau of Asian Research. More fuel is needed
because supplies became scarce when the companies had to sell
at a loss, but demand for more oil may not be what officials
planned.

“I suspect it’s taken them by surprise,” Herberg said.

“That’s probably the perverse effect of these subsidies
that they maintained for so long,” said Herberg. “I’m not
sure the policy-making bureaucracy quite understands how
these markets work.”

Robert Ebel, chairman of the energy program at the Center
for Strategic and International Studies in Washington, said
the effect is that China’s fixed fuel prices are continuing
to lag behind market levels while they contribute to driving
world prices still higher.

“The crude that they’re buying today is a lot more
expensive than they were paying last month, so I think on
balance, they’re not any better off than they were before,”
Ebel said.

“They’re chasing world prices up, in effect,” Herberg
agreed.

The problem is that the government is still setting prices
instead of relying on market forces of supply and demand.
“It’s what happens when the government continues to get
involved,” said Ebel.

Even after the recent increase, China’s fuel prices are 15
percent below those in the United States and as much as 60
percent less than in European countries, according to U.S.
Department of Energy and news service reports.

Olympics impact

Experts say it also unclear why China is building up
stocks of fuel for the Olympics when it has ordered millions
of cars and trucks off the road for a two-month period to
clear the air for the games. The restrictions would be
expected to mean less demand for fuel rather than more.

“When the Olympics is over and the dust settles and the
air clears, maybe we’ll have a better idea of what has
happened,” Ebel said.

China’s driving bans may result in a surplus of fuel that
could cause it to stop buying on world markets for two or
three months after the Olympics, said Herberg.

“It’s a seriously contradictory policy,” he said. “That’s
probably another force that’s going to whipsaw the world
market.”