China Cuts Subsidies - Is a Pullback in Oil Next?

I have talked a little bit over the last several weeks about my thoughts on speculation in the oil market and the very real supply & demand imbalance that exists.  While it is clear that oil consumption in the U.S. is beginning to slow, the main driver in the increase in the price of oil and other commodities over the last several years has been the ever-increasing level of consumption in the developing world.  China’s consumption of oil alone is probably one of the most important factors in the oil market right now. 

That is why I was fascinated by Thursday’s announcement that the Chinese government was going to increase gasoline prices by 17%, diesel prices by 18% and jet fuel prices by 25%.  Other types of fixed energy prices will also be increasing as the Chinese government attempts to fight runaway consumption and an overheating economy.  

Such an action could cause a short-term reversal in the energy markets that could  be expedited by all the fast money that is currently awash in oil contracts.  In the long run, Chinese growth will likely overcome any decreases in consumption that is tied to any further increases in the price of gasoline.  As a result, I would be a buyer of oil and gas related sectors on any significant pullback.  

The Chinese government’s announcement is tied to the fact that it subsidizes the country’s energy expenses.  Many countries worldwide subsidize their gasoline prices and as a result, consumers in these countries do not have the same incentive to conserve that consumers in the U.S. and Europe have.  When consumers do not have to pay higher prices, due to artificial price controls, consumers will not conserve and as a result we are all worse off.   

That is why the move by the Chinese government should be applauded as it is forcing the Chinese consumers to begin to start to pay for the replacement cost for the products that they use.  Below is a little chart I stumbled across on the various degrees of gasolines subsidies across the world.  It is rather interesting and shows how many other countries will need to either end or reduce subsidies before any global slow down in oil consumption can even be considered.       

 

Comments

[2-cents]

Look beyond the obvious! Any with some basic economic can write these basic stuff. Do you know much about Chinese and their cultures. Mark my words: watch for higher oil prices.

[chistletoe]

The government of china has recently discovered what Nixon discovered in the USA: any attempt to put price controls on gas and oil results in spot shortages, unavailability, and a resulting crimping of the overall economy.
The raise in price yesterday is going to have the opposite effect of what traders anticipated yesterday, namely, it is going to increase availability and demand for gas and oil in China.
The ultimate effect in the United States will be to raise prices even further.
While I agree in applauding the Chinese government, I must also continue to denigrate the US government, which continues to speak and act totally irresponsibly.

[Dan Walker]

Have you by any chance examined the current Chinese charts lately?

[Jack Yetiv]

To add to Chistletoe's comments:

In a FREE market, increased prices normally reduce demand, although the elasticity of that decrease is probably very small.

But China has not been (and still isn't) a free market. In fact, SUPPLY of refined goods has been constrained by the fact that refiners in China have not produced sufficient refined products because it has been a losing proposition for them.

China raised these prices for two key reasons. One, to placate the US and other OECD countries re: its subsidies. Two, to encourage refiners to make more refined products to decrease shortages, especially with the Olympics coming. However, as artificial shortages are decreased, demand may well go UP despite somewhat higher prices.

Furthermore, it appears that China is going to be offering some rebates or other "help" to its citizens to make up for the increase in prices. This will further blunt any negative impact on consumption that this price increase might have otherwise had.

Therefore, it seems rather unlikely that this modest increase in prices will do much to retard China increasing demand. Keep in mind that even combined with last Nov's 10% increase, refined products prices have increased much less in China than they have in the US. And also keep in mind that on a per-capita basis, China uses about one-twentieth the amount of oil that we use in the US.

Jack

[oilsands]

Right on, Jack. Oildriller has it right, look for higher prices.
What a joke, the US govt criticizing another country for waste.
Wish I could laugh. Also, we are so brainwashed in this country that the subsidies we hand out in various tax breaks and the expenditures of the Dept of Defense protecting middle eastern oil are not noticed.
Amazing.