05.28.08
China’s Oil Manipulation, Gas Prices, and US Presidential Politics
Everyone knows that China has been under pressure for years, led by the US Congress, to allow the value of its currency, the RMB or yuan, to appreciate. But the “weak” RMB that hurts American exporters is not likely to be the main issue of concern to American voters. They’ll be more worried about $4/gallon (or higher!) gasoline. And this (Chinese article) is a big reason why. China has price controls on diesel and other fuels, such that there is now an RMB6000 (US$870) disparity between what a ton of diesel goes for in China and what it goes for abroad. Chinese oil refiners like Sinopec are getting slammed, since their costs are rising but the sale price of fuel is controlled by the Chinese government. The government is responding with measures to import more oil to help ease pressures.
Why does China control prices? Well, it’s obviously a good way to spur growth, and it’s been working as the country has been growing at 10%+ for over a decade. It’s also a way to over pollute the country and congest the roads. And it’s contributing to the skyrocketing oil prices worldwide, since 25% of the world’s population, the Chinese, are paying a lot less for the oil they use than everyone else.
SHTig adds (5/28 6:50pm PRC time): Mul called to ask what this means, and nator commented below also asking for clarity. To answer – yes, China buys oil on world markets at prevailing prices. But then, when that oil is sold domestically it is done so at a price lower than the prevailing world price. The government forces Sinopec and others to sell it on the cheap, and makes up for this by subsidizing Sinopec with the difference. This process allows everyone in China to get oil in all forms for less than the ‘true’ price, which results in more oil being consumed in China than what should be. We expect consumption to be inversely proportional to price – and when prices are kept artificially low, consumption is artificially high. With oil consumption artificially high in China, China demands more oil from the world markets than it should from an economic prospective and this is what adds to the upward pricing pressure on oil.
If your taxi driver had to pay the prevailing market price for gasoline, your taxi flagfall would be higher than RMB 11 (as it is in Shanghai), and you’d pay more per kilometer. The ride might cost you 50% or 100% more, and at the margins, some people would opt to take a bus instead. Multiply this behavior by 1,300,000,000 and remember that China is the world’s workshop, and we’re talking about a lot less oil being used, if only they – the end users – paid the prevailing price. That would reduce global demand and thus the price of oil as well, ceteris paribus.
Wonder if John McCain and Barack Obama will talk about this when asked what they plan to do about $4/gallon gasoline? If Chinese consumers paid the same price for fuel as everyone else, it might serve to put them on the same competitive playing field as other countries, and it might also serve to increase efficiencies within China.
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nator said,
May 28, 2008 at 17:55
NATOR ASKS: SHTig, I question the connection between oil price controls in China and high prices globally. Can you explain this a bit more clearly? As I understand it, the government is paying global market prices for oil, controlling the sale price in China, paying subsidies to Sinopec and the other oil companies so that they don’t go bankrupt, and (presumably) funding these subsidies through taxes. So the price controls here shouldn’t affect the global price beyond the slightly increased global demand created by low consumer prices in China–right?
brandonjusa said,
June 1, 2008 at 05:09
This article has many good points. One that I think is missing and is critical to viewing the situation correctly would be to know how much oil comes out of the ground in China. If you take in account how much money is being held by China in US dollars, you would realize that it is of greater importance to China as a nation to spend the US dollars or otherwise invest them than to sell its domestic oil to other countries which would result in growing their surplus holding of US Dollars.
Now to my point. China sells it’s fuel at a lower cost to Chinese people because it does spur growth and allows it’s industry to continue developing at a smooth, if not quick pace. China’s domestic oil is virtually free. Why? First, because it exists under China’s land and secondly, the government controls what oil is allowed to be sold outside the country and what oil will be sold locally. All China has to worry about is paying the workers for pumping, processing and shipping the domestic oil all around the country. China’s government will purchase oil on the open market if they need more than they have decided to use of their domestic supply. The result is a hedge of sorts against being totally dependent on world market prices of oil. China probably doesn’t care much about how much higher the foreign oil is to domestic oil. They need to give people jobs so they will be busy. Busy people do not cause as much trouble as unemployed, hungry, bored people. This may affect prices outside of China as much as they add to the competition for oil in the open market, but selling that oil cheaply in their domestic market does not directly affect other countries, but allows China to remain stable and competitive with the outside world, regardless of the pollution consequences. As an American, I think this is smart policy on their account. It allows imports to remain competitive despite currency appreciation. I would hate to be a shareholder of Sinopec or PetroChina, but if you invest in the stock index in China (CSI 300) this may contribute to overall stability of your investment. I agree with George Soros when he says that policy is necessary to balance markets.
nator said,
June 12, 2008 at 18:39
SHTig, thanks for the explanation. But I still don’t see why China’s price controls are doing anything more than contributing–slightly–to global demand. I would imagine that manufacturing and heavy industry use a lot more oil than “Chinese consumers” (presumably automobile owners, mainly). It might be more accurate to say that Western companies who build in China, or even Western consumers who buy Chinese-made products, are the ones getting the biggest break on cheap Chinese oil, and the ones who are responsible for most of the upward pressure on global oil prices attributable this phenomenon. And I just don’t think China’s increased demand is doing all that much. I think it’s safe to say that China’s economy would be growing even with higher gas prices, and that demand for cars would be increasing as well.
Truth From Facts » China Makes Another Good Move for the Environment and International Oil Market said,
June 19, 2008 at 23:37
[...] month I brought you analysis of China’s Oil Manipulation, arguing that China’s price controls for energy is one of the reasons for the elevated [...]