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The Wall Street Journal: As Oil Price Sets New High, Stress Hits Developing Nations

Fuel Shortages, Unrest
Spur Beijing to Act;
Market Turning Point?

By SHAI OSTER in Beijing, PATRICK BARTA in Bangkok and RUSSELL GOLD in Austin, Texas

November 1, 2007; Page A1

One of the biggest forces behind the near-quadrupling of oil prices this decade has been voracious fuel demand in China and other developing nations. But with crude closing in on $100 a barrel, shortages and price spikes are sparking economic and social tensions from Beijing to Tehran. That stress could signal a turning point in the long-running energy boom.

Yesterday, China announced an almost 10% increase in domestic gasoline and diesel prices, in a dramatic move to tamp down demand. China’s price move, reducing its need for subsidies to oil firms, was seen by analysts as an attempt by authorities to cope with an energy market run amok. Supply shortfalls have been triggered by the country’s combination of subsidized energy prices and breakneck economic growth, which has led to insatiable fuel demand.

PUMPED UP
 
•  Price Hike: China, hit hard by fuel shortages, lifted pump prices by almost 10%.

•  Growing Turmoil: Countries around the world, from Iran to Myanmar, have experienced protests either for suffering shortages or raising fuel prices.

•  Rising Crude: Oil prices closed at $94.53 a barrel yesterday in New York Mercantile Exchange trading, climbing $4.15 in a single session.

Over the long haul, China’s move should help curb demand and thus could eventually act as a brake on global prices. But first, it will likely increase demand. Chinese refineries have faced such unattractively low government-set prices for their gasoline and diesel that they have held back from buying crude; now, the new higher prices give them an incentive to snap up more crude to make more gasoline and alleviate the shortages.

In fact, within hours of China’s announcement, crude oil set yet another record high on the New York Mercantile Exchange, closing at $94.53. Crude rose above $95 early in after-hours trading, bearing in on the inflation-adjusted high of $101.80 in April 1980.

Scarcities of diesel fuel are being reported in regions throughout China, forcing truckers to line up for supplies. The severity of the problem was further underscored by shortages in the capital of Beijing, which is traditionally kept well supplied. Several gas-station managers in the city’s suburbs said they had run out of some types of diesel and were rationing others.

Officials say the situation could worsen if not quickly resolved. A man was killed by another customer Tuesday morning after jumping a line to buy gasoline in the Henan Province city of Xinyang, local police said.

China isn’t the only developing nation to wrestle with the problems caused by fuel subsidies in a time of rising oil prices. As governments have begun to unwind fuel subsidies, people have taken to the streets to protest from Katmandu, Nepal, to Conakry, Guinea.

Over the summer, the Iranian government raised gas prices by 25%, then began fuel rationing. Protests erupted in Tehran, with several gas stations being torched.

More recently, the decision in August by Myanmar’s military government to increase fuel prices — doubling the price of diesel overnight — led to protests in Yangon. This sparked widespread antigovernment demonstrations and a brutal crackdown when the military began shooting at civilians and arresting Buddhist monks.
Elsewhere, fuel protests have cropped up in Yemen, Iraq and Indonesia — often leading governments to quickly reinstate subsidies. India and Indonesia have ruled out any fuel hikes soon.

But China’s moves have the biggest impact. Without China’s growing thirst for oil, world oil demand would be growing only moderately. Over the past five years, Chinese oil consumption has grown at an 8.7% annual rate. The rest of the world has grown at an annualized rate of 1.5%.

China’s current consumption of 7.6 million barrels of oil a day represents 9% of world oil output, according to the International Energy Agency, the Paris-based energy watchdog for industrialized countries. Five years ago, China consumed just 6.4% of world output.

China heavily subsidizes fuels in its domestic market, a big reason that fuel consumption has kept rising briskly there even as world oil prices climbed into the stratosphere. Yesterday’s move raises the prices of gasoline, diesel oil and aviation kerosene by 500 yuan, or about $67, per metric ton for wholesale prices. But even after the increase, the Chinese will pay approximately $2.50 to $3 a gallon for diesel and gasoline.

By comparison, U.S. drivers pay an average of $3.23 a gallon for diesel and $2.90 a gallon for gasoline, according to AAA. And in Europe, where fuels are heavily taxed, motorists pay upwards of $5 a gallon for both fuels.

“The adjustment was made to shorten the gap between highflying international crude prices and domestic oil prices,” said China’s economic planner, the National Development and Reform Commission, according to the Xinhua news agency. China last raised fuel prices in May 2006. Since then, international oil prices have risen about 30%.

Previous changes were telegraphed weeks in advance. Up until recently, the government was saying it liked the idea of raising energy prices to encourage fuel efficiency, but insisted that its hands were tied because inflation was already going up too quickly.

Yesterday’s step thus came as a surprise, but doesn’t go far enough to cure China’s basic problem. If China doesn’t fully liberalize fuel supplies and let prices rise, it could face even-worse energy-supply bottlenecks. Tuesday’s queue-jumping killing may offer a preview of the social unrest that long waits at the pump could spur.

But China is in a bind because rising fuel prices could also heighten societal pressures. The country’s leadership has made a key issue of addressing the growing gap between China’s swelling ranks of urban rich haves and usually rural have-nots. The poor and middle class are already reeling from soaring prices of staple foods.

In August, Premier Wen Jiabao visited a pig farmer to highlight his concern about the rising cost of meat. A big jump in fuel prices, especially diesel, would hit rural farmers especially hard. Their incomes continue to lag far behind salaries in cities like Shanghai or Beijing, and Chinese leaders worry a bigger gap could eventually spark social instability or even threaten the Communists’ grip on power.

Rising oil prices could yet derail the still-booming Asian economy. Countries there have widely used fuel subsidies to spur strong economic growth. But cheap fuel also distorts demand and discourages consumers and industry from being efficient. The McKinsey Global Institute, the consulting company’s economics-research outfit, estimates that “ending fuel subsidies worldwide would cut demand for transportation fuels by three million barrels a day.” That’s equal to roughly 3.4% of daily use.
Moreover, the subsidies come at a steep cost to governments, and they can create distortions that stress the broader economy. In 2005, for instance, Indonesia’s currency and equity markets nose-dived amid concerns over whether the government could continue to foot the bill for its big subsidies.

Pressure has been growing on China’s government to raise its low, state-set fuel prices to offset losses to its refiners because of the higher costs of oil. The inflation-wary government has forbidden them to pass on increased production costs to consumers, despite the widening gap between domestic and global diesel prices.

The problem is mostly limited to diesel fuel, which outsells gasoline because it is used for trucking and farming, while China’s gasoline-fueled private car market is still relatively small. With the harvest season over, most buyers are truckers, who play a key role in the vast logistics network that feeds China’s export juggernaut. With winter fast approaching, the trucks also play a big role in transporting the coal needed to keep cities warm.

Shortages are more severe in the south, where they first began to appear in recent weeks. According to Sui Jingwen, general manager of China Cargo Alliance, the supply gap could affect domestic trade, especially for food and goods. “Fruit in the south needs to be transported to the north, and grain from the north needs to be taken to the south,” Mr. Sui said.

China has given the country’s biggest refiner, China Petroleum & Chemical Corp., known as Sinopec, big subsidies at the end of the past two years to offset its losses.

The supply shortfall underscores the rising importance of independent oil refiners and gas stations, which supply an estimated 5% to 10% of China’s market. These smaller companies are more vulnerable to fluctuations in international prices than the two state-owned oil companies that dominate China. Smaller refiners don’t get government support. So, they have been willing to stop production completely rather than keep selling at the state-set prices — which meant selling at a loss.

The impact of surging oil prices hasn’t been uniform. PetroChina Corp., China’s biggest oil producer, has benefited from the rising prices because it can sell its own crude oil. Harder hit has been Sinopec, which has to buy about 75% of the crude oil it uses to make fuel.

Because of its special role in keeping China’s tanks full, Sinopec has been basically forced by the government to make up for any shortfalls.

But some big players are suffering, too. Earlier in the week, Sinopec said it was under “tremendous” pressure from the rising prices. “We will try the best to ensure a stable supply of fuel in the market, but it’s a big challenge for us,” Sinopec’s chief financial officer, Dai Houliang, told reporters Monday.

Elsewhere in Asia, the central-bank governor of Thailand and officials in Indonesia and Malaysia have spoken out in recent days about the potential for oil-based inflation. And Thai oil-and-gas conglomerate PTT PCL raised retail fuel prices by about one cent, to about $1 a liter depending on the grade of fuel, effective yesterday. Prices at PTT are considered to be a benchmark for Thailand’s consumer market.

Speculation has mounted that Thailand’s Finance Ministry will revise down the country’s economic-growth forecast sometime this month after taking into account the recent rise in oil prices. Growth is expected to tally around 4% this year, relatively modest for Thailand.

Still, developing Asia is being cushioned somewhat by the recent rise in the value of its currencies, which makes average consumers feel wealthier and enables them to spend more on fuel. Several countries — including India, Malaysia and Indonesia — continue to subsidize consumer fuel prices, which further eases the pain for consumers. There is little evidence the countries can’t afford to maintain those subsidies, at least for the time being.

In Indonesia, Energy Minister Purnomo Yusgiantoro recently said the government wouldn’t raise fuel prices before 2009.

India’s subsidies are believed to have cost $10 billion or more last year. Much of the cost is shared by domestic oil companies, including exploration and production giant Oil & Natural Gas Corp. Some firms deeply resent having to finance such extravagances. India is importing some 70% of its oil, and that percentage could increase in the coming years, leaving the country’s oil companies particularly vulnerable if international prices keep rising.

Even so, the pressure to keep subsidies in place in India is great, especially as prices for food and other commodities have also climbed. In one indication of the political landscape, the Indian government recently promised not to raise retail prices of gasoline, diesel, cooking gas and kerosene oil.

–Kersten Zhang in Beijing, Ellen Zhu in Shanghai, Aries Poon in Hong Kong and Jun Yang in Singapore contributed to this article.

Write to Shai Oster at [email protected], Patrick Barta at [email protected] and Russell Gold at [email protected]

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