China Cuts Fuel Subsidies... But Don't Believe This Myth About Oil

Date 20/06/2008

The Right Side

Garry White

If something’s more expensive, less people will buy it.

That’s NOT the case with oil.

Take China. Yesterday, it did the unthinkable...

It cut oil subsidies. That means the Chinese people will pay 18% more for a tank of fuel than the day before.

It’s the biggest one-off price hike in a decade.

Some analysts, like the Wall Street Journal’s Edward Hadas, say this will drive down the price oil.

I believe he’s wrong. In fact, it could actually drive world oil demand up higher - and quicker - than at any time in history.

Here’s why...

Why higher oil prices could boost consumption

China’s subsidy u-turn might have the opposite effect to what everyone thinks.

Admittedly, the oil price fell $5 on the news... but I don’t expect it to fall much further.

The Chinese economy is different to ours — and an increase in price could actually BOOST oil consumption.

PetroChina and Sinopec’s profits are capped because they have to sell refined products at a level set by the government — margins are thin.

With margins looking more attractive due to higher prices, oil companies will refine more crude... and there will be fewer shortages at the pump.

Goldman Sachs agrees.

In a note to clients issued last night, the broker said that, in the near term, the announced price hike was likely to alleviate the current shortages and boost crude oil demand, as it should improve domestic refinery margins and incentivise increased refinery runs.

Goldman also pointed out that after previous price hikes, China's imports of crude oil actually increased.

The broker upgraded its stance on Sinopec shares to "buy" from "neutral", raised its rating on PetroChina shares to "neutral" from "sell," and upped its rating on Shanghai Petrochemical to "buy" from sell."

Don’t believe the "oil collapse" myth

I was shocked and surprised by the news.

A few weeks ago I said I expected subsidies would not be cut in the short term —China herself had indicated as much. I was wrong. This is a brave move by China. It will stoke inflation. And it’ll hit poor people the hardest.

But, what the Chinese government takes away with one hand, it gives back with the other...

To ease the transition, China will pay $2.9bn in subsidies to help farmers, fisherman and public transport operators cope with higher costs. The news prompted a near $5 pullback in the oil price, but all futures contracts for the next 12 months remain above $132. There has been no collapse — and I don’t expect there will be.

I also don’t believe that China’s new middle classes will stop driving their shiny new cars — in fact it’s now more likely vehicle ownership will increase.

"As long as there’s supply... people will pay for it"

In China around 20 people per 1,000 own a vehicle, compared with at least 450 cars per 1,000 in the US. Every day, about 17,000 new private cars hit the road.

And China is STILL not a consumer economy - yet!

The industrial sector represents 68% of all primary energy consumption in China. In the UK, the equivalent figure is 25%.

Eduardo Lopez, senior global oil demand analyst at the International Energy Agency (IEA) also thinks the move would not curb demand...

"There is strong pent-up demand. It’s not a matter of price, as long as there is supply; people are prepared to pay for the supply."

Take it from me... I seriously doubt the IEA will reduce their forecasts for Chinese oil consumption.

On 10 June the body said it expected China’s oil demand would rise by 500,000 barrels a day, or 6.7%, to 8 million barrels a day this year.

So, I don’t expect this move by the Chinese authorities will be the magic bullet that brings down the oil price — and I remain extremely confident in our Smart Commodities UK energy plays.

To access to all our open positions and specific oil related investments, click here now.

Regards

Garry White
Editor
Smart Commodities UK

^ Back to top

LinkedIn
Twitter
Del.icio.us
Digg
Facebook
Google Bookmarks
Livejournal
StumbleUpon