China’s Looming Oil Crisis

From Martyn…

An already very jittery world oil market went into apoplexy on Wednesday as the fallout from Hurricane Katrina sent crude oil prices surging above $70 a barrel – 60% higher than a year ago. The simple reason is because very little excess capacity exists around the world to adequately offset any production losses in a time of high demand. This makes a lot of countries, particularly countries like China that have a negligible amount of reserves, very nervous indeed.

As an update to an earlier post, the very latest on the petrol crisis in Guangzhou: as of yesterday it was still very difficult to buy No. 90-octane grade petrol (used by taxis) and the supplies of No. 93 petrol have become very tight indeed. Many petrol stations still remain closed. The potentially dangerous stand off between the government and the city’s taxi drivers has been eased slightly by the local government further reducing the monthly management fee collected from each taxi and also planning a one-yuan (US$0.12) fuel add-on fee for each taxi ride.

So far, the petrol crisis has been prevented from spiraling out of control by the bringing in of supplies from smaller cities, which, in turn leaves them short of fuel. This hasty and stopgap solution will almost certainly result in further shortages this winter.

The problem is that, here in China, a barrel of oil is about US$25 cheaper than Monday’s closing crude price of over US$70 dollars on the New York Mercantile Exchange.

Put simply, the government can’t continue to arbitrarily keep domestic prices low if global oil prices remain at very high levels. China relies heavily on cheap fuel and other subsidized raw materials to prime its manufacturing growth and keep its exports the cheapest in the world. Indeed, low-cost inputs have been one of the cornerstones of China’s economic growth, much to the chagrin of competing economies. However, any rise in domestic prices would have a huge and negative impact on the economy, as an AFP report from Shanghai explains:

Soaring global crude prices have backed China into a corner, where it faces the tough choice of risking serious damage to its own oil industry or allowing surging inflation that could devastate the economy.

With prices now more than double the levels reached in 2003, China is finding it difficult to handle a two-tiered oil pricing system that was to blame for recent severe shortages in Guangdong province, analysts say.

Under the system, Beijing fixes oil prices by using a basket of the previous month’s global trading levels in London, New York and Singapore and then allows the price to float within eight percent of daily trade.

As the price of crude being paid on the international market has became impossible to recover at the wholesale and retail level, refineries in Guangdong refused to replenish supply because they were losing money.

Guangdong Province accounts for 11% percent of China’s 1.6 trillion dollar economy, double that of Shanghai. This huge contribution to the nation’s GDP will be directly threatened if high oil prices continue. This is the problem faced by the government on a national level and is what the refiners SinoPec and PetroChina know only too well. The only solution would be to loosen the domestic caps on petrol prices and risk spiraling inflation:

“If prices — adjusted for inflation — were to go above those of the 1970s oil crisis, then China would face a trade off. It either lets its refiners go bankrupt or it sacrifices its inflation target.”

In theory, artificially low prices protect the consumer against inflation, a key worry for a government obsessed with macro-economic expansion.

“It forces the oil refineries to subsidize fuel so consumers in China don’t feel much of the pain of high energy prices,” said Victor Shum, partner at Purving and Gertz, a US-based global energy consultancy.
The problem is that an inflationary scenario elsewhere in the world would likely act like a slow puncture, seeping into the Chinese economy.

Inflation remains one of the Chinese Communist Party’s biggest fears. China has not suffered from high inflation since the early 90s, although it did reach a slightly worrisome 5% in 2004 due, partly, to a spike in domestic food prices. The rate has since dropped following a rare interest rate rise by the central bank in October 2004. The central bank isn’t keen to raise interest rates again, which, in China’s only partially-free market economy, does not have the same economic impact as in free market economies. Therefore, the choice the Chinese government faces is to either run the risk of its refiners going bankrupt or face rising inflation.

However, the threat of social unrest is never too far away:

That would not just dull the shine of three years of China’s otherwise glowing GDP growth, but have a powerful ripple effect through society from consumption to unemployment and social unrest, analyst say.

For three decades China’s insular, Stalinist-modelled economy allowed Beijing’s mandarins to escape the sometimes capricious volatility of globally integrated trading.

But today it is one of the main drivers of global growth, and a sharply slowing Chinese economy would impact Asia’s export-driven economies and even provoke world recession, analysts warn.

A growing number of its 1.3 billion people are already disenfranchised, many angry enough to come to blows with police over rampant party corruption, health-destroying pollution and widespread housing evictions and unemployment.

Also, just to add to the fun, America’s trade deficit spiked in June as oil prices pushed petroleum imports to record levels. The politically sensitive deficit with China also saw a new record, hitting US$17.6 billion in June, beating the previous high of US$16.8 billion set last October. In 2004, America’s deficit with China reached US$162 billion, the highest imbalance ever recorded with any country. This year’s imbalance is already running 32% above that of 2004.

The skyrocketing international oil prices are not only effecting China but also other Asian economies, excluding perhaps oil-producing Malaysia. High fuel prices have sparked protests in Thailand and Indonesia; governments have subsequently slashed growth estimates for the year. In Japan and the Philippines, the governments are hastily implementing energy conservation measures to try and stem the effect of oil prices. India is also expected to raise domestic prices and faces the very real threat of political instability and social unrest.

It’s surprising that the rest of the world is yet to fully appreciate this looming problem in the world’s most populous nation, because, if it does spiral out of control, the effects will almost certainly be felt far beyond the borders of the People’s Republic of China.

The Discussion: 24 Comments

Hell, they’re going to have social unrest and lost profits if they DON’T get some fuel to the pumps and the factories. Ticklish situation either way. Anybody want to tackle the “perfect storm” scenario that could brew up any day or any year now? Combine fuel crunch with ANY economic glitch (say a crack in the housing bubble or a recession among their export customers), and any number of social “contradictions”, and it could get ugly quickly.

Sorry for such a short comment on a good long article, but I’m in a crunch at work and have to scoot.

September 1, 2005 @ 1:54 am | Comment

PS, I haven’t tried to buy gas in SZ lately, but I hear they have some at the pumps now. I’ve just been biking and busing.

September 1, 2005 @ 1:55 am | Comment

I’m not so sure about it not affecting Malaysia; my personal correspondence with people living in Malaysia suggests that the government is facing somewhat similar problems, since it subsidises petrol prices. They’ve been allowing petrol prices to rise a little every so often, but that has had an effect on the cost of other goods, particularly foodstuffs and other staples that have to be transported to urban centres.

September 1, 2005 @ 2:05 am | Comment

Fascinating stuff, Martyn. I note no disruption of supply here in Beijing, within site of party leadership, diplomats and international media.

Speaking of international media, Mark Magnier, of the LA Times, based here in Beijing, did a good, comprehensive survey of China’s oil situation about six weeks ago. Still work a read (free reg required):

September 1, 2005 @ 2:07 am | Comment

PS: Today’s u-cook-em poll on Xihuanet’s English site asks what people think the oil price will be at the end of the year: 70, 75 or 80 (if I recall correctly). Might be lowballing! The majority of respondents were shooting high, last I looked.

September 1, 2005 @ 2:10 am | Comment

As a net exporter (I believe) with a single, government controlled petoleum company Malaysia might have an easier time managing the conflicts created by its subsidy.

On the other hand, Indonesia has a single, government controlled petroleum company as well and it’s on the threshold of disaster. It’s a net exporter, though and its fiscal situation is probably substantially more precarious than Malaysia’s though, especially after yesterday’s rupiah hiccup.

September 1, 2005 @ 2:19 am | Comment

In 1998, Suharto was forced to raise retail gasoline prices because it is part of the IMF’s rescue measures to reduce the government budget deficit caused by the fuel subsidy. The rise in the retail gasoline prices was the “cataylst” that led to riots and eventually anarchy in Jakarta. It also led to the downfall of the Suharto government though there is much debate that the US Treasury together with the IMF engineered the conditions that led to Suharto’s ouster (but that’s another story).

I was in Jakarta at that time and things were truly scary. The locals were burning down malls and putting up blockades to the airport and looking for Chinese to kill.

I am sure this has not escaped the present Chinese government and they are now between a rock and a hard place. Raise prices and risk social unrests or keep things as they are and risk choking off the fuel supply for the logistics network that moves most of the exports of China

September 1, 2005 @ 3:57 am | Comment

i just happened to stumble across your site…..and read some of your past post as well as your newer ones. i can’t say that i agree on everything you say, but definitly most of it. i am an american, and that being said….i sometimes feel that i am being led to believe that majority issues only affect us. well, anyway….i have class in about 5 minutes….so i just wanted to say keep up the good work.

September 1, 2005 @ 6:16 am | Comment

They are in a bind, but to me it seems overcapacities in most major industries and a risk of recurring deflation should allow them to liberalize oil prices slightly. Plus, a bit of sensible market economics wouldn’t hurt in shifing investment to low-energy use high-tech projects from power-guzzling high-polluting industry, supposedly a party goal. This could have been done last year instead of some of the ad hoc macro-controls they slapped on everything.

September 1, 2005 @ 6:55 am | Comment

your point is well taken, but that is not how the CPC works. As pointed out at PD many times before, the CPC is intensely factionalised. While some support more free market responses, others still cling to state intervention as the way to manage economic challenges. The very reason why the “macroeconomic controls” were/are implemented in the way they are (rather than conventional methods such as raising interest rates) is precisely because of this internal contradiction within the CPC. Plus as PC and others point out, all the CPC agrees it doesn’t want to face the fate of Suharto et al by precipatately making ordinary people pissed off.

September 1, 2005 @ 8:12 pm | Comment

Great post. I have just learned more about China and its domestic oil market in the last 5 minutes than in the last 30 years.

What interests me now though is what do you think China should do? Or, what can it do?

September 2, 2005 @ 12:39 pm | Comment

It is fascinating alright. As far as I can tell the Chinese are just finishing up the economic war they have been fighting with the US for the last, lets say, 20 years. Oh yeah … I’m pretty sure they have pretty well won it.

How they will deal with this will be the fascinating part. They may not even tell the US ;). Ah yess 6000 years of finesse.

Do What Now ??? … Standards and Practices !

September 2, 2005 @ 3:27 pm | Comment


Where did you get 6,000 from? Try 2,000. And to what 20-year economic war with the US are you referring? It has escaped my notice.

September 2, 2005 @ 8:47 pm | Comment

Thanks for the great comments. I’ve been in Hong Kong for a few days re-newing my one year visa.

I think that China doesn’t have any choice but to allow domestic oil prices ro rise, perhaps slowly, but rise nonetheless.

Never mind the internal pressure from the oil refiners, it just can’t keep subsidizing each barrel of oil for 25 bucks a piece. That’s the long and short of it.

Anohter problem that eminates from the low domestic oil price is energy inefficiency. China is one of the most wasteful countries in the world in its oil use. It simply doesn’t get as much bang for its oil buck as do Japan, the US, Europe etc.

That means that another benefit of higher domestic oil prices would be increased energy efficency from Chinese industries.

I’m working on a final post about what China should actually DO to address this current problem.

September 3, 2005 @ 2:24 am | Comment

Nice post. China is in a bit of a mess with this one. Ha! It has a population addicted to cheap oil but it can’t keep subsidzing the price. The people who will have to pay the full world price will howl with anger when it comes.

That $25 per barrel subsidy will start to come straight out of peoples pockets. I can’t imagine Chines epeople putting up with a sharp fall in their profits/livlihoods, wages etc.

Problems, problems.

September 3, 2005 @ 7:43 am | Comment

I’m surprised to read this kind of article on a blog. It’s quite comprehensive and very informative. Much better than the cut/paste/link fare available on most other blogs. Good to see a bit of thought go into a post.

So, China is facing continued subsidies or potential social unrest? Quite a nice situation. It surely has little choice but to allow oil prices to rise, yes? I mean, if it can’t afford to keep paying for the cheap oil then it’s got to piss off those taxi drivers and farmers.

I’ll keep watching with interest. Please keep us informed as things unravel. Thanks!

September 3, 2005 @ 10:18 am | Comment

Good post. I look forward to the next installment about what China should do.

September 3, 2005 @ 11:29 am | Comment

Hui Mao: China already CLAIMS the South China Sea. What do you mean saying how do we know what China will do with its armed forces?

All other countries involved in the Parasol/Spratleys territorial dispute are willing to negotiate and accept compromise EXCEPT China, which thinks the entire sea is theirs.

China’s current land disputes with India, Vietnam etc are currently on hold. DO yuo honestly think that china will accpet any compromises if/when it is a world power? I don’t think so.

September 3, 2005 @ 12:25 pm | Comment

Sorry, wrong thread!

September 3, 2005 @ 12:27 pm | Comment

Asian blogs 8: Peking Duck

The eighth addition to my Asian blogroll is The Peking Duck, another multi-author China weblog. Lately it has had plenty of posts of interest to econobloggers, including China’s Forex Piggybank, China’s Looming Oil Crisis and the looming Export Bust.

September 4, 2005 @ 5:16 am | Comment

I’ve just took a glance at PC’s site and it’s good. Solid economic stuff. Good reading. Also, thanks for the oil post martin.

September 5, 2005 @ 6:11 am | Comment

china economic roundup (xii)

As China Economic Roundups are to be occasional, I’ll resist apologizing for the gaps between editions. Still, there is some good stuff in this one, so I hope it was worth the wait. Howard French hasn’t put much original material

September 6, 2005 @ 11:49 am | Comment

When the great sun rises fully and completely in the eastern skies, the world will stand in awe.

February 28, 2006 @ 9:40 am | Comment

i do agree with the price of meat, however i do feel that bush meat (eg monkey) is not for the faint hearted. but if you feel like killing your own dog and eating it, do it infront of of your first born child and serve it to him on his birthday. that reminds me of a story concerning a young boy who got raped by a certain young fellow called mr bibby

all right josh R n B ur now famous
if you ahve any fan maill please send to the following adress (you 2 are the best @ i love you . love

ps hate mail will be rejected and you WILL be tracked down and killed in a horrific un humanic way…!”£%£$%^*”£^

pps if you want a signed pic of us please send some cow sperm in a stamped adressed evnvolope adressed to Bunbury School.
it will be put into good use (involveing some unsuspecting chikens and gerbles)

October 11, 2006 @ 6:02 pm | Comment

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