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Friday, June 20, 2008

China Increases Energy Prices

China increased energy prices across the board yesterday in an important policy shift that is likely to have an impact both inside and outside the country.

On the one hand the measure is bound to add to the country’s already high inflation rate. On the other, if the rate of demand increase were to slow inside China itself, then this would perhaps take some pressure off global oil prices.

Global oil prices fell immediately following the announcement in Beijing that petrol and diesel prices would go up by to 18 per cent and electricity tariffs would rose by just under 5 per cent. Oil prices – which were already under pressure from a possible Saudi announcement this weekend that they are going to increase oil production – fell more than $4 a barrel to $132.32.

Before the announcement, petrol prices in China were about 40 per cent below those in the US. In the last month, India, Taiwan, Malaysia and Indonesia have all cut their subsidies amid mounting fiscal cost and in spite of concern about high inflation, and the Chinese decision does of course follow last weekend's Group of Eight finance ministers statement said last weekend that “reducing subsidies” was an important step on the way to lessening the rate of increase in oil prices.

We will now need to watch and wait to see what impact the decision will have on China's internal inflation, and on Chinese demand for fuel products. We may well not see lower Chinese oil use in the short-term, since the decision may well be more effective in stimulating supply than it will be in curb demand.

The previous price caps had caused significant problems of shortages, and the two large state-owned refiners had been continuously complaining about their losses and the shortages which had been produced at petrol stations across the country as many small refineries stopped operations. So ironically the increase in retail prices could now boost Chinese demand, rather than reduce it, at least in the short term, simply because higher prices will probably encourage refiners to import more oil and boost sales in order to to ease current petrol and diesel shortages.

The IEA said earlier this month that the fuel shortages that have beset China since 2007 suggest that “pent-up demand remain considerable”.

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