Streetwise Professor

October 31, 2007

Chinese Gasoline Price Controls and the Demand for Oil

Filed under: Commodities,Energy,Politics — The Professor @ 10:04 am

This somewhat goofy article from Slate does contain something of interest:

China’s CPI rose 6.5 percent between August 2006 and August 2007, thanks in part to an 18.2 percent year-over-year increase in the price of food. Beijing has responded in part by telling government officials not to use the word inflation. But it is also taking action. The International Herald Tribune reported that China hasn’t permitted gasoline prices to rise since May 2006, when oil was about $70 per barrel. (Yesterday, oil closed at nearly $94 per barrel.) And in September, China froze prices on certain household staples.

The unanswered question here is how the price control is being managed. I didn’t notice any gas lines in Beijing when I visited there this summer, and haven’t read any stories about shortages. This suggests that refiners’ (e.g., Sinopec, CNPC) purchases of crude are being subsidized, or the refiners are being forced to produce sufficient gasoline to meet demand at the artificially low controlled price. If either is the case, there is some positive feedback going on here that is contributing to the higher world oil price. If either through subsidy or compulsion refiners are satisfying the excessive quantity of gasoline demanded (relative to the efficient quantity) at the artificially low price, the price control is contributing to an increase in the world demand for oil, thereby increasing the world oil price. That is, the price control on gasoline encourages consumption, bumping up world demand for oil, leading to higher prices.

Price controls on gasoline are not uncommon–I have read about such controls being in effect in Iran and Iraq, for instance, and would not be surprised if they were quite common. How these effect the world oil price depends on how the controls are implemented. If they reduce the incentive to refine crude into gasoline, because they are not offset by subsidies to refiners or forcing refiners to incur losses while supplying the excessive quantity demanded at the artificially low price, then these controls tend to reduce demand for crude and restrain prices. If, on the other hand, through subsidy or compulsion refiners are induced to meet the excessive quantity of gasoline demanded at the artificially low price, the price controls perversely increase the demand for crude, and thereby raise prices that consumers in non-price controlled countries pay.

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