Streetwise Professor

Another article in today’s WSJ on Chinese energy price controls. This article confirms what I had conjectured in earlier posts. Specifically, that (a) price controls are encouraging consumption, but (b) through a combination of cajoling and subsidies, the government has prodded/induced major refiners (notably Sinopec, for whom I’ve taught the last two years) to produced enough refined products to avoid shortages.

Here’s what I infer from the recent developments. This is conjecture, but is consistent with the news coverage I’ve seen. In recent years, government subsidies have been sufficient to induce Chinese refiners, notably Sinopec, to produce sufficient oil to meet demand at the artificially low official price. The continuing increase in the price of oil has made Sinopec uncertain about the credibility of government promises (explicit or implicit) to make good its losses from selling fuels at the artificially low prices, so it has cut back on output, or at least not expanded output sufficiently to keep up with burgeoning demand. This has led to episodes of shortages, lines, etc., which has the government worried. So it is trying to deal with the situation by a mixture of policy tools. It is trying to reduce the excess demand by increasing the official price. At the same time, it is ratcheting up the pressure on Sinopec and other refiners.

This Rube Goldberg approach reflects a problem I mentioned when interviewed about Russian food price controls–once in place, they are very hard to get rid of even as their costs escalate. Politically, the Chinese government feels that it cannot cut the Gordian knot and eliminate the controls. Similarly, it has concerns about the political ramifications of rationing, particularly in rural areas which are already restless and less than enamored with the government. But at the same time rising oil prices make it progressively more expensive to subsidize output of refined products, which puts strain on the budget. So the government is resorting to tried-and-true authoritarian/communist techniques–ratcheting up the pressure on producers. As for one of the expedients, forcing refiners to defer maintenance in order to sustain output in the short run just kicks the can down the road. There will be more refinery outages in the future, putting more pressure on the rickety edifice. And refiners will be very reluctant to invest in new capacity. Someday–perhaps some day soon–the whole thing will come a cropper. And it won’t be pretty.

I am in the process of putting together some back of the envelope calculations regarding the impact of price controls and subsidies in developing nations, like China, on overall market demand, and hence on prices. The basic idea is to determine (a) the elasticity of demand in such countries, (b) total consumption in these countries, and (c) the amount of the subsidy. Given these figures, it will be possible to estimate (at least crudely, no pun intended) how much oil consumption would fall if these countries were to let domestic energy prices rise to meet world prices. Presumably energy demand in such countries is more elastic than in the US or Western Europe, as energy comprises a larger share of expenditures in such countries (even at subsidized prices). Nonetheless, I would wager that price controls (combined with subsidies or other measures like those in China to ensure supplies meet the quantity demanded at the controlled prices) contribute substantially to demand for oil, and hence are contributing to high world oil prices.