Streetwise Professor

November 14, 2007

This is What Happens With Price Controls, Even “Informal” Ones

Filed under: Commodities,Economics,Energy,Russia — The Professor @ 11:05 am

From Reuters an article on Russian fuel shortages:

Russia’s transportation fuels market is facing its biggest crisis in almost 20 years as severe shortages force some retailers to close their filling stations.

As global oil prices beat records, Russian firms are rushing to export both crude oil and refined products. That, combined with outages at refineries in central Russia, has caused a spike in wholesale gasoline and diesel prices.

The shortages have forced wholesalers to ration supplies to retailers, who in turn are unable to pass on higher costs after pledging to the Kremlin to keep pump prices stable ahead of a Dec. 2 parliamentary election. . . .

In May of this year, major oil firms pledged to keep petrol prices capped until the 2008 presidential elections despite rising wholesale prices.

As day follows night, price controls–even informal ones (although given enforcement mechanisms in Russia one would be well-advised to live up to such pledges)–lead to shortages.

There is an interesting contrast between what is going on in Russia and events in China. In Russia, the state is apparently not using compulsion to force recalcitrant refiners from selling petrol at unremunerative prices, nor is it subsidizing consumption, whereas both things are going on in China. Hence, Russian refiners are selling more abroad, and there are shortages at home, whereas in China there are few shortages.

And speaking of China, the FT’s Energy Special had this tidbit about the situation there, which is consistent with my earlier conjectures:

The companies have been given a degree of licence to go offshore in search of energy assets, but at home they are constrained by numerous regulations, most importantly the government’s power to set prices.

The price controls, which have turned into a price freeze in the last six months of this year, as part of a raft of measures to control inflation, have prompted an almost annual stand-off between the government and Sinopec, the main refiner, in recent years. China last raised prices at the pump 17 months ago.

With the government declining to allow local prices to rise in line with global levels, refiners have been losing tens of millions of dollars on imported oil.

At the year’s end, they have usually been compensated out of public funds.

In the meantime, however, the companies play cat-and-mouse with the government, cutting production, to register their displeasure with government policy, resulting in embarrassing shortages.

So, through subsidies and compulsion, the Chinese government has encouraged sufficient production to meet demand at the subsidized prices. The shortages that occur appear to be a Sinopec bargaining tactic. In contrast, Russia is living with shortages.

Apropos my earlier analysis of the food price freeze pledge, the experience in the Russian gasoline market foretells coming shortages for basic food products, and I have read some reports of hoarding. This is especially true inasmuch as the inflation rate appears to be rising more rapidly than forecast. This may reflect the injection of liquidity into the market in response to concerns about the stability of the Russian banking system during the subprime credit crisis.

And there is also reason to wonder whether, in light of these increasing inflationary pressures, whether the government will have the stones to allow fuel and food producers to raise prices post-election, given that they know that prices will spike dramatically when they do. Their choice in March: a price spike, or growing shortages, either of which may take the bloom off of Putin’s rose pretty quickly come April. Thus, short-term political calculations have put the Russian government in something of a box. I guess they’ll worry about that tomorrow, just like Scarlett O’Hara.

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