Why China Can Withstand $90 a Barrel Oil - And Higher

LONDON Oct. 19, 2007 (Dow Jones Newswire)

The rest of the world is wincing as crude oil prices surge past $90 a barrel, yet China - the world's second-largest oil consumer - appears set to continue sucking up oil at ever higher prices.

What's it got that the rest haven't?

Experts say the country's not entirely immune but that a timely combination of extremely robust finances, strong political incentive to uphold costly fuel subsidies, and less exposure to world oil price fluctuations than many realize is what's keeping Chinese oil demand seemingly insatiable.

Chinese consumers, though less energy-efficient than their Western counterparts, are shielded from the impact of surging oil prices which would otherwise curb their thirst by hefty government subsidies.

The burden falls primarily on Chinese oil companies: China National Offshore Oil Corp. Ltd. (CEO) and PetroChina Co. (PTR), which are obliged to pay a windfall oil tax whenever the price rises above $40 a barrel, shelled out more than $2.3 billion in the first half of this year.

"There will be at some point a limit to that unless (the companies) get additional funds from the Chinese government," Simon Wardell, an energy analyst at Global Insight in London, said Friday.

The Chinese government is comfortably positioned to do that, sitting on top of a whopping $1.43 trillion in foreign exchange reserves as of the end of September.

The Paris-based International Energy Agency said in its monthly oil market report, released last week, that Beijing was likely to take whatever steps necessary to sustain demand and maintain stability ahead of the Communist Party Congress this week at which the country's leadership is renewed through to 2012 and ahead of next year's Olympics.

"The Chinese government will most likely do the utmost to keep the economy growing, through heterodox means if necessary," the energy watchdog's report said, noting that inflationary pressures elsewhere in the Chinese economy are also an argument against lifting caps on fuel prices.

Talk of rolling back subsidies or imposing a fuel tax on consumers, "should probably not be taken at face value," it said.

In fact, comments this week by Zhu Zhixin, a vice-minister with the National Development and Reform Commission - China's economic planning agency - indicated that China was comfortable with record oil prices, hoping it would aid the government's drive to increase energy efficiency.

High oil prices "may encourage enterprises that use a large amount of oil to adopt energy-saving measures and reduce emissions to increase efficiency and economic returns," Zhu said.

As the U.S. dollar fell to a new low against the euro, the price of oil surged to an all-time high of $90.07 a barrel in London Friday morning. The dollar's weakness has supported high oil prices because a lower dollar makes oil cheaper in countries paying in other currencies.

China has not benefited from the currency cushion as much as others because its currency, the yuan, is set at parity with dollar.

"They do feel it a bit more," said Wardell.

Yet that is more than offset by stimulus that a lower exchange rate gives to its roaring exports. The yuan's depreciation against the euro in recent months has resulted in Europe becoming China's largest export market.

Some more skeptical of China's resilience have noted that its export sector could face weaker demand ahead from the U.S. and Europe due to subprime woes and market turmoil.

"This pessimistic scenario is far from certain," as the government would be likely to step in, said the IEA.

Others note that China is not as exposed as some might think: China still depends overwhelmingly on coal for energy, while it sources 10% of its energy consumption from domestically produced oil.

That means only about 10% of its energy consumption is actually exposed to world oil price fluctuations - though that is still a sizable 3.3 million barrels a day in absolute terms.

Meanwhile, imports from less traditional sources - such as the 50.5 million barrels of oil provided by Sudan in the January-August period - have offered some protection: Sudan's Dar Blend crude is highly acidic so it trades at a substantial discount to market prices and reduces China's need to tap more expensive sources.

Yet the country is not impervious: demand growth is expected to have been in the relatively sluggish range of 3% to 5% growth on-year in September.

It is also more exposed to sudden disruptions because its stockpiles are lower than those in major industrialized countries: some 21 days worth compared with 53.5 days for countries belonging to the Organization for Economic Cooperation and Development.

High prices have already slowed down the Chinese government's efforts to fill those strategic reserves, Keun-Wook Paik, an expert on China and energy at the London-based think-tank Chatham House, said Friday.

"It has become very expensive to fill up those reserves," said Paik. "The Chinese government will sooner or later start to express their anxiety about the high oil price."

But he said that moment probably has not yet arrived.

"(The rise in prices) has been absorbed step-by-step from $60 to $70 to now $80 and $90. I would be very surprised to see China's oil demand fundamentally affected up to $100," Paik said.

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