China Stimulus Package May Underpin Crude Oil Prices

BEIJING (WALL STREET JOURNAL via Dow Jones Newswires), November 10, 2008

Beijing's move to rev up its economy with $586 billion in government spending could buttress global crude prices by strengthening demand in the world's second-largest consumer of oil.

As crude demand has plunged recently in the U.S. and Europe, driving down prices from their midsummer highs, oil traders have looked to China and the Middle East for evidence of sustained demand growth. But signs that China's economy is cooling has led some analysts to predict that global oil demand could fall flat or even shrink next year for the first time in decades.

China's massive stimulus package is sure to change that calculus, though it could take months to show its full impact.

"If China succeeds in keeping [gross domestic product] growth at above 8% in 2009, there could be positive surprises from China's oil demand growth, especially now that the domestic refining sector has started to make profits," said Gordon Kwan, head of China energy research at CLSA Asia-Pacific Markets.

China's economic output is expected to grow by nearly 10% this year, but signs of deepening economic malaise had led some analysts to fear that China's growth rate could decline to less than 6% next year - a potential change in fortunes that has clearly rattled the Chinese government. The huge boost in government spending, combined with a cut in interest rates, could shove the growth rate back above 8% in 2009.

News of China's stimulus package drove oil prices up sharply in early trading on the New York Mercantile Exchange. But prices eased off on continued worries about the state of the U.S. economy. U.S. benchmark crude was trading midday Monday at $61.21 a barrel, up 18 cents from last week's closing price.

Soaring demand in China, the Middle East and India helped push oil prices to a record high of $147 a barrel in July, before the economic crisis slashed fuel consumption in the U.S. and drove prices down to near $60 a barrel. China is now the world's second largest oil consumer, using around 8 million barrels a day, compared to around 19 million barrels a day in the U.S.

The global economic slowdown has hurt China's export economy, forcing factories to close or curb production. The domestic construction industry has also slowed sharply, reducing demand for transportation fuel, especially diesel used by logistics companies. Year-on-year car sales grew by only 8.3% in October, sharply down from their nearly 20% growth rate over the last few years.

Chinese are also cutting back on air travel, pushing aviation fuel imports down. And power electricity declined for the first time since 2005, especially hurt by huge drops from big industrial users like aluminum smelter and steel plants, leading to a drop in oil demand from the few power plants that use oil instead of the more widespread coal.

But even before the new announcement, analysts predicted that China's oil demand would continue to grow at a relatively brisk pace despite the slowdown in the overall economy. The Paris-based International Energy Agency said oil demand would increase by 5.2% next year, compared to 6% this year.

The slowing global economy was already having an unusual impact on China's oil industry. Because of state-set fuel prices, China's oil refineries had been losing money for years. But now, with domestic pump prices on the rise, refiners are finally breaking even, prompting them to buy more oil to refine into fuel.

In addition, China's government may consider lowering domestic fuel prices, a step that would further spur domestic demand, especially since high prices - in Beijing some gasoline is more expensive than in the U.S. - has begun to exact a social toll. In the past few weeks there have been two large and unruly protests by hundreds of taxi drivers in two different cities complaining about high fees, including the cost of gasoline.

Heavy industry in particular will rebound if the government lives up to its pledge to dramatically boost spending on roads, bridges, housing, and agriculture.

Still, clouding the picture is a large buildup of oil stockpiles bought in preparation for the Olympics. With no clear data available, it's unclear how quickly those stockpiles are being depleted and when oil companies will have to start buying more to replenish them.

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