Monday, August 22, 2005

Oil bubble hits China extra hard (e)

Column -- Everyone may be marvelling at how well the US economy is handling US$60 oil, but it is China we should be worried about. In recent weeks, the strain on the Chinese economy has begun to show. Stories have emerged of massive queues, rationing and fraying tempers at police-guarded gasoline stations. The planning wizards at central command must be really starting to sweat as they try to figure out how to make the 60% rise in crude since the beginning of the year fit into their economic strategy without creating dreaded social unrest. It is really no surprise the US and Canada have been able to weather the energy storm so far. About 70% of North American economic activity is generated by the consumer and only 15% by manufacturing. It is true North American consumers may be starting to balk at cost of gasoline at the pumps and economic activity may fade further in the months ahead. But in China, where industrial production still makes up half its gross domestic product, the high price of oil must be really starting to pinch. Much of that industrial production is devoted to producing manufactured goods for us, its own emerging middle class and all the heavy equipment and machinery required to upgrade cities for a few hundred million people. The official inflation statistics show hardly a whimper, however. The rising price of fuel has driven up every consumer price index across the West, but the oil component in China's CPI is registering a laughable 7.7% decline, according to Stefane Marion, assistant chief economist at National Bank in Montreal. It's not because of your typical Chinese fudging of the figures. It's because China sets the price of oil. "Think of it this way," Marion said. "You've outsourced production to a country that is less oil efficient than you are and they have price controls at the retail level. To me it says they're subsidizing us for the manufacturing products we buy." The folly of this centrally planned throwback in a country slowly opening to free-market economics is starting to take its toll. Newspapers reported China's oil refiners posted losses totalling 6.09-billion yuan ($910-million) in the first half of the year, unable to pass the high price of crude to consumers. The refiners have reacted by holding back supply, creating the shortages China is now witnessing. The policy mandarins are waking up. Reuters news service reported last week the country's top planners at the National Development and Reform Commission have called in oil firm executives and other top officials to discuss its pricing system. Analysts don't expect a major revamp however, only more frequent price adjustments.

Andy Xie, China specialist at Morgan Stanley in Hong Kong, said in an e-mail interview that high property prices are offsetting high oil prices for now, much as they are in North America. And with factories running full tilt, some of the shock can be absorbed. As in Canada, soaring oil prices are also creating winners and losers. "One of the big group [of winners] is the owners of small coal mines who have seen the value of their mining rights triple in the past three years," Xie said. "Seventy percent of the 2-billion ton coal production is from this group." But Marion figures something has to give soon. He expects higher prices will eventually get passed on to both Chinese and North American consumers. Pass on the rise too rapidly, however, and you risk social unrest. Past it on too slowly and you risk further shortages and social unrest. The solution? Marion says watch out for a further revaluation of the yuan, which would make those imports of oil cheaper.
(National Post 050822)