Energy Subsidies And Levels of Demand

There has been increased talk recently about the relationships between energy prices and demand levels for crude oil, natural gas, electricity, diesel, and gasoline. Even as prices have hit record levels, global demand has not fallen as sharply, or in some cases, even at all, putting into question the traditional relationship between the levels of price and demand. As it turns out, many countries are subsidizing the energy demands of their citizens, causing many users of energy to not directly feel the effects of higher energy prices, and therefore have no reason to curb their energy usage.

Recently, some of these countries are being singled out in the ever growing and popular game of assigning blame for higher energy prices. Just ask SUV drivers, President Bush, the Saudi King, congress, the Iraq war, speculators, supply-demand relationships, environmentalists, emerging markets, Mother Nature, and even alternative fuels, such as ethanol. Each has had its turn as the energy boogie man. As a sign of increasing pressure, the Wall Street Journal is reporting that China is now lifting energy prices for domestic consumers, raising prices for gasoline (by 17%), diesel (by 18%), and electricity (by 4.7%). As a comparison, this will raise gasoline prices in China to the U.S. equivalent of just over $3 a gallon. China has also stated that some of the gains in global energy prices that are realized will be passed on to consumers.

Ironically, the raising of prices may actually increase demand, and subsequent prices, as profits return for Chinese refiners. Refiners are currently buying crude oil on the open market at recent high prices, yet are limited as to how high they can price their refined products. As prices rise to meet and exceed their raw material costs, refiners will begin making more gasoline, resulting in more crude oil being purchased. Price controls have created fuel shortages in some parts of China since last year, and the level of pent-up demand is strong. The United States ran into similar problems in the 1970s as shortages developed and volatility increased when price controls were implemented.

Yet, the question still remains - will this have any impact on the global price of energy? Probably little, unless more countries follow suit. China currently consumes about 10% of all global oil. Significant, but small changes in China may have less of a global impact than hoped. Furthermore, the economies of China and other emerging countries continue to grow at high single and double digit rates. Small changes are therefore unlikely to slow growth enough to reduce demand, and as seen with the refiners, could have the opposite effect.