Why does Oil Price Regulation in China have a minimal impact on demand?
China is now the second largest consumer of crude oil after the United States, consuming an estimated 9.6 million barrels of crude a day this year. Up to 55% of this is imported.
An understanding of how China prices its oil products is important as it determines the elasticity of its price demand. The regulation of oil products prices (in general prices of basic necessities) is performed by the National Development Reform Commission (NDRC ) a state owned body in the Chinese legislation. In many parts of the world, oil prices are subsidised to control inflationary pressures and maintain social stability. This gives a skewed picture of demand which persists even as international prices are rising. This is the case in many parts of Middle East.
Oil product prices regulation in China
An excellent historical write up of oil products regulation in China is here. Since 1998, China has regulated oil product prices (in particular gasoil and gasoline) to maintain inflationary pressures, maintain demand and supply balance and smooth out price volatilities from international markets.
In almost all measures it adopted, it adjusted its wholesale (ex refinery prices) when international prices move beyond a certain band over a certain number of days. This band and number of days have been reduced progressively in the past to tighten its linkage with international price. It however proved inadequate as it was too broad and transparent. When international prices rose too quickly, it encouraged speculative hoarding (and oil exports). Or when international prices fell too quickly as during the summer of 2008, it encouraged smuggling into the domestic markets as prices did not react as quickly to international prices). Such scenarios caused a temporal disruption in supply which has occurred as lately as Oct 10, when international prices fell too quickly.
Why China differs?
Comparing the typical income elasticity of oil between China and the developed world indicates the following:
Two features stand out – the income elasticity of China takes a shorter time to reach the peak and then decreases gently from this peak. The first is presumably to the greater technological knowledge and efficiency available to nations which modernise later. This peak then takes a longer time to decrease due to the wide income disparity between the inland and coastal regions of China. Its population size of 1.2 billion people is another factor as wealth spreads across its populace. This observation is also commented by the respected Hamilton in his paper Understanding Oil Prices.
Further China tax on oil products is minimal 20% compared to many developed countries. (300% in France, 120% in Japan and 20% in USA) effectively lowering its absolute oil prices.
Although China does not directly give out fuel subsidies, it however compensates its two largest oil companies Sinopec and PetroChina on its refining losses. For the 3rd consecutive year, Sinopec has received compensation for its refining losses, with the latest being in Dec 2010 of $1.74b.
In conclusion, the oil price regulation in China needs to be seen as a bespoke case compared to the rest of the world. These regulations shift temporal demand rather than make an absolute impact on its oil demand.