Rising prices make waves?
By Guo Tong (China Business Weekly)
Updated: 2004-06-02 09:22

Steady oil price hikes in international markets bring mounting challenges to oil supply security and economic stability in China.

The authorities should take positive measures to fence off such risks, including building strategic oil stockpiles and a domestic oil futures market while finding more energy substitutes for oil.

One year after the outbreak of the US-led war against Iraq, crude oil prices in the international market had soared to a 13-year-high in March, as the global economy recovers and the demand for oil increases rapidly.

New York crude oil futures ended at US$38.08 per barrel on March 19, the highest close since October 1990.

According to reports from OPEC (Organization of Petroleum Exporting Countries), the global demand for oil reached 78.3 million barrel per day in 2003, up 1.68 per cent from the level of 2002.

China's oil consumption also stood at 5.56 million barrels per day last year, based on a staggering 9.1 per cent economic growth in 2003.

The International Energy Agency (IEA) estimated that the global demand of oil would continue to grow this year and the growth rate would go beyond expectations, especially for developing countries.

A weak dollar, Middle East political turmoil and reduction of oil output in OPEC countries could further widen the supply shortage and add more fuel to the price rally.

However, such sky-high oil prices would have a negative impact on the world economy, as it would unavoidably blow up deficits and inflation.

According to estimation of the Financial Times, if the international oil prices keep the present level, the United States, as the world's biggest oil-consuming country, would have its consumers pay an additional US$30 billion to shoulder the expenses. That would greatly reduce their spending power which could be used elsewhere and drag the pace of the economic recovery.

In the previous global oil crisis in the 1970s and 80s, China managed to shun the shockwave due to the lack of openness in the domestic market at the time.

But the fast economic growth and gradual opening-up have increased its links to the international markets.

China is expected to become the world's second-biggest oil consumer in 2004, according to IEA predictions.

OPEC's latest monthly report on the oil market also foresaw an 8.3 per cent economic growth rate for China in 2004, and a daily demand for oil at 5.96 million barrels.

But with limited domestic exploitation capacity and refining technology, the domestic supply will be only 3.41 million barrels per day, leaving a big shortfall that can only be mended by heavy oil imports.

Moreover, China's crude oil and refined oil prices had integrated into the global market respectively in 1998 and 2000.

Therefore, the disruption of overseas oil supply and major fluctuations of international oil prices could exert a big impact on the Chinese economy.

Take the aviation industry for example, surging international oil prices, especially that of fuel oil, in the second half of 2003 increased the industry's overall expenditures by 1.27 billion yuan (US$153.3 million). The oil price rally also triggered a chain reaction on other commodities and pulled up their prices.

How to guarantee stable oil supply in the long-term is a critical issue for China's sustainable development and requires quick reactions from authorities.

First, to ensure oil security, the government and oil companies should work together to build strategic oil stockpiles, which can enhance China's capability to deal with changes in the market in case of emergencies and secure economic stability.

China is so far the only one of the major oil importers that still does not have strategic oil stockpiles. During the initial period, the government should be the major force to build the stockpiles and meanwhile, as a supplement to government expenditures, relevant oil companies should also gradually make a certain amount of oil reserves available.

Second, to cushion the exposure brought by the big fluctuations of international oil prices, China should build an oil futures market.

Such a futures market can enable domestic enterprises to hedge risks and the government to establish an orderly circulation system for oil products.

It can also help China win a bigger say in the global oil price formation system, which will put it at a more advantageous position in international competition and enhance the macro-regulating power of the State on the oil market.

Presently, the international oil prices are based on the benchmark prices of oil futures on the NYMEX (New York Mercantile Exchange) and IPE (The International Petroleum Exchange) markets. But China, as a major oil producer and importer in the world, should have an equal influence on the setting of oil prices in international markets.

Finally, China should further improve oil-exploiting and refining technologies and encourage technological innovation.

Presently, domestic enterprises still have a lot of catching up to do in terms of expertise and management during oil exploitation and refining. And few are internationally competitive.

The government should come up with more incentives to encourage innovation and build up competitive enterprise groups.

It should also increase input into technological development, either during oil production or through the energy-saving process.

At the same time, it should enhance public awareness about saving energy, further upgrade the energy structure and develop more oil substitutes, such as natural gas.

China now boasts 2.2 trillion cubic metres of geological storage of natural gas, but only 5 per cent of the storage has been discovered.

Given this huge exploitation potential, natural gas can be an ideal substitute for oil. If its ratio in the overall energy supply in China could be increased from 2.1 per cent presently to 8 per cent in a decade, it would be a great relief to the country and reduce the reliance on oil supply.

Other energy resources, like wind, solar power and terrestrial heat could also be energy substitutes for oil.

The author Guo Tong is a senior economist with the National Bureau of Statistics.