Cooling China's economy and red-hot oil
prices By Adam
Wolfe
Geopolitical tensions, unexpected increases
in demand and heavy speculation have helped to push the
price of oil above US$40 per barrel and have caused many
producing countries to increase their supply to near
capacity levels. This surge in oil prices presents a
threat to the recovering United States economy, as well
as to the growth of developing states from Latin America
to Asia. In the short term, there is little that can be
done to lower the price of oil - the US-led occupation
of Iraq and al-Qaeda terrorist activity will not end in
the near future; a movement toward greater efficiency,
and disruptions in supplies from Venezuela and Nigeria
last year, have caused oil companies to lower their
stocks and fueled speculation in the futures markets
that will not end until reserves reach more robust
levels.
The single most important factor in
determining the price of oil for the near future may be
the ability of China's leaders to slow the economic
growth of their country. As Beijing attempts to rein in
control of its economy, the threat of a hard landing for
China's growth emerges as a potential destabilizing
effect on the global energy markets and is the only
factor that could substantially affect oil prices in the
near term.
The recent Organization of Petroleum
Exporting Countries (OPEC) meeting highlighted the
trading bloc's limited ability to control the price of
oil during this period of geopolitical tension. "We are
deeply concerned about the continuing rise of oil prices
in recent weeks," OPEC president Purnomo Yusgiantoro
said. Yet the trading bloc put off making a decision on
increasing production until a formal meeting next month
in Beirut.
Most OPEC countries are pumping as
much oil as they can; it is estimated that OPEC states
are already pumping oil by at least 2 million barrels
per day (bpd) more than the agreed level of 23.5 million
bpd. Any increase in the target level is unlikely to
translate into additional oil production because the
only OPEC country with significant untapped reserves is
Saudi Arabia, which, even as the largest producing
member, is unable to fulfill the growing global demands
for energy.
Saudi Arabia's decision to increase
production by 500,000 bpd on May 21 was able to lower
the price of oil by less than $1, only $.87, and further
statements declaring the intention to increase
production, if demand continues at the current levels,
to the capacity level of 10.5 million bpd were largely
ignored by the market the following weekend. There is
little hope within the oil markets that Saudi Arabia
will be able to satisfy the global demand for energy,
even if the kingdom is able to increase production to
capacity levels. A statement that OPEC intends to raise
the agreed levels of production next month will have a
stabilizing effect on the futures market, but other
factors that have contributed to the increased
speculation in the oil market will overwhelm any relief
offered from OPEC.
Perceived risks to the supply
of oil by terrorist and global insecurity are amplified
by the lowered reserves of most oil companies. Traders
estimate that a "terror risk premium" of between $4 and
$8 per barrel is being paid because of threats to the
oil supply in the Middle East. Terrorist attacks at
places such as Saudi Arabia's Yanbu oil complex on May 1
demonstrate the oil supply's vulnerability, and futures
markets are adding a premium to each barrel because of
this threat. The effect of this is more striking because
there is little cushion available on the supply or
demand side of the oil market.
Many factors have
contributed to the low inventories of most oil companies
- a general move toward greater efficiency and freeing
of capital for other investments within the industry
have caused many companies to lower their preferred
reserve levels; last year's general strike in Venezuela
and instability in Nigeria, as well as the war in Iraq,
have forced oil companies to dip into their reserves to
keep up with demand; OPEC's seasonal drops in production
have limited the restocking of most reserves; terrorist
threats have led many industrialized countries to fill
emergency reserves that take oil out of the free market
- and the result is that most oil companies are more
exposed to the whims of the free market than at any time
since at least 1980, which has fueled heavy purchasing
by speculative hedge funds that have only exacerbated
the problem.
High-demand unlikely to change
soon This situation is unlikely to change soon,
because the United States' recovering economy and the
meteoric growth of the Chinese and Indian economies has
placed huge pressures on the demand curve for crude oil.
The single most important factor for the oil
market this year will be the ability of China to
cautiously slow its rate of economic growth. Last year,
China became the second-largest oil consuming country,
surpassing Japan, and has accounted for 40 percent of
the world's oil-demand growth between 2000 and 2004.
Beijing now imports one-third of the oil it consumes.
The majority of this increased oil use is
currently in the manufacturing sector - a fast-growing
sector that is prone to sudden shifts in energy demand.
China's demand growth has been more difficult for the
market to predict, because it doesn't follow the
seasonal flows of other markets, which has increased the
supply problems for other countries during off-peak
seasons when oil pumping states lower their production.
Chinese Premier Wen Jiabao and the technocrats in
control of China's economy are better prepared to deal
with an overheating economy than their predecessors of a
decade past when the last Chinese boom went bust, but
recent heavy-handed techniques have demonstrated that
they may not be able to slow the current growth without
bursting the bubble.
Chinese regulators phoned
state banks ahead of the May holidays and ordered them
to halt lending. Loans now account for 136 percent of
China's gross domestic product (GDP), leaving any
slowdown exposed to mass defaults. Still, most
economists are confident that Chinese President Hu
Jintao can lower the rate of growth by focusing on those
industries that are the most overheated.
However, there is some concern about the tools
that Beijing possesses to lower its rate of growth. An
important factor that could contribute to the
speculation in the oil markets is that China hasn't
adopted a system for comprehensive data collection on
its energy consumption and inventories. This opacity
could lead to bottlenecks in supply, because it is not
clear where the oil is most needed and where there are
adequate reserves. China's ability to control problems
like this as it reins in its economy will be the most
important factor in determining oil prices for the rest
of the year.
OPEC and other oil producing
countries are keeping a careful eye on Beijing's
actions, wary of a situation like the Asian economic
meltdown that helped to cause a price crash in 1998 in
which oil producers were too slow to respond to the drop
in demand and flooded the market with cheap oil. This,
in turn, may cause producing countries to overreact to
any drop in demand from China, and will help to keep oil
prices at higher levels until the Chinese economy
becomes more predictable.
The US and global
economies are much more able to succeed in an
environment of relatively high oil prices than they are
with the bursting of the bubble in China's economy.
Japan is just beginning to emerge from years of
contraction, largely because of growth in its exports to
China. India's service-based economy depends greatly on
the manufacturing base that China provides. China has
provided the greatest growth in consumer spending on
which US and European Union countries have come to
depend.
Global markets from Jakarta to New York
have built straight-lined growth of China's economy into
their expansion plans. Should the overheated sectors of
China's economy collapse, it could make the Asian
meltdown of 1998 look like a mere statistical anomaly.
For this reason, it is much better for the US to help
China gradually cool the overheated sectors of its
economy and approach high oil prices as a fixed problem.
There are several measures that the US could
take to protect itself from the higher oil prices of
today's market. First, government spending on research
for alternative sources of energy will put pressure on
producers to keep their prices within reasonable limits.
Oil-rich countries benefit most from the situation in
the US where a bottle of water still costs more than a
gallon of gasoline; should the US pursue other energy
sources,the situation will change in favor of consuming
countries.
Second, the US could review its
regulation of refineries. There hasn't been a new
refinery built in the United States since president
Ronald Reagan (1981-89) was in office, even as demand
has ballooned. The complex regulations set by each
state, and county, have created a situation where a
refinery in Southern Illinois cannot supply the Chicago
market in the north of the state. This makes the entire
country vulnerable to bottlenecks in supply, and
discourages new entries into the refining industry. If
the US were to standardize regulations at the federal
level, gas prices across the country would better
reflect their true market value.
Finally, the US
can do more to stabilize the geopolitical unrest that is
contributing to the higher oil prices. Most new reserves
are being discovered in unstable countries such as
Sudan, where even an engaged Washington has failed to
move the country closer to peace. The administration of
President George W Bush has encouraged unrest in
important producing countries like Venezuela, without
leaning on other producing states to increase their
supply to compensate for the disruptions that have
lasted longer than predicted. A more focused approach to
the global energy situation will protect the US from
higher energy costs and, if coupled with a close eye on
the Chinese economy, will help to protect the recent
growth in the US economy.
Published with
permission of thePower and
Interest News Report, an analysis-based
publication that seeks to provide insight into various
conflicts, regions and points of interest around the
globe. All comments should be directed tocontent@pinr.com.
