The
decision last week by the Organization of Petroleum
Exporting Countries (OPEC) to raise oil output by 2.5
million barrels per day
was largely aimed at countering
market fears of an impending oil shock. With crude-oil
prices hovering in the high-US$30 price range, way above
OPEC's alleged benchmark $22-$28 price range, everybody
from the Thai government to the airline industry has
been muttering about the negative impact of high oil
prices on economic performance.
But as the doors
swing open for the Beijing Motor Show this Thursday, the
auto industry in China seems remarkably sanguine about
the prospect of continued high prices for crude oil.
General Motors (GM) on Monday unveiled an ambitious $3
billion (24.85 billion yuan) expansion plan for China,
while Ferrari is confidently predicting the sale of 200
vehicles there this year, double last year's sales. The
auto industry's cheery outlook for China's fiery economy
is indicative of the Middle Kingdom's role in driving
the current bout of high prices as well as any potential
oil shock.
Previous oil shocks, such as the one
in 1981 during the Iran-Iraq War, were triggered by
tight supply. While current uncertainties in Saudi
Arabia have created a "terror premium" for the black
stuff, the likelihood of Saudi extremists disabling
Saudi's pipeline system completely is thought to be low.
In fact, the bulk of the current price surge can be
attributed to a combination of heavy demand in the
Asia-Pacific region - China, Japan, Korea and India -
and speculators (read hedge funds) piling into the
market betting on further increases.
While
robust Asian demand has been the initial driver behind
the current prices, the prominence of speculators has
further exaggerated prices. Speculative interest in oil
futures on the New York Mercantile Exchange has hit some
of its highest levels of the past decade. Heavy
speculator presence not only exaggerates upward price
pressures, but any falls in price are likely to be
equally dramatic. So far, most of the emphasis on the
direction of oil prices has been on the terrorist threat
to the supply side. Yet assuming no major disruptions to
oil supply in Saudi Arabia - as long as terrorists
continue to target expatriate workers rather than actual
pipeline infrastructure - the strength of China's
economy will be the real bellwether for future movements
in oil prices.
Chinese demand so far has been
dizzying. When OPEC met earlier in the year it had no
intention of raising output, but its hand was in effect
forced on the back of Chinese demand, which accounts for
nearly half of this year's surge in demand, and US
concerns over rising gasoline prices. Energy demand in
the Pearl River Delta and Shanghai region is so strong
that power is already being rationed, and many factories
have taken to installing generators to hedge against
blackouts. This in turn has resulted in shortages of
diesel as companies stockpile supplies for the peak
energy-consumption period this summer. Various oil
companies are falling over themselves to supply the
hydrocarbon frenzy in the world's second-largest oil
importer. The current situation of high prices and
strong demand has been further aggravated by China's low
inventories and the pegging of its currency to a weak US
dollar.
Any oil-supply crisis or sustained price
of more than $35 to the barrel also has China's
oil-import-dependant neighbors Korea and Japan worried.
Memories of the first oil shock back in the early 1970s
have been burned into both nations' political and
economic psyche. Tokyo, for one, has stockpiled more
than 160 days of oil to hedge against market volatility,
and is a world leader in energy efficiency. Beijing,
meanwhile, lives hand-to-mouth on just over 20 days of
reserve supply. In addition, the Chinese ratio between
the amount of oil needed to produce a unit of output is
high. Tokyo has recently re-floated the idea of an Asian
Strategic Petroleum Reserve to protect the region
against high prices. Beijing's reaction, however, has
been cool as it looks to build its own stockpile.
The International Energy Agency predicts growth
in demand this year to be the highest in 16 years. To
some, all this may be indicative of strong demand that
is set to persist. But for others, China's ravenous
consumption is another sign that its economy is
dangerously close to overheating. Asset bubbles appear
to have formed in a number of sectors, from aluminum to
property.
The oil-dependent auto sector is also
a prime candidate for accession into the bubble
category. Since early 2002 the Chinese auto sector has
registered a blistering 60-80% growth per annum - a boom
fueled by aggressive lending by Chinese banks. The
Chinese banking sector is not noted for its savvy
lending practices, and the auto-loans sector has been a
growing source of defaults.
Worries that all
this reckless lending is stoking overcapacity and
inflation have China's policymakers scrambling to
engineer a "soft landing" for their turbocharged
economy. An alleged directive in April by the China
Banking Regulatory Commission to suspend all lending for
three days caused regional markets to nosedive
temporarily. But the credit crunch is having an effect.
May auto sales were up "only" 20% year-on-year, compared
with this year's 45% average - the first drop since
2002.
This still does not mask serious
structural flaws in China's economy, especially in its
rickety banking sector, and the tendency for emerging
markets to gravitate toward harmful boom-and-bust
cycles. OPEC has been here before. Back in 1997 Saudi
Arabia sanctioned OPEC's 10% output increase, its
highest one-time output increase ever, and in effect
precipitated the collapse of oil prices. Just a few
months later, the Asian financial crisis kicked in and
cut the legs out from the demand side as oil plunged to
less than $10 a barrel. It is worth remembering how
quickly confidence in Southeast Asia's tiger economies
turned once investors felt the game was up, and the
ripple effects it created in Russia and Latin America.
Despite Beijing's best efforts to create a soft landing,
things could go the same way.
Ironically, a
China crash would probably be a bigger threat to
oil-dependent Asia's current economic rebound than an
oil shock. Most businesses and governments have begun
factoring in higher prices for crude but not a
hard-landing scenario in China. This would not be so
important were China not the main locomotive for
regional growth. While it accounts for just 4% of global
gross domestic product, by some estimates it has
accounted for 15% of global GDP growth and nearly 20% of
the growth in global exports and imports. Any downturn
in Beijing would trigger serious economic fallout, not
just in the oil-exporting gulf but also for Japan,
Korea, Taiwan and Australia.
Whatever happens,
high prices today tend to be indicators of low prices
tomorrow. As Frank Verrastro of the Center for Strategic
and International Studies puts it, "Price is volatility;
it's been the rule, not the exception." Perhaps it's a
good idea to put off buying the Ferrari from that
Shanghai dealer until next year.
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was largely aimed at countering
market fears of an impending oil shock. With crude-oil
prices hovering in the high-US$30 price range, way above
OPEC's alleged benchmark $22-$28 price range, everybody
from the Thai government to the airline industry has
been muttering about the negative impact of high oil
prices on economic performance. 
