China’s Energy Pricing

While all the recent headlines about oil and refined products have been regarding OPEC’s inability to agree an increase in production and the IEA’s decision to release 60 million barrels from its strategic reserve, a far more important announcement, with potential long term implications, has received little, if any, attention.

China has announced it will review its retail pricing formula. So why is this so important? Well, global oil demand growth is lead by India, Saudi Arabia and China with their growing economies and subsidised energy prices. That means that their industries and retail consumers are not exposed to the full force of international, free market prices. Since they do not feel any financial pain when prices go up there is no incentive for them to reduce consumption.

At present the Chinese pricing mechanism is designed to adjust the price of gasoline, diesel, and jet-kero if the price of a basket of crudes rises or falls by 4pc over a trading month (20 – 22 days). The proposed change reduces the amount the basket has to rise or fall, by an as yet undisclosed amount, and reduces the period down to 10 days. If China does alter their pricing mechanism to make it more responsive to market forces, and at the same time removes the management of the system away from the politicians and into the hands of the energy companies, we could see a dramatic reduction in demand from the Chinese consumer as they start to feel the effect of high international oil prices. That is as long as it does not lead to social unrest!

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