Basic economics would suggest that an increase in the retail price of fuel would slow demand as drivers balked at the higher cost.
On the 19th June's $4 fall in the price of international benchmark crude oil futures, following China's announcement that it would raise the price of its petrol and diesel, supported such a thesis.
But in the case of China, traders should be warned: moving towards free-market fuel prices may, in fact, have counter-intuitive consequences, at least in the short term.
On the 19th June's decision by Beijing to raise the government-set retail price of petrol and diesel by 17-18 per cent was designed to ease some of the economic pain refiners have felt from having to pay world prices for crude while being unable to charge market rates for the refined fuel they sell.
As international oil prices have risen to $130-$140 a barrel – doubling in the past year – China has maintained its retail price caps, and refiners have been caught in the middle, incurring huge losses. Some smaller, so-called teapot refiners have gone out of business. The policy limited inflation, but had the unwanted side-effect of creating fuel shortages.
The new, higher street prices could lead refiners to increase crude throughputs or even go back into business and solve some of those shortage problems, some analysts argue.
Nauman Barakat, senior vice-president at Macquarie futures in New York, said on the 19th June: “I think, overall, this is supportive for oil prices. Firstly, the Chinese refiners will want more crude to run. Secondly, while these price increases seem substantive, I think the drivers in China can still afford [them].”
China may still use less than half the amount of oil the US does, but it is the world's most important country in terms of demand growth – a key ingredient of the recent surge in oil price.
Analysts expect Chinese oil demand to grow 5-10 per cent this year. A lack of reliable data makes such forecasts difficult and many think there is a sizeable level of pent-up demand that could become apparent once the shortages are resolved.
China is not the only country that subsidises its fuel. Many other Asian countries, including India, Malaysia and Indonesia, shield their citizens from the full rise in prices – thereby helping to keep inflation in check. Middle East countries, especially those rich in petrodollars, and some countries in Latin America – notably Venezuela – also subsidies their fuel.
Together, countries that subsidise fuel account for half the world's population and a quarter of the world's fuel use. More importantly in terms of price, the countries that subsidies their fuel account for 100 per cent of current demand growth, because demand in developed regions such as the US, Europe and Japan is either flat or contracting, as drivers have been feeling the full effect of higher, unsubsidised fuel costs.
That makes any changes in policy in the countries that do subsidise especially important. Analysts believe that, in the long term, government decisions to let fuel prices reflect market conditions will reduce demand – even in China – and therefore also eventually the international oil price. This would also cut the amount of carbon dioxide emitted into the atmosphere.
Many countries have had to raise their prices in recent months, either because – like China – they risked bankrupting their state refiners, or because the weight of subsidies on their budgets was ballooning to untenable levels.
The decisions to raise prices have led to political backlashes and protests in the streets. Their impact on demand is not yet clear, but with angry drivers and fisherman also taking to the streets in Europe, it will have global ramifications.
Together, countries that subsidise fuel account for half the world's population and a quarter of the world's fuel use. More importantly in terms of price, the countries that subsidies their fuel account for 100 per cent of current demand growth, because demand in developed regions such as the US, Europe and Japan is either flat or contracting, as drivers have been feeling the full effect of higher, unsubsidised fuel costs.
That makes any changes in policy in the countries that do subsidise especially important. Analysts believe that, in the long term, government decisions to let fuel prices reflect market conditions will reduce demand – even in China – and therefore also eventually the international oil price. This would also cut the amount of carbon dioxide emitted into the atmosphere.
Many countries have had to raise their prices in recent months, either because – like China – they risked bankrupting their state refiners, or because the weight of subsidies on their budgets was ballooning to untenable levels.
