Countdown to $100 Oil ?!? (2): Asian subsidies crumbling

In a diary over the weekend entitled, Countdown to $100 Oil ?!? Subsidies, hoarding, and bailing out billionaires, I took the contrarian position that oil is more likely to re-cross to the downside the $100 a barrel price, before it hits $200 a barrel. I cited evidence of hoarding on tankers, the Fed's realization that destroying the dollar might be a bad thing, and most of all, intense pressure being applied to Asian governments' subsidies of consumer oil prices in support of that position.
Today, with the price of a barrel of oil at the moment at $123.75, comes fresh evidence that those oil subsidies are collapsing. It turns out the laws of supply and demand work on the other side of the globe too.

In my first diary on this topic, I noted that the E.I.A. reported that Americans had cut back on their use of gasoline ever since it crossed the $3 a gallon threshold late last year.

The dropoff in US demand has accelerated: The latest MasterCard SpendingPulse survey found that demand for gasoline in the U.S. fell by 4.7 percent last week — which included the long Memorial Day holiday weekend — compared to the same week last year. Averaged over the last four weeks, demand was down 6 percent last week compared to last year.

There has also been a dropoff in Europe: Gasoline demand in Britain in April was running 7 percent below a year ago, while demand for diesel was down nearly 2 percent, according to government figures.

Conventional wisdom has been that an increase in demand in Asia would more than offset this US decline. However, it turns out that demand in Asia has been undrewritten by government subsidies to consumers, subsidies that are now exhausting government resources. A report last year by McKinsey & Co. estimated that ending those subsidies would prune demand for transportation fuels by 3 million barrels a day.

How much are those subsidies costing Asian governments? Well, in china, Sinopec, Asia's biggest refiner by volume, said it received a $1.75 milliion subsidy from the Chinese government in the first quarter alone!

Yesterday billionaire trader George Soros testified before the Senate that the oil futures market was poised for a steep sell-off, and suggested that the most likely catalyst was a demise of the Asian subsidies.

Today brings fresh evidence that those subsidies are crumbling:
yesterday Malaysia scrapped fuel price controls and India said subsidies were becoming unsustainable.

Malaysia will end price controls on gasoline and set prices at a market rate starting in August, a minister said today. Yesterday, Indian Prime Minister Manmohan Singh said subsidy payments can't be allowed to rise further. The end of capped fuel prices in Asia, the region where demand is rising fastest, may curb global crude oil demand.

``All the talk of subsidy cuts show that Asian consumers may not be willing to keep buying at such high prices,'' said Robert Montefusco, a broker at Sucden (U.K.) Ltd. in London. ``We may see prices come off a bit.''

Smaller Asian oil consumers such as Taiwan, Indonesia and Sri Lanka have all already raised domestic fuel prices:

Indonesia has decided to decrease their fuel subsidies; thus raising the price of gasoline for consumers at the pump. The new price will rise 28.7% to a price of 65 US cents per liter or $2.46 per gallon. India also announced an increase in gasoline prices to $2.66 per gallon, an increase of about 7%. Taiwan is another country that is ending a freeze on gasoline prices.

gasoline will rise 11 percent in India's capital New Delhi to 50.6 rupees ($1.17) a liter from midnight. Pump prices in Malaysia will increase 41 percent to 2.70 ringgit (83 U.S. cents) a liter from tomorrow and will now track global market rates.

Petroleum Minister Murli Deora told reporters that gasoline prices will be raised raised 49 cents a gallon, and diesel prices 30.4 cents a gallon.
That's an 11% increase in New Delhi, the capital, where gasoline will be hiked to $4.56 a gallon.

Previously gas prices in New Dehli had risen only 4% since 2006!

Perhaps the most important overarching note to make here is that hopefully we can firmly put to rest the notion that Asia was "decoupling" from the global economy and the effects of the US on that economy. A slowdown in Asia will on the one hand amplify the US slowdown, but if as a result the price of gas at least temporarily abates (remember the Goldman Sachs rejiggering of their commodity index that caused a 25%+ decrease in the price of gas before election day 2006?), US consumers will at least temporarily have a respite.

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Comments

hearing yesterday

Did you catch just how much Goldman Sacs, JP Morgan had in oil futures? It's like Enron, part II. I would imagine if they pull subsidies out it would cause a major price drop but my first thought in reading this are those infamous "free trade" folks putting out press releases to chastise any government who tries to regulate and esp. price control anything. So, I'm not so sure I believe the premise in so many words.

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Why the renewed spike? Hoarding, the US peso

No sooner does demand destruction assert itself via subsidies being cut in Asia, when speculation about the new US peso causes a reverse of course:

Oil prices shot up nearly $7 a barrel Friday... after a Morgan Stanley analyst [Ole Slorer] predicted prices could hit $150 by the Fourth of July....

Friday’s surge [of $6.27 to $134-06] builds on a $5.49 gain Thursday, which was the biggest single-day price increase in the history of the Nymex crude contract....

“Asia is taking an unprecedented share” of Middle East exports to build up stocks, Slorer wrote in his report.
....
The dramatic reversal in what had been a weakening oil market began Thursday after ECB President Jean-Claude Trichet suggested the bank could raise interest rates and the euro climbed against the dollar. ... Many investors tend to buy commodities such as oil as a hedge against inflation when the dollar is falling....

I've highlighted the quote that suggests Asian governments/refiners are hoarding oil in anticipation of price rises (from the ending of subsidies). Remember that hoarding (and breathtaking changes in daily prices) is a symptom of panic, not regular supply and demand.

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symptom of something

I'd like to see any supply/demand curve throughout history for anything that has the slope that is implied by these prices, any real commodity.

Did you watch the Senate Committee hearing on speculation on all of this? One of the more interesting things was how JP Morgan and Goldman Sachs were heavily invested in these oil futures. There was one bank when had pretty much locked down the entire oil heating market in the North East.

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China raises oil prices 30%

GAME ON! re Chinese Subsidies:

China, the world’s second largest oil consumer, will increase retail gasoline and diesel prices by 1,000 yuan ($145.50) per tonne from Friday, according to industry sources.
….Oil prices tumbled $3 following the news.

“Even with the $18.60 (per barrel) increase in price (Chinese fuel prices) are still well below the global market and the subsidy amounts to something on the order of $56 per barrel [at a level equal to $78.69].”

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that's something

I've discovered they do quite a bit of games with different economic tools. There tariff schedule for example, they will only lower it after they have captured and now control a particular product or industry. I saw Shanghai crash last night and bankers are saying there is way too much speculation money in China.

We're sure hearing that word a lot of recent days but I'm unsure of how much of their stock markets is speculation.

But, looks like you were on target in your contrary piece.

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There is a great deal of speculation

one of the huge problems facing China is dependence on export markets for growth. In 2005 or 2006, the Economist reported that 43% of Chinese GDP derives from exports.

Which means that about half of their economy is dependent on exports to other countries.

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countdown to $100 oil

NDD, I just am adding this comment since you wrote this about a month and a half ago and magically we have oil tanking. Talk about one hell of a prediction going against the stream. Pretty impressive!

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Thanks. Of course, tomorrow...

...oil could reverse course again and be at $150 next week. That's the problem with this parabolic move. Don't tell me that it is fundamental market forces causing these 10%+ moves up and down in just a couple of days.

My view of what is crucial is essentially the same as that of Calculated Risk. I expect oil to reverse soon (now?) and for inflation to moderate, and the recession to have a respite -- possibly an anemic brief recovery. If oil doesn't, the recession gets deeper.

And that depends first and foremost on when China slows down. I watch the news out of China daily the best I am able, but I suspect we will get little if any warning.

And Time Magazine still refuses to have an oil-related cover story!

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China

Well, I just wrote up a report on R&D investments and there is an additional report I want to get to talking about China sovereign wealth fund. They are flush with cash. Maybe we have temporary malaise but all indicators to me imply we're getting our ass kicked.

I agree with you though, this supply/demand stuff, that has been the #1 indicator to me, not the actual "hidden supplies" that make me believe the speculator theory has some real merit. My issue is I just don't understand commodities futures markets and derivatives to point to anything for analysis, but intuitively the slope of the price change just I don't see how can correlate to real world supply demand curves.

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Air passenger traffic plunges in China

From Bloomberg:

China Southern Airlines Co. and the nation's other carriers posted a 3.8 percent fall in combined passenger traffic last month, as an economic slowdown curbed demand for air-travel.
....

Inflation, near a 12-year high, coupled with a falling stock market has cut Chinese spending on leisure. A series of natural disasters including an earthquake that killed more than 69,000 people in China also hampered demand for tours.
....

Cargo traffic for the country's carriers fell 0.8 percent to 321,000 tons in June. It rose 8.1 percent in the first six months of the year.

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growth

I think I read yesterday that their economy had cooled to a mere 10.5% growth for the year from 12%. ;) they may be going through a patch but 10% is still outrageous.

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Bank of China: You Won't Be Hoading Yankee Pesos

From the NY Times today, 9/5/2008 the Bank of China reports that its Capital has eroded to $3.5 Billion, far less than 1 per cent of assets. The BOC is forced to raise capital but the Finance Ministry resists due to trade. Almost $1.5 Trillion is held in U.S. Treasuries. The likely place to get capital is to dump US Treasuries.

Were it not for these uncertainties, factors in the U.S. economy from employment, to trade, to commodities and housing, point to serious deflation. The effect of a BOC dollar dump would most likely be like 1987 in the fall, when BOJ dumped Treasuries. U.S. Fed bought back Treasuries but not without effects on equities. Monetization of a BOC dollar dump would be a reflation when Treasuries become monetized, but short term it is deflationary, and points to dollar losses and a spike in metals. No contradiction, consider the economy in 1872 to 1875 and 1932 to 1934.
Devaluation of a dollar in a deflation, revaluation of Gold or Silver.

Under the rules of Basel II, BOC must maintain primary and secondary capital standards, BOC is not compliant. A dollar asset conversion is inevitable.

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Burton Leed