Asia Has Blown Its Chance to Destroy Oil Demand

Asia Has Blown Its Chance to Destroy Oil Demand

Andy Mukherjee

May 29 (Bloomberg) -- Asian governments are squirming.

With crude oil near $130 a barrel, their strategy to shield consumers from high energy prices is becoming a drag on national budgets. The unsustainable subsidies and price controls must go, say economists. The problem is with the timing of any such move.

The cost of living is soaring almost everywhere, pushed higher by food. Inflation expectations are hardening. In such an environment, policy makers will have to think twice before raising energy costs. A quickening of inflation is to be avoided, even if the acceleration is temporary.

A good time to act was last year, especially in the first half of 2007 when the price of crude oil averaged about $60 a barrel. Inflation wasn't as big a challenge in 2007 as it is now and authorities had ample leeway to start letting higher costs of petroleum products pass through into local prices.

They missed the chance.

A survey of 42 developing countries by the International Monetary Fund showed that as much as three-fifths of the extra cost of 2007 was absorbed by governments and refiners. Only eight nations fully passed on last year's 48 percent increase in gasoline prices to the retail consumers in their countries.

Indonesia, which was forced to increase fuel prices from May 24 after holding them steady for almost three years, is a case in point.

Indonesian Protests

Retail gasoline prices have been allowed to rise by more than a quarter. Even then, motorists in Jakarta are only paying 64 U.S. cents for a liter of gasoline, or $2.40 per gallon. In neighboring Singapore -- where there aren't any fuel subsidies -- the pump price is 2 1/2 times as high.

Who will explain this to protesters on the streets? As far as they are concerned, the cost of living is already very high.

But what option does Indonesian President Susilo Bambang Yudhoyono have? If he doesn't plug the large hole that energy subsidies are leaving in the government's budget, the rupiah might falter, stoking inflation and hurting the poor.

Indonesia's resolve in going through with the price increase is prompting analysts to consider the likelihood of similar action by China, India, Russia and the Middle East, which will together consume more crude oil in 2008 than the U.S.

With little chance of a spectacular increase in supply, a reduction in petroleum demand in these nations holds the key to making oil affordable again. And these are precisely the countries where governments distort demand in a big way.

`Complex Web'

As Francisco Blanch, head of commodities research at Merrill Lynch & Co., puts it, ``the oil market is trying to find a demand destruction point.'' And it can't find such a point partly because of ``a complex web of subsidies and price caps.''

A report last year by McKinsey & Co. estimated that ending subsidies would prune demand for transportation fuels by 3 million barrels a day. Contrast this with the increase in crude- oil production promised by Saudi Arabia: 300,000 barrels a day.

It's never easy, politically, to remove subventions.

But it's especially hard now with runaway inflation.

With the Bharatiya Janata Party -- India's main opposition party -- winning control of the legislature in the southern Indian state of Karnataka in recent polls, the government of Prime Minister Manmohan Singh will think twice about removing price controls on gasoline and diesel.

India, China

Indian refiners, such as state-run Indian Oil Corp., are together losing about $140 million a day because the government hasn't allowed them full cost recovery. The price of diesel sold at gas stations in New Delhi has risen just 4 percent since September 2006.

China, where inflation is at a 12-year high, has rejected as ``baseless'' speculation that it will allow heavily subsidized prices to rise.

China Petroleum & Chemical Corp., or Sinopec, is losing about $430 on each ton of products it sells even after receiving $1 billion in compensation last month from the government, more than for all of last year.

The Malaysian government estimates handouts to be 51 percent more expensive this year because of higher crude prices.

Out of the estimated $16.5 billion Malaysian subsidy, the biggest contribution will come from Petroliam Nasional Bhd., or Petronas. The state-owned refiner is forgoing profits by selling gas to power producers and other consumers below cost.

Malaysia, which last raised prices of gasoline, diesel and liquefied petroleum gas in February 2006, is also hesitant to allow another increase because of political reasons.

Political Compulsions

Prime Minister Abdullah Ahmad Badawi's government is in trouble. His predecessor, Mahathir Mohamad, wants Abdullah to quit for delivering the ruling coalition's worst poll performance. Opposition leader Anwar Ibrahim, emboldened by unexpected electoral gains, has threatened to topple the government by Sept. 16.

Taiwan, which relaxed controls on fuel and electricity prices this week, is in a better position. The decision has been taken by a new government, which -- unlike the one in Malaysia -- isn't running low on political capital.

Asian authorities should have shown greater alacrity last year in weaning their populations off cheap energy. For too long, they hesitated to do the right thing.

Starting in August 2007, they may have even begun to see such adjustments as unnecessary, hoping that a recession in the U.S. would cause petroleum prices to stabilize.

They were so wrong.