Playing with oil prices

PUBLISHED : Tuesday, 11 October, 2005, 12:00am
UPDATED : Tuesday, 11 October, 2005, 12:00am

A recent report in Russia's Labour News - warning that 'America is using oil prices as an economic weapon against China' - sent nervous whispers down the corridors of Zhongnanhai. The article argued that, in the wake of Hurricane Katrina, the US government was propping up oil prices to contain or even derail China's growth.

While it may sound like pure conspiracy theory, it raised questions in Beijing. Some point out that the Bush administration, at its outset, changed its description of the Sino-US relationship from 'strategic partners' to 'competitors'. But what could the United States possibly gain from high oil prices?

China is the world's second-largest consumer of oil, behind the US, importing 3 million barrels a day - mostly from the Gulf region.

The Labour News analysis claimed that it was the manipulation of oil prices that, effectively, forced the collapse of the Soviet Union. But, in the late 1980s, prices actually dropped - down to US$7-$8 per barrel - tripping up Soviet oil exports, its main source of foreign exchange.

It is true that oil prices are fixed through an oligopoly, but three obvious methods allow manipulation. First, Washington persuades American companies to limit exploration and higher production volumes. That has been maintained steadily throughout the Bush administration. Second, the Saudis do as they are told by the US: they did not increase production, either, during this period. Third, oil prices set on the US futures market are controlled by American players speculating on price. So, New York and Washington together call the shots.

Several observations alarm Beijing. Before US President George W. Bush's invasion of Iraq, the White House announced that after overthrowing Saddam Hussein, Iraq would provide the world with 3 million barrels per day, and 5 million barrels a day within three years. Today, however, Iraq exports only 1.5 million barrels per day - even lower than Hussein's export volume. Supplies seemed strangled. What is wrong?

Such a conspiracy theory probably amounts to no more than paranoia. But Beijing has reason to be paranoid: China has virtually no strategic oil reserves. In case of a crisis or war, that would be a big problem. China's foreign exchange earnings and economic miracle derive from massive industrial manufacturing and exports. These can be derailed by high oil prices. The US has both the reserves and control over refining capacity to sustain high prices - China does not.

High oil prices will affect China's current-account surplus. Currently, oil prices are subsidised indirectly by state-sector enterprises, especially the national oil companies. So rises in production and transport costs are being passed on to consumers to only a limited extent. Profit margins, however, are shrinking as a result.

China has 10 million private car owners, and fuel prices have already been increased five times this year. The costs are being absorbed by China's oil companies, through indirect subsidies, but they carry a penalty in foreign exchange.

Oil price increases affect every link of China's economy, both industrial and agricultural, from export-assembly to the production of pesticides and fertiliser. Some economists estimate that increased oil prices could possibly shave 2 percentage points off gross domestic product growth.

Concerns about social unrest top Beijing's policy-making decisions. To prevent a crisis from unfolding, its key tools are preventing oil price rises from affecting consumers, and managing foreign exchange. So, Beijing clearly does not appreciate White House pressure to tinker with its exchange-rate mechanisms.

It is always a mistake to embrace conspiracy theories as fact. Dismissing them as paranoia, however, may prove negligent. But, is there anything wrong with examining the facts and asking questions?

Laurence Brahm is a political economist and lawyer based in Beijing