There were about five pieces of news on Friday that delivered such a massive upside kick to oil.
1) Chinese oil consumption numbers came in much higher than expected.
Wall Street is still being blindsided by the impact of the Sichuan earthquake, and apparently most of it is ignorant that ~30 percent of Chinese oil/ natgas/ heating oil comes from Sichuan and Gansu (which was also thrown into chaos by the quake).
2) Shaul Mofaz rattled Kadima’s flimsy sabre at Iran, again. Anyone who took that seriously is ill-informed.
3) The dollar continued hemorrhaging. Brokers are cutting back trading with Lehman Brothers, and Bernanke will probably be called out on his fateful March 17 nationalization of banks’ default risk. He will have to throw hundreds of billions of dollars in Treasuries at Lehman’s crippled balance sheet, further debasing Treasuries specifically and US financial credibility generally.
4) Morgan Stanley said oil would go to $150.
5) The USD and EUR are both heavily overvalued. As long as China keeps its currency peg alive, the dollar and euro will both be overvalued. The only other large currency alternative is commodities, so that’s where money is going.
As I have said many times, government witch hunts against “speculators” never signal the top of a bull market.
Israel’s saber-rattling might have been good for 1 percent of oil’s gain. Obama’s triumph in the US presidential primaries multiplied that, for a total of maybe 3 percent.
In the meantime, Asia’s cracking currency regimes are effectively increasing their subsidies of fuel.
HONG KONG: Buckling under the weight of record oil prices, several Asian countries have cut or are thinking of cutting their fuel subsidies, which raises a pressing question for Beijing: Can China afford its own oil subsidies at a time when it is spending billions on post-earthquake reconstruction?
The short answer is yes, because China is blessed with both large trade account and fiscal surpluses. The reconstruction cost is projected to amount to about 1 percent of China’s gross domestic product, while the fuel subsidies account for another 1 percent, JPMorgan estimates.
Remember that China had a fiscal surplus of 0.7 percent of gross domestic product last year, or $174 billion. So even if spending on post-earthquake rebuilding and fuel subsidies were to cause a 1 percent fiscal deficit, that would still be very manageable.
But here is a more important question: Why should China keep domestic fuel prices at about half of the global average?
The usual answers are to keep inflation in check and stave off social instability that could result if prices were to rise too quickly.
But by distorting fuel prices, China is encouraging fuel consumption and discouraging the use of new energy. Since the Chinese still live in an $80-a-barrel oil environment, demand for anything from cars to chemical products will spiral higher and raise the risks of economic overheating.
Increasing subsidies on fuel will crowd out more investment in other areas, such as education or health care, to name two possibilities.
What’s more, a worsening fiscal situation might put downward pressure on the yuan. Fuel subsidies have exaggerated inflation in the developed world, while understating inflation in the developing world. China’s inflation could well hit 15 percent if Beijing were to free up caps on energy prices, Morgan Stanley estimates.
“If China is not able to take away the subsidy and cut down its demand, it will have huge implications for the world,” said Shikha Jha, a senior economist at Asian Development Bank.
Countries like China and India, along with Gulf nations whose retail oil prices are kept below global prices, contributed 61 percent of the increase in global consumption of crude oil from 2000 to 2006, according to JPMorgan.
Other than Japan, Hong Kong, Singapore and South Korea, most Asian nations subsidize domestic fuel prices. The more countries subsidize them, the less likely high oil prices will have any affect in reducing overall demand, forcing governments in weaker financial situations to surrender first and stop their subsidies.
That is what happened over the past two weeks. Indonesia, Taiwan, Sri Lanka, Bangladesh, India and Malaysia have either raised regulated fuel prices or pledged that they will.
Actions taken by those countries will not be able to tame a rally in prices though unless China, the second-largest oil user in the world, changes its policy. While the West is critical of China’s energy policy, there is little outcry for change within the country, except for complaints from two loss-making refineries.
By contrast, Indonesia has convinced its people that fuel subsidies benefit the rich more than the poor, because rich people drive more and consume more electricity. Jakarta rolled out a $1.5 billion cash subsidy program to help low-income Indonesians cope with higher prices. Although no country wants to build a system on subsidies, the cash subsidy at least makes fuel subsidy cuts politically feasible.
“The people need to wonder, who pays for the subsidies?” said Louis Vincent Gave, chief executive of GaveKal, a research and asset management company. “Most Asian countries are printing money to pay for them.”
Fuel subsidies compromise countries’ ability to control their own budget spending. If China and India can cut their subsidies, they would be able to spend more on infrastructure and education.
While Asian governments dole out cheap food and cheap energy, Asian currencies settle the bill. Morgan Stanley expects some emerging market currencies to face downward pressure, probably for the first time in a decade, as those countries unwind their fuel subsidies and domestic inflation shoots up.
China’s domestic fuel prices are among the lowest in the world, equal to about 61 percent of prices in the United States, 41 percent of Japan and 28 percent of England. The longer it waits, the more painful it will be when it tries to remove the subsidy.
China actually doesn’t have much freedom to splash dollars for fuel. Its entire macroeconomic policy can be summarized as “long USD, short RMB.” Not a good trade.
