What better symbolizes the modern oil market than the American sport utility vehicle? The outsize crowd carrier embodies the unbridled gasoline consumption and disregard for cost that receive widespread blame for fuel prices now pressing hard on consumers and economies. By those parameters, however, the taxi cab in Jakarta and cooking stove in Kuala Lumpur deserve comparable scorn.
Indonesia and Malaysia belong to the large group of countries whose governments cap prices of oil products and natural gas or otherwise subsidize consumption. Where prices are controlled, fuel consumers don’t feel the same compulsion to conserve that their counterparts elsewhere do. It is partly because of this muted price signal that oil consumption continues to rise in the subsidized world as it falls elsewhere. The effect is strong enough to keep global oil demand rising, which will keep prices heading upward until supply catches up.
Developing world
Subsidization of oil and other energy consumption occurs mostly in the developing world. Elsewhere, oil use is falling.
In its May Oil Market Report, the International Energy Agency predicts oil consumption will decline for the third consecutive year during 2008 in all of the industrialized countries represented by the Organization for Economic Cooperation and Development (OECD). The projected annual decline is small—0.7%—in part because of downward adjustments to IEA’s estimates for OECD demand in 2007. Comparisons between oil use in March 2008 with that of March 2007 show more clearly what’s happening: down 2.8% in the OECD American and Pacific regions and down 2.3% in Europe.
In contrast with the OECD declines comes IEA’s projection for a 3.7% increase in non-OECD oil use this year. Some of that jump relates to strong economic performance in Asia and the Middle East. But some also reflects protection of consumers from the sting of rising oil-product prices in many developing countries. This increase in the market segment representing 44% of worldwide oil consumption is enough to offset the OECD decline and leave a net projected gain in global oil consumption, according to IEA, of 1.2%. A question worth asking is whether oil demand still would be rising in the absence of developing-world price ceilings.
Consumption subsidies are as difficult to sustain as they are painful to repeal, especially in poor countries. Governments must compensate for the difference between prices at locally controlled levels and higher, free-market levels. Difficulty grows as market prices rise. Indeed, the new IEA report documents the strain.
China, for example, has begun compensating Sinopec and PetroChina for the downstream losses they incur by selling oil products at capped prices. The government worries that product shortages will develop during the Olympic Games next August in Beijing. For now, the Chinese government can afford the payments. Other Asian governments aren’t so lucky.
IEA reports that the incoming administration in Taiwan might lift price controls imposed last November and cites reports that, if it doesn’t, the state oil company might be bankrupt in 2 years. In Thailand, the government has reintroduced diesel subsidies, letting refiners offset the costs by suspending contributions to national oil and conservation funds. Indonesia is grappling with the financial pressure created by gasoline, diesel, and kerosene subsidies estimated to cost $12 billion this year. Malaysia recently decided to maintain fuel-price caps despite the costs but, says IEA, “hopes to target subsidies more effectively.” Vietnam, meanwhile, has frozen oil product prices until June and will suspend import taxes and help importers of gas oil, kerosine, and fuel oil. Although gasoline in Vietnam was supposedly deregulated last year, importers still must have government approval to change retail prices.
Other distortions
Asia isn’t the only region where governments subsidize consumption. IEA also reports distortions caused by market controls in Iran and India. And subsidizing consumption isn’t the only way governments manipulate markets. European governments punish consumption with high taxes on oil products, for example. And the US limits future supply by restricting access to federal land.
Consumption subsidies nevertheless help explain why worldwide oil demand keeps rising despite record-setting price increases. SUVs aren’t the only reason.
