When $100 oil may not, in fact, be $100 oil

Posted Jan 6th 2008 9:25AM by Joseph Lazzaro
Filed under: International Markets, Other Issues, China, Russia, Venezuela, Commodities, Oil

As oil trades near $100 per barrel, one of the questions economists and analysts are asking is why hasn't global energy demand moderated?

With only isolated exceptions, both oil use in emerging markets and gasoline use here in the United States continue to increase. Emerging markets, particularly China, continue to register sizable increases in oil use. There has been some slackening of the increase in gasoline consumption in the U.S. as gasoline rose again above $3 per gallon this year, but not enough to cause a substantial drop in prices at the pump.

Is +$90 oil a price that's too costly for nations? Economist David H. Wang says perhaps not, particularly if a nation is not, in effect, paying the spot price, and he argues that a little-publicized fact regarding the oil market may be stoking demand. Namely: oil pacts among oil producing and consuming nations below the spot price for oil.

Wang said many people know about gasoline subsidies in some oil-producing nations -- oil producer Venezuela charges its citizens less than 25 cents a gallon for gasoline, and that has led to higher gasoline consumption in that nation, but few know about below-market oil pacts.

For example, oil producer "Russia has probably signed several oil and natural gas pacts with China for below-market prices," Wang said. In the case of oil, it's "probably for $70 or even $65 per barrel for oil for three to five years," he said. International law does not require either nation to disclose the nature of these agreements, or the price, he said.

Now in theory, a below-market price sale would take some pressure off oil's spot price -- that same oil in the open market could have been priced higher -- but the effect the agreement has on demand in China is the key, Wang said. As one might guess, if China's oil importers pass on that savings to consumers, the cost of oil is not reflecting the current +$90 market price for oil, and the effect is obvious: oil consumption in China is higher than it would be with a higher price.

Hence, while oil trades near new $100 highs, the world, from a price impact on demand standpoint, may not, in fact, be experiencing $100 oil universally. "It may be experiencing only $70 oil in some consumption theaters, with consuming patterns the same in these areas, which would explain why oil demand continues to march upward," Wang said.

Tags: China, emerging markets, gasoline prices, GDP, oil, oil consumption, oil prices, Russia, U.S. economy, Venezuela

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Reader Comments (Page 1 of 1)

1-07-2008 @ 9:31AM

Half-Empty said...

Is this a case of Russia and China doing to the US what the US did to the former USSR in the '80s - only in reverse? Then, the US drove down the oil price until the USSR broke down trying to earn foreign currency by pumping more and more oil for less and less cash. Now, the situation is reversed, with the US suffering from high oil prices because of rising demand on tight supply - a situation in which China and Russia both drive the process and benefit from the protection given to China's growth by low fuel prices