Timid fuel price rises fail to temper demand

By Jonathan Leff - Analysis

SINGAPORE (Reuters) - Reluctance by China and India to fully eliminate fuel subsidies means it may be years before gradually rising prices begin to seriously erode oil demand in the world's fastest growing major consumers.

While smaller countries are shocking their drivers into conservation by raising prices sharply to ease the burden of subsidies, Asia's first- and third-largest consumers -- which together account for half of the world's demand growth this year -- are set to maintain a far steadier, gentler approach.

India agreed to raise diesel and gasoline prices by 10 percent on Wednesday, at the top end of expectations and the biggest one-off increase in a dozen years.

But that pales next to Indonesia's 29 percent rise last month, and Malaysia's decision to hike gasoline prices by 41 percent and diesel prices by a sharper 63 percent.

"In general, price changes leave oil demand nearly untouched in the short run," say consultants at Vienna-based JBC Energy. "Oil consumers might find it easier to adjust to small price changes."

The issue of demand destruction has come into sharp focus in recent weeks, with oil prices falling from their peaks as traders fear that Asian demand -- one of the catalysts for oil's long rally -- could quickly fall as subsidies are removed.

There is precedent for the case -- Indonesia's demand fell by a fifth in the wake of a doubling in prices in October 2005, and has only recently recovered; India's oil demand growth, however, has accelerated to its fastest pace in eight years, despite domestic fuel prices having risen by up to 65 percent since 2003.

The Chinese and Indian economies are booming, despite U.S. woes, and salaries are rising even more quickly.

"So far fuel prices have been so low that the share of fuel expense was relatively minor compared to total income, which was growing very rapidly," says Yonghun Jung of the Asia Pacific Energy Research Centre, which studies demand trends.

If drivers in Beijing or Delhi feel their governments will continue to keep prices from rising swiftly, analysts say they may see little reason to hold back from spending some of their growing wealth on the ultimate status symbol -- a private car -- and fuelling it may take precedence over other expenses.

"We have no choice but to pay up. We have to cut down on other expenses such as eating out and things for yourself because it's not in your budget anymore," said Bina Chadha, a government officer in Mumbai, in response to India's fuel price hike.

SLOW RESPONSE

Even in the United States, whose prices are relatively cheap by world standards, a trebling in gasoline pump prices since 2004 to $4 a gallon has seen evidence of weakening demand only appearing now, highlighting the challenge in prying drivers away from the steering wheel.

By contrast, Chinese and Indian prices have not even doubled since 2003, when both began controlling prices more rigidly. Officials said India would have had to raise petrol prices by 50 percent and diesel by 100 percent to match global rates.

There is little doubt that cheap prices have artificially encouraged consumption growth in the two giants, where oil demand has risen by a third since 2003, adding another 2.78 million barrels a day to world demand -- more than Germany's entire use.