Chinese shrug off $100 oil, but Beijing must beware

By Emma Graham-Harrison

BEIJING (Reuters) - Oil prices at $100 a barrel mean little to Chinese consumers insulated from the global rally by cheap fuel prices, but the latest market peak should sound a warning to Beijing over its disjointed energy policy.

China's leaders extolled the virtues of energy efficiency at every turn last year, but refused to do the one thing that would immediately curb demand -- lift the caps on gasoline and diesel prices, a move they fear would feed already-high inflation.

Strains caused by the widening gap between international and domestic markets may become unmanageable if oil prices stay in three-figure territory, but Beijing may struggle to escape from the vicious cycle its policies have created.

The higher international prices climb, the harder it becomes for Beijing to bring domestic fuel costs in line. But by waiting to act, they allow oil demand in the world's second-biggest consumer to grow unchecked -- fuelling higher prices.

"Consumers in China and India are being subsidized by their governments so they are not paying prices at $100 a barrel, they are still paying $40-$60 a barrel," said Puru Saxena, a Hong Kong-based money manager overseeing over $370 million in assets, half of which in commodities.

That protection in China is magnified by the strengthening of its yuan currency against the dollar -- which gained 6.9 percent last year -- and the rising affluence of the growing middle class, which together have created an indifference to prices.

"I don't know exactly how much money I spend per month on fuel, I never really count that," said one 45 year-old telecoms manager surnamed Ma, at the wheel of a sleek black Buick.

Global crude prices have trebled since the start of 2004; China's domestic gasoline prices have risen only 60 percent.

WAITING FOR STABILITY

But China is paying indirectly for its cheap oil, with the country's refineries deep in the red. Beijing is expected to grant top refiner Sinopec a more than $1.4 billion subsidy -- its third in as many years -- to compensate for the losses it endured in supplying fuel to the local market.

Sinopec and rival PetroChina revved up production after Beijing raised domestic pump prices by 10 percent in November, and have been pressured into importing extra supplies -- despite still running in the red.

The mounting losses threaten more than just investor profits.

"Higher oil prices mean that refining losses will expand, and that will slash the cash flows available for investments into building new refineries," said Gordon Kwan, oil and gas analyst at CLSA in Hong Kong.

"China could end up being a big importer of refined products and that would jeopardize national energy security," he added.

Beijing appears to have hoped that crude's ascent towards $100 would halt long enough to allow them to gradually move prices towards international levels, and in January 2007 they trimmed gasoline prices on the back of falling crude.