In China, OPEC's nightmare comes true: John Kemp

-- John Kemp is a Reuters columnist. The opinions expressed are his own --

By John Kemp

LONDON (Reuters) - China's decision to link domestic fuel prices indirectly to the international crude oil market, subject to a price cap, while hiking the consumption tax on gasoline and diesel and phasing out a variety of road tolls and other fees shows Saudi Arabia's worst fears about high prices are demand destruction are starting to come true.

It seems likely to confirm the kingdom's determination to see prices stabilize around $75 per barrel, well below recent price peaks, and far below the level sought by some other OPEC members, as well as international oil companies and advocates of alternative energy.

China is among the world's most inefficient users of energy, measured in terms of BTUs consumed per dollar of GDP produced.

Since China's economy is one of the largest and fastest growing, and heavily reliant on imported crude oil, China has been hit harder than any other country by the recent surge in oil and energy prices.

Rising energy prices have worsened the country's terms of trade, and threaten the viability of much of the industrial base (including the power-intensive steel and aluminum industries).

The central government has made reductions in energy consumption per unit of output a top priority.

Policymakers have used investment controls and other administrative measures to try to limit the expansion of energy-intensive industries aimed at producing primarily for export.

At the same time, export taxes have been introduced on a wide range of low-value added semi-manufactured products (such as unwrought aluminum) and VAT rebates scaled back to encourage the manufacturing sector to concentrate on exporting higher value-added items in which energy is a smaller fraction of the overall unit cost.

But efforts to increase energy efficiency have been only partially successful, because the government continued to hold prices for gasoline, diesel, thermal coal and on-grid electricity below international levels, using a combination of price controls and subsidies. The government's strategy for improving energy efficiency came into conflict with the priority on economic and social stability.

Extensive price controls and subsidies largely insulated households and businesses from the rise in international oil and energy prices, blunting the incentive to improve energy efficiency.

Eventually, the rise in global oil prices became overwhelming. The resulting pressure on the current account of the balance of payments and need for growing subsidies to the country's oil refiners forced the government to raise administrated gasoline and diesel prices almost 20 percent earlier this year.

One welcome effect of the rise in oil prices and the decision to increase domestic gasoline and diesel charges was that it sharpened incentives for energy efficiency considerably.

But as the economy has slowed sharply and international oil prices have tumbled, the government has come under pressure to cut fuel charges.

Instead, the National Development and Reform Commission (NDRC) has introduced a carefully integrated package of measures designed to provide short-term economic relief while maintaining the pressure for greater energy efficiency in the medium term.