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Funds News

Fuel to stay cheap for some, keeping oil expensive

BEIJING (Reuters) - China, India and other nations that subsidise cheap petrol and diesel may be even less willing to raise prices than they were six months ago, aiding crude’s ascent toward $130 even as demand deteriorates elsewhere.

A worker counts Indian currency at a petrol pump in the northeastern Indian city of Siliguri February 5, 2008. REUTERS/Rupak De Chowdhuri (INDIA)

While Indonesia appears set to raise prices as soon as this week, the world’s fastest-growing oil users show little inclination to tackle their subsidy schemes, as fighting food-fuelled inflation has become their top priority.

That’s bad news for oil consumers in the rest of the world, who face record crude costs partly as a result of demand growing unchecked in countries where pump prices have barely risen since the middle of 2006 -- when crude was in the $70s.

Even as the fiscal burden of subsidies mounts with each new record high on the NYMEX, two things have changed in recent months to stay policymakers’ hands, for now.

One is the advent of food-price inflation, which has taken over from energy as the world’s biggest price threat.

The other is the approach of major political events -- Beijing’s summer Olympics and India’s elections next year -- making them wary of anything that could rock the boat of society.

And with economies booming or oil revenues flowing, these countries are under less pressure than Indonesia, which may announce its first fuel price rise in two and a half years at a press conference scheduled for Thursday.

“The key for me is that the fiscal positions of all these players are relatively strong ... so they may be able to afford to retain low prices,” said Jeff Brown, Singapore-based Chief Economist for FACTS Global Energy Group.

The importance of these subsidies in driving oil prices higher grows clearer every day as rising costs start to erode consumption in the United States, Europe and Japan.

WHY STOP DRIVING?

On Tuesday the International Energy Agency once again cut its forecast for global oil demand growth this year, primarily due to record prices and the dimming U.S. economic outlook.

But prices have barely risen in some of the fastest-growing consumers, giving drivers little reason to cut back.

On its current sums, incremental consumption from China, India, the Middle East and Latin America -- where most fuel prices are subsidised -- now accounts for the IEA’s entire 1 million bpd global growth forecast for this year.

Brown estimates that artificially low prices could be responsible for one-fifth or more of that annual growth, although quantifying the impact of low prices is tricky and inexact.

For these countries, the irony of cheap fuel prices feeding into rising global crude costs is secondary to domestic considerations, analysts say, part of a global trend toward inward, protectionist policies across the commodities spectrum.

Eventually, at least some of them will have to bow to higher prices, braving the risk of a populist backlash in order to bolster government balance sheets, temper demand growth and encourage greener energy policies.

“It will not be easy to unwind them, but when such shifts do come, they could cause temporary downward shocks to demand,” the IEA said in its most recent report.

Indonesia, where demand fell by 20 percent when it doubled fuel pump prices in late 2005, will hold a press conference on Thursday about the first price rise since then. But officials have said it will be less than 30 percent, leaving gasoline and diesel rates near the lowest in Asia.

For a graphic showing retail fuel prices versus crude see: here

CHINA, INDIA HOLD OFF

In China, leaders have pledged for years to introduce the rigours of market pricing into its energy sector; six months ago, with oil hovering in the $90s, it looked like it might happen.

But that hope has been crushed -- for now -- by rapidly escalating food prices and the unrelenting rally in crude, which have driven inflation to the highest level in 12 years just as Beijing prepares for its Olympic coming-out party.

Instead of raising prices, which it has done only once in the past two years with a 10 percent increase last November, Beijing is cutting tariffs and handing out monthly subsidies to oil majors Sinopec SNP.N0386.HK and PetroChina 0857.HKPTR.N, whose shares have still been hit hard by fears of lasting losses.

“While implied subsidies are no longer tiny, they are simply not that big either,” said UBS analyst Jonathan Anderson.

“At current levels the government could carry on for a very long time if it really wanted to,” he added.

With a budget deficit of a tiny 0.6 percent of GDP this year, even a subsidy cost in the tens of billions of dollars is bearable, analysts say.

And for now, with the summer Olympic Games approaching, refiners appear wary of deploying their usual pressure tactics for higher prices, such as cutting sales to cause shortages.

The situation is similar in India, where the fragile ruling coalition relies on Communist support to maintain power, and is already thinking ahead to how racing inflation could affect its chances in next year’s general election.

“With a view to reining in inflation...the government may have to keep these prices under check for some more time,” Petroleum Secretary M.S. Srinivasan told Reuters last week, tacitly supporting the government’s focus on growth.

Crude oil prices are up by more than two-thirds since mid-2006, hitting a record $126.98 a barrel on Tuesday, but India has raised retail prices only once over that period -- a meagre increase of 3 to 5 percent in February.

VICIOUS CYCLE

Gulf nations are even less worried about funding cheap fuel and far more concerned about maintaining stability among a public that believes cheap crude is a national right.

For these counties, rising crude prices mean higher export revenues, bigger fiscal surpluses and increased public spending -- feeding more demand growth in a region that already boasts some of the highest per capita oil consumption in the world.

In Venezuela, Latin America’s biggest oil producer, gasoline sells for just $0.12 cents per gallon, the world’s cheapest, at an estimated cost of $10 billion a year in lost revenue.

Even more cash-strapped countries across Asia and part of Latin America are persisting, for now, with cheap fuel.

Thailand in March reintroduced diesel subsidies, while Vietnam and Malaysia have resisted upping prices.

And while Brazil’s state-run oil company Petrobras is nominally free to set fuel prices, the government has de-facto control over diesel and gasoline costs, which it raised this month for the first time in over two years.

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