The trouble with subsidies

Very low demand growth -- under 2%/year -- was seen in the United States, Western Europe and Japan, Drollas said. However, Chinese oil demand grew by nearly 7%/year during that period, India and Southeast Asian demand by nearly 5%/year, and the Mideast by nearly 4%/year."The thing that characterizes this group is the help demand for oil receives from state subsidies," Drollas explained.

Several speakers at this week's Platts conference in Vienna were questioning whether gasoline and diesel subsidies--primarily in Asia and the Mideast--are distorting the industry's notion of global oil demand.
Leo Drollas, Chief Economist for the Center for Global Energy Studies, argued that oil demand is being artificially lifted by price subsidies, helping to drive prices higher, the implication being that lifting subsidies would raise pump prices to the point at which consumers in those countries will change their driving patterns, pulling demand lower.

Drollas said that during the 1985-2006 period, global oil demand grew by 1.6% per year, while economic growth climbed by an average 3.6% a year. Very low demand growth -- under 2%/year -- was seen in the United States, Western Europe and Japan, Drollas said.

However, Chinese oil demand grew by nearly 7%/year during that period, India and Southeast Asian demand by nearly 5%/year, and the Mideast by nearly 4%/year. "The thing that characterizes this group is the help demand for oil receives from state subsidies," Drollas explained.

"In China, [there is] $45 billion this year in the form of subsidies," Johannes Benigni, Managing Director of JBC Energy Vienna said in a separate presentation. "For China, that's important. They have 1.3 billion people...moving from agricultural to the industrial to the service sector. If you don't give them the fuel to develop you have social unrest. It's a very simple equation."

And there lies the problem, for economists trying to measure "true" demand, at least. The governments of emerging economies see subsidies as a means to prosperity, and as long as those economies continue to grow, there is no practical reason to halt those subsidies.

Also, it is fair to question how much those subsidies really increase demand. As energy consultant Matt Simmons pointed out on the sidelines of the conference, oil demand in the emerging economies listed by Drollas may also be high simply because those economies are growing. Raymond Vale, Merrill Lynch's Global Oil Trading Analysis Manager, pointed out that China is in the process of building a massive highway system. Currently, only around 11 out of every 1,000 person in China owns a car, compared to 850 out of 1,000 in the US, which leaves plenty of room for demand growth.

The subsidies may help bolster demand, but by how much? We won't really know unless the subsidies are halted.
Caroline Bain, Senior Commodities Economist with Economist Intelligence Unit, said there are signs that "the breaking point" for subsidies is being reached, with Syria reducing subsidies and Jordon ditching them altogether.

But governments will only end subsidies when they can no longer afford them. With China raising foreign reserves by $1 billion/day, according to Vale, more than offsetting the $45 billion/year cost of its subsidies, its hard to see how subsidies there will come to an end.