Monday, June 30, 2008

When All Else Fails-3

"China, widely seen as the one nation most responsible for the soaring deamnd and price of oil in recent years, reminded the world it can nudge both in the other direction as well. The government, which controls domestic fuel prices, raised its base price for gasoline by 17% and diesel by 18%, a move that global oil traders quickly concluded could diminish the country's voracious appetite for fuel. ... Thursday's price hikes come just days before world leaders and oil executives meet in the Saudi Arabian city of Jeddah Sunday to bring record oil prices back to earth. ... Asia's other large consumers--such as India, Indonesia and Malayasia--all subsidize fuel heavily, but have risked popular ire in recent weeks to reduce those supports in order to protect state coffers. ... U.S. Treasury Secretary Henry Paulson ... urged Beijing to abandon its fuel-price controls, saying the U.S. found out the hard way in the 1970s that they don't work", WSJ, 20 June 2008.

Oil fell $4.75 a barrel on Thursday, to $131.93, a 3.475% drop. Supposedly China consumed 7.58 million barrels a day in 2007 and will consume 8.02 million in 2008. Using 2008's figure, does the drop in oil make sense? Assuming China's short-run elasticity of demand for oil is .1, we expect Chinese oil consumption to drop by .18 x .1 x 8.02 million = 144,000 barrels a day. With current world oil consumption at 86.8 million barrels a day, this is 0.166%; I see this accounting for about a 1.66% price reduction, $2.27. Alternatively, the market said oil's short-term price elasticity of demand is .21; .1 x (3.475 / 1.66). Traders relax. This is not that big a deal. Unless you think it has portents for other countries.

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