June 20th, 2008
10:29 AM GMT
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LONDON, England – Anytime you read an article or get an explanation about why oil prices are rising, soaring demand from China is always on the list.Now the Chinese government is taking some of the subsidy consumers enjoy by raising retail prices on gasoline and diesel by at least 17 percent. It's the first rise in Chinese fuel prices in eight months. Oil prices fell nearly $5 a barrel on the news to just under $132 a barrel.

The market's reaction underscores the idea that it isn't speculators driving the price higher, but issues about fundamental demand. And the market thinks that the higher prices the Chinese will have to pay at the pump will lead to less demand.

But not everyone is buying the argument. Why? First of all, even though its a big hike, it may not be enough to discourage people from driving. Secondly, refiners who have to pay world prices for oil have been operating at losses because they haven't been able to pass on the true cost. Refiners have cut production. Now, that prices are higher production could actually rise, helping to meet demand where they have been shortages and rationing.

Even with the price announcement, what the Chinese pay for their petrol is still way below market prices. One estimate said that China would have to raise fuel prices by 60 percent to come into line with international levels.

Of course, China isn't the only country to subsidise fuel. Other nations, in Asia, the Middle East and parts of Latin America all help foot the fuel bill. These countries make up half the world's population and their increased oil needs is what is pushing up prices. In places like the United States, Japan, and Europe, demand is is either flat or contracting.

If all those developing countries did away with subsidies, then that would probably would lead to less demand. But polticians know that would also likely lead to widespread social unrest, which has happened in some parts of the world. It would also mean less growth and higher inflation.

So even though the Chinese have raised prices, they are still way below market prices - and until that changes, and changes elsewhere, expect oil prices to remain high.

Tell me what you think - should the Chinese have raised prices more? Should governments do away with subsidies altogether? Looking foward to hearing your thoughts.

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