>Price hikes put China's oil demand recovery at risk

Sydney - China's fuel demand has rebounded since hitting a low in January, but an unprecedented double hike in pump prices in a month could derail that recovery if consumers scale back their gasoline and diesel use.

Analysts say June will be an important month for testing the boundaries of Chinese fuel demand elasticity, after Beijing followed a 6-7% rise in gasoline and diesel prices on June 1 with an 8-10% hike four weeks later.

China's move shows its confidence that costlier fuel won't trigger social instability, even though it will eat further into profit margins of low-income, and sometimes volatile, groups like taxi drivers and farmers.

Gasoline and diesel prices in some regions of China are now near heights reached in summer 2008, when crude oil futures peaked above $147 a barrel.

"On a psychological level I think we are beginning to arrive at the point now where consumers will start counting their fuel costs and maybe rein back spending," said Tom Grieder, Asia-Pacific energy analyst for consultancy IHS Global Insight.

This will be the case particularly if users believe that crude prices will keep on rising, he said.

Nymex crude soared 40.7% in the second quarter, the biggest quarterly percentage gain since the quarter ended September 28, 1990, during which time Saddam Hussein's Iraq invaded Kuwait. Year to date, oil is up 56.7%.

China isn't alone in Asia in taking action at the pump. Pakistan will raise local fuel prices by around 12% Wednesday, a senior government official said this week.

India's Essar Oil Ltd. (500134.BY), which operates about 1,250 filling stations, hiked gasoline and diesel prices in June. More price changes are on the cards, with Indian fuel retailers set to lift jet fuel by about 6.5% from Wednesday.

And Wednesday, Vietnam came in with a more modest 5% rise in fuel prices, but this was its third rise since early May.

Paul Ting, president of research firm Paul Ting Energy Vision LLC, said there were signs in the market that Chinese oil demand is being hit.

"The most important is the fact that there were already price discounts taking place in China in June," Ting said, citing evidence from independent fuel retailers and others.

"Any time you have to give 'trinkets' such as eggs and soft drinks away to sell fuel suggest a very competitive market," he said.

Faster, Higher, Stronger
China's fast-growing economy has been a key driver of crude oil prices in recent years, but the world's second-largest energy consumer has felt the impact of the U.S. and major trading partners in Europe sliding into recession.

The International Energy Agency on Monday cut its global oil demand growth outlook for the next several years. It sees China's 2009 oil use shrinking by 0.4%.

Others are more bullish. In a June 19 report, Citigroup oil and natural gas analyst Graham Cunningham forecast China's 2009 oil demand will grow 3% to 8.1 million barrels a day.

"In the second half of 2009, we expect oil demand growth to be supported by rising stimulus spending, which will be weighted towards energy-intensive Western China development and infrastructure spending," Cunningham said in the report.

China's gasoline use has received considerable support in recent months from government policies aimed at shoring up the country's auto industry. These include subsidies and a purchase tax cut on small cars.

Auto sales in China rose 34% in May from a year earlier to 1.12 million units, the China Association of Automobile Manufacturers said. In the first five months of this year, sales rose 14.3% from the same period of 2008.

Relatively low inflation has been supportive to oil demand, as it means Chinese consumers aren't feeling the pressure elsewhere in their budgets. China's consumer price index fell 1.4% in May from a year earlier, the fourth straight month of drops.

Seasonal factors have been at play in underpinning demand, with farmers having little option earlier in the year than to keep buying diesel to for farm machinery at the start of the planting season.

However, much will depend on the National Development and Reform Commission, China's economic planning agency, and its commitment to stick with the fuel pricing mechanism that it introduced at the start of January.

Under this reform, domestic fuel prices may be adjusted when the moving average of a basket of international crudes changes more than 4% over a period of 22 working days. The reforms guarantee refiners a 5% profit margin as long as crude prices are below $80 a barrel.

"If crude rises above $80 per barrel I think the NDRC will become much more cautious to implement further raises due to the potential impact on social stability and may step in and provide subsidies to soften the cost for consumers," said Grieder, of IHS Global Insight.

Damien Ma, China analyst at Eurasia Group, expects the NDRC will keep raising prices, not least because a fuel consumption tax introduced late last year has generated a great deal of revenue for Beijing at a time when it needs to fund its fiscal expansion.

"As tax remittance from other sources drop, Beijing may view these types of consumption-based taxes as a good way to pad central coffers. It also dovetails with the sustainability goal of curbing pollution," Ma said.

Any sudden weakness in domestic demand will present China's refiners with a dilemma: lower runs and squeeze profit margins or keep output high with surplus supply diverted overseas or stockpiled.

China's export options look limited, despite strong volumes shipped overseas in May and April, as it's unclear how much excess supply neighboring countries can take without a meaningful pickup in their economies.

Analysts said refiners would most likely speed up plans to raise commercial stockpiles of oil products. PetroChina Co. (PTR), China Petroleum & Chemical Corp. (SNP) and China National Offshore Oil Corp. are spending billions of yuan on new storage tanks around the country.

Data on China's crude and refined product stock levels typically is issued by state news agency Xinhua in the first few days of each month and May data are due imminently.

"If fuel prices are going to rise this is a good strategy as it will save (refiners) costs over the longer term," Grieder said.

Source: COMMODITIESCONTROL