Why Beijing Maintains Its Hearty Thirst for Crude

By NATALIE OBIKO PEARSON and DAVID WINNING

The Wall Street Journal Online

LONDON -- Most of the world winced as crude-oil prices tiptoed above $90 a barrel, yet China -- the world's second-largest oil consumer behind the U.S. -- appears set to continue sucking up oil at ever higher prices.

Experts say the country isn't entirely immune to oil's price, but a timely combination of robust finances, strong political incentive to uphold costly fuel subsidies, and less exposure to world oil-price fluctuations than many realize is keeping China's oil demand seemingly insatiable.

Chinese consumers, though less energy-efficient than their Western counterparts, are shielded from the impact of surging oil prices by hefty government subsidies. The burden falls primarily on Chinese oil companies China National Offshore Oil Corp. and PetroChina Co., which are obliged to pay a windfall oil tax whenever the price rises above $40 a barrel. In the first half, the companies shelled out more than $2.3 billion. "There will be at some point a limit to that, unless [the companies] get additional funds from the Chinese government," said Simon Wardell, an energy analyst at Global Insight in London.

The Chinese government is comfortably positioned to offer such funds, sitting on $1.43 trillion in foreign-exchange reserves as of the end of September.

The Paris-based International Energy Agency said in its monthly oil-market report this month, that Beijing was likely to take whatever steps necessary to maintain stability. Talk of rolling back subsidies or imposing a fuel tax on consumers, "should probably not be taken at face value," it said.

Zhu Zhixin, a vice minister with the National Development and Reform Commission -- China's economic planning agency -- indicated last week that China was comfortable with record oil prices, hoping they would aid its drive to increase energy efficiency.

While the dollar hit a new low against the euro Friday, oil surged to an intraday record of $90.07 before closing down 87 cents at $88.60 on the New York Mercantile Exchange.The dollar's weakness has supported high oil prices because a lower dollar makes oil cheaper in countries paying in other currencies.

China hasn't benefited from the currency cushion as much as other nations because its currency is pegged to trade in a narrow band with the dollar. That is offset by the stimulus a low exchange rate gives its roaring exports. The yuan's depreciation against the euro in recent months has made Europe China's largest export market.

China's export sector could face weaker demand from the U.S. and Europe because of subprime-credit woes and market turmoil. But "this pessimistic scenario is far from certain," as the government would be likely to step in, the IEA said.

China also isn't as exposed as some might think: It still depends overwhelmingly on coal for energy, while 10% of its energy consumption comes from domestically produced oil. That means only about 10% of its energy consumption is exposed to world oil-price fluctuations -- though that is still a sizable 3.3 million barrels a day.

Meanwhile, imports from less traditional sources, such as the 50.5 million barrels of oil provided by Sudan between January and August, have offered some protection. Sudan's Dar Blend crude is highly acidic so it trades at a substantial discount to market prices and reduces China's need to tap more expensive sources.

Yet China isn't impervious to oil prices. Demand is expected to have grown a relatively sluggish 3%-5% in September from a year earlier. China also is more exposed to sudden disruptions because its stockpiles are lower than those in major industrialized countries, about 21 days' worth compared with 53.5 days for members of the Organization for Economic Cooperation and Development.