Notes On The News With Paul Maidment
What’s Really Pushing Gas Prices? Subsidies.
Paul Maidment 06.04.08, 10:54 AM ET


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Might U.S. lawmakers keen to skewer the culprit for high gas prices be tilting at the wrong windmill?

At its hearings Tuesday on “energy market manipulation” (no assumptions of innocent till proved guilty, there), the U.S. Senate’s Commerce committee was champing at the bit to regulate, well, anything really that had to do with oil trading.

Several of its witnesses dutifully pointed the finger at oil market speculators, though billionaire financier George Soros provided a reality check on how effective regulating them would prove (see “Soros Tells Congress To Pop An Oil Bubble”).

Instead consider the views of two fixed-income analysts at Morgan Stanley (nyse: MSnews people ), Stephen Jen and Luca Bindelli, who point their finger at a target beyond the reach of Congress, governments of fast-growing economies that subsidize energy prices, and gasoline in particular.

Soros touched on these in his testimony when discussing the role of rising global demand for energy. Jen and Bindelli provide much more detail.

Half the world’s population benefits from energy subsidies, which translates into a quarter of the world’s gasoline production, they say in a note to clients. Though three-quarters of the world’s gasoline consumption is taxed, those taxes vary hugely around the world, resulting in a spread of prices at the pump from five cents a liter in Venezuela to $2.70 a liter in Turkey. (It is about $1 a liter in the U.S.)

Such subsidies distort the market, by preventing rising prices from lowering world demand to the extent that the textbooks say they should. While oil prices remain fundamentally driven by supply and demand, they are not absolutely so. Demand is overshooting, so prices are, too.

That prices are not fully reacting to slowing demand growth and yet neither are inventories being built up, is a curiosity. One would expect this if speculation were the main mover of oil prices.

At the end of 2006, when oil was trading at $60 a barrel, only 10.4% of the world’s gasoline consumption was taxed. That has now risen to 22%, Jen and Bindelli calculate, and oil has similarly more than doubled in price.

The silver lining? The growing fiscal pressure on subsidizing economies will force some governments to remove the subsidies, Jen and Bindelli believe.

Malaysia, a net oil exporter and which has been spending $16.5 billion a year on fuel subsidies, according to government numbers, Wednesday announced it will raise its 60 cents a liter gasoline price by 40% to take a bite out of that. Its gasoline subsidies are equivalent to four times the government’s combined budget for national defense, education and health care.

Taiwan, which spends an estimated $3 billion a year, did something similar earlier this month. So have India, Sri Lanka, Pakistan and Indonesia.

That could all be good for developed economies; it will lower inflationary pressures. But for emerging markets, it risks creating stagflation, as well as being politically challenging. As America’s lawmakers can well attest, nothing angers constituents like the rising price of gas.


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