Let me explain…

The Subsidy Gambit

It turns out that a number of Asian governments - most notably Taiwan, Malaysia and China, for instance - are actually reducing or eliminating fuel subsidies designed to shield their consumers from crude oil’s relentless march. Ostensibly, this is designed to control demand, but history suggests this will merely give those with the money access to increasingly large supplies that they’ll gobble up. In other words, we believe that demand may be growing fast enough to override the prices that governments around the world still believe to be inelastic.

Combine that possible new reality with the fact that a developing Asia accounts for as much as 70% of the increase in global oil consumption, this end of subsidies would probably hammer worldwide markets, including our own.

Given that Asia represents a mere 20% of current global usage, Asia’s growth is critical to how the rest of the world uses and prices petroleum-related products - particularly gasoline. Incidentally, this stands in stark contrast to how Japan and much of Europe do things where high taxes on fuel and transportation are used to blunt demand.

The economic forces that will be unleashed when these subsidies are removed have the potential to make the Great Tunguska Blast that took place 100 years ago this month look like a wet firecracker.

Indonesia, for instance, spends nearly 20% of its budget to underwrite fuel costs and has telegraphed a 30% hike in fuel prices when those subsidies are removed. It’s much the same story in China, India and the Philippines, where separate figures for fuel subsidies are hard to come by, but where it’s safe to say that the net effect of these price controls have contributed to artificially low prices and artificially high levels of demand.

In China, where the government caps gasoline prices, for instance, motorists pay about half of what their U.S. counterparts pay. All in all, governments around the world will spend about $100 billion on oil subsidies this year - meaning about half the world’s population is benefiting from “cut-rate” petroleum prices. This year, those folks will account for all of the growth in global oil demand, equal to an additional 1 million barrels of oil per day, says Deutsche Bank AG (DB).

Now, pressure is escalating globally for countries to end the subsidies the world economy can ill-afford.