By Jennifer Yousfi
Oil futures fell yesterday (Thursday) on news that China plans to sharply reduce fuel subsidies starting today, which is expected to have an effect on demand.
"The announcement of the Chinese fuel price increase sent the market sharply lower," Michael Fitzpatrick, vice president for energy risk management at MF Global Ltd. (MF) in New York, told Bloomberg News. "This should have a big impact on demand."
Crude oil for July delivery fell $4.75, a decline of 3.5%, to settle at $131.93 a barrel at 2:50 p.m. on the New York Mercantile Exchange, the biggest drop since March 31, according to Bloomberg data.
China, the world's second largest oil consuming nation, has been subsidizing refined oil products to the tune of $25 billion a year, but now is bowing to the high cost of oil that recently flirted with prices near $140 per barrel as recently as June 16.
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The Asia nation will raise both the cost of gasoline and diesel by $145.50 (1,000 yuan) per metric ton. The cost of jet fuel will also increase by $218.25 (1,500 yuan) per metric ton.
"Global crude prices have been rising sharply and Chinese domestic fuel prices have lagged behind. The price difference has highlighted the contradiction between demand and supply," state television said, quoting the National Development and Reform Commission (NDRC), Reuters reported.
Refinery share prices gained on the news, as they will now receive a higher price for refined products. Sinopec Shanghai Petrochemical Co. (ADR: SHI) shares gained $1.20, a 3% increase, to close at $42.03 yesterday.
Oil consumption in China was expected to increase 440,000 barrels to an average 8.02 million barrels a day this year, according to a report from Organization for Economic Cooperation and Development.
"The developing countries, in particular China, have been driving demand growth," Eric Wittenauer, an analyst at Wachovia Securities (WB) in St. Louis, told Bloomberg. "Subsidies and price caps insulate consumers from the full impact of higher prices. By rolling them back, some of the insulation is reduced and we can expect to see a demand response."
It had been expected that China would wait until after the Beijing Olympics to increase fuel costs, as inflation is already high and the government is hoping to avoid social unrest while the nation is in the global spotlight due to the games.
Hoping to curtail potential consumer unrest, Beijing pledged subsidies to lower income groups that will be hardest hit by the price increase including farmers, fishermen and cab drivers, Reuters reported.
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