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September 7, 2006
A Clue About World Oil Prices

Americans have demanded answers to questions about the rapid rise of gasoline prices over the past two years, and even with market forces finally working our favor recently, still remain skeptical about their influence on prices at the pump. Analysts understand that the rapid growth of the Chinese economy have permanently changed the oil markets, but even the experts may not wholly understand how much of that impact could have been avoided through better efficiencies. Der Spiegel takes a look at the challenges that China presents to enery markets:

China's economy is expanding at an average rate of nine percent every year. Economic planners in Beijing recently discovered that their economy is actually 17 percent larger than they had previously thought. That's as if the Chinese had accidentally discovered an economic surplus the size of Turkey's Gross Domestic Product.

The consequence is that China is getting even hungrier for energy. But it's not just consuming natural resources to produce the many cheap products it exports to Western industrial nations. With growing prosperity, consumer demand is rising as well: Every year, millions of Chinese migrate from their villages to the large cities on the wealthy east coast. Many move into apartment blocks built from concrete and steel. Shanghai already has 4,000 skyscrapers -- twice as many as Manhattan -- and the new buildings are equipped with new refrigerators, new stoves, new air conditioning systems -- all of which were, of course, produced using natural resources and which themselves consume energy.

While China is responsible for only four percent of the world's overall economic output, it's already consuming 13.6 percent of the world's energy.

That figure represents something other than high productivity, however. Der Spiegel calls China "The Great Squanderer," and for good reason. Their inefficient use of energy costs them seven times the amount of energy expended per dollar of GDP than the Japanese economy. This creates an enormous and mostly wasteful demand for energy to feed their rapidly-growing economy, and to keep ahead of the expectations of the traditionally poor Chinese.

China has many grand plans for energy production, but most of them will take years to reach fruition. They have recently completed a wind farm of 167 turbines, which will hardly put a dent in their demand for electricity even in the region of the wind farm. Beijing has grand plans for a series of cutting-edge nuclear power plants, and given the West's indefensible rejection of this source, China has N-plant builders lining up to do business with them. However, even with the ambitious programs the Chinese envision, nuclear generation will only provide four percent of their energy needs at the end of the 14 years to complete the project. Hydroelectric power from proposed dams is even further away.

The only options the Chinese have in the near term is to use oil, either domestically produced or imported from abroad. Beijing has had some success in oil exploration, having found a substantial oil reserve ironically in an area where Muslim Uighers live, as well as natural gas. It won't be enough to give them anything close to energy independence, and so China must do what the US does: buy abroad.

However, while the majority of our imports come from our own hemisphere -- Canada and Mexico export more oil to the US than Saudi Arabia, with Venezuela at #4 -- China has to look closer to home. We played a part in that lack of choice, having squeezed the Chinese out of major plays in Canada. Now China looks towards Iran, especially since the US buys nothing from the Islamic Republic. This creates more international complications than just a hike in oil prices, as we see now with the lack of fortitude on China's behalf on Iran's nuclear ambitions. China cannot afford to do without Iranian oil for very long, not unless someone finds another source that can deliver on levels that meet China's requirements.

All of this figures into the price of oil on the open market, a commodity like any other, subject to the psychology of futures trading. As the situation in Iran develops, traders have figured into the price any potential market disruption that Iranian sanctions might impose, just as they did with the potential for hurricane damage. In the long term, we can see that the prices will not come down much even if the Middle East suddenly transformed into an oasis of peace and harmony. The rapid economic rise of China combined with its gross inefficiences have ensured that oil will not revert back to its former status as a cheap commodity for many years, if at all.

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Posted by Ed Morrissey at September 7, 2006 5:13 AM

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