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Does China Underprice Its Oil Consumption?

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Program on Energy and Sustainable Development, page(s): 29

February 6, 2009

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From 1996 to 2006, China’s oil consumption growth far exceeded that of all major consuming countries. China’s average growth in oil consumption over the time period 2000 to 2006 was estimated to be approximately 8 percent per year, up from 6 percent per year from 1996 to 2000. One factor alleged to have caused this rapid increase in the growth of oil consumption in China is the under-pricing of oil to domestic consumers--selling oil-derived products such as gasoline and diesel fuel domestically at prices that are less than the world oil price plus the cost of producing that product. We explore validity of this claim, quantify the extent to which oil domestic oil consumption is subsidized by the Chinese government, and assess the impact of these subsidies on China’s demand for oil. We find economically significant evidence of under-pricing of gasoline and diesel fuel by China relative to the US over our sample period of January 2005 to July 2008 for all of the approaches to computing the comparable price of these products for the two countries. We estimate that underpricing of oil in the form of gasoline and diesel fuel in China resulted in a total subsidy to Chinese consumers of between 5 and 15 billion dollars in 2007. We also analyze the likely change in the consumption of gasoline and diesel in 2007 that would result from the elimination of this underpricing and find that it had little impact on gasoline and diesel fuel consumption for short-run own-price elasticities in the range of recent estimates of these magnitudes from cross country studies.

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