Name:Wang Xiaocui   Student ID：S07644
Research paper supervisor:Dr.Seku Conde
Minzu University of China
2007-2008 Academic Year
 

Abstract
The price of crude oil is becoming higher and higher. Why oil price is so high? In the second part of this paper I use Figure 1 to explain the reasons. From the explanation we know the reasons are
Keywords: crude oil price; China’s oil industry; impacts of high oil prices
Part One:  Introduction
At present the price of crude oil is very high. The start of this year was marked by oil prices reaching $100 a barrel, which could greatly affect the global oil industry, and especially China.
Rising oil prices have become a top global concern, as it consequently brings up the price of fuel and other oil products, increases production costs, causes hikes to consumer goods prices and ultimately puts inflation pressure on the Chinese oil industry. China's annual oil production has stood at 170 million tons since 1993. The nation is still in the industrialization stage, a period during which economic growth relies considerably on oil. For example, China currently imports 50 percent of its total consumption and is the second largest oil consumer in the world after the US. Skyrocketing oil prices force consumers to spend more on fuel consumption and squeeze expenditures on other commodities. In 2003, No 93 gasoline was tagged at 3.02 yuan per liter in China, and by the end of last year had climbed 76.8 percent to 5.43 yuan per liter. For a family with a car, 200 to 350 yuan is spent per month more than 2003, an increase of 35 to 65 percent.[2]
According to a survey conducted by the International Monetary Fund, if oil prices in international markets fluctuate by $1 per barrel, China's GDP will be affected by 0.046 percent. From 1999 to 2000, China has raised refined oil prices seven consecutive times, for a total increase of nearly 60 percent. However, these increases have not substantially influenced either psychological tolerance or social stability. Even so, in the long run, China may become one of the major sufferers of the sharp oil price rises and fluctuations on the world oil market.
Part Two: The reasons for the rise of oil price
  The rise is a result of multiple factors interacting. It was fundamentally a reflection of the supply-demand chain between oil importing and exporting countries, and a white-hot battle to maximize their respective interests.
  Figure 1: Brent Crude Oil Price, 1970-2005
   
Figure 1 shows nominal and real prices for Brent Crude Oil for the past three and a half decades. Although oil prices continue to set new records in nominal terms, in real terms they remain well below the peak established in the oil shock of 1979, having generally fluctuated within a broad band of about $20-40/bbl.From the figure we know that the prices in 2005 are high compared to their historical average, though they would have to rise by another $35-45/bbl to hit the peak of $107/bbl.The increase in nominal oil prices seen during the recent run-up have also been more modest and gradual than the earlier shocks.[3]
Of course, oil prices reflect underlying fundamental forces of demand and supply, and demand of oil has seen steady growth, largely propelled by Asia’s strong economic performances. For example, between 1990 and 2003, for the world as a whole, annual demand for oil at 1.3%, while for the PRC and India combined it expanded at 7%. Together, these two countries have accounted for almost 40% of the growth in demand since 1990.
Despite substantial increase in oil prices, demand remains robust. Driven by still-strong growth in the US and developing Asia, global oil demand reached 82.8 million barrels per day (mb/d) in the first half of 2005,or an increase of 1.3 mb/d from the same period of 2004(though this increase is substantially less than the surge in the first half of 2004).As a whole, the increase in developing Asian demand accounted for nearly half of global demand expansion in 2004.
 Shorter-run influences are also at work on prices. In the face of severe capacity constraints, refiners have joined the drive to increase operating inventory levels. In 2005, prices exceeded spot prices, helping maintain upward pressure on spot prices by reducing the cost of carrying inventories. Investments in refining capacity have been too low, and a mismatch emerged between the type of refining capacity required and what was available. For some time, world oil demand has been driven by high-quality “light” crude (oil of low density or containing a low wax content, which makes production and refining easier) and by “sweet” crude (oil with a low sulfur content).Recent additions to production capacity have, though, largely been in the “heavy” and “sour” grades of crude, which are more difficult and costly to refine.
In the first half of 2005, world supply increased to 84.1 mb/d , up by 1.7 mb/d on 2004’s level. At that time OPEC’s spare capacity had been reduced to about 2.2 mb/d. However, once countries that are prone to supply disruptions, such as Iraq, Nigeria, and Venezuela, are excluded. Given this narrow buffer, events that threaten to disrupt supply are transmitted very quickly to prices. For instance, an early start of the hurricane season in 2005 along the US Gulf Coast was the main culprit for the prices in July, while anxieties over Iraq’s resumption of nuclear activities and fears of terrorist attacks on Saudi Arabia lifted the price further in early August .Hurricane Katrina pushed up the price in early September.
Looking ahead, there are proven oil reserved sufficient to cover current global consumption needs for over 40 years. But investments in oil production, refining, and distribution infra-structure has been paltry following a protracted period of low prices through the late 1980s and 1990s. The oil industry is now moving from an exploitation phase to an investment phase .In this changing environment, the rise in long-dated oil prices reflects expectations of higher long-run marginal production costs. Long-dated prices also incorporate a premium linked to financial risks. Actual costs are a function of project complexity, host-country policies, and a range of other factors –including the supply of equipment and skilled labor-none of which is known with much certainty.
Together with fundamental tightness in the current crude oil supply and demand balance, there also several significant risks that could cause price to rise further or to spike, including robust global demand (and predicted surges in demand from a large country such as the PRC), weather and accident-related disruption, and heightened geopolitical uncertainties.
Now that oil prices have become a political matter, producing and consuming nations struggle for their respective interests. In the meantime, the continuous rise in prices has kindled the tension between consumers and the state, like street demonstrations, and sieges of refineries and gas stations to protest high oil prices in England and France. Besides tightening the supply-demand chain, media propaganda, overheated marketing promotion and distorted reports caused consumers to hoard heating oil for winter, which in turn contributed to the high oil prices.[4]  
Part Three: Oil Pricing Practice in China
The fluctuations of world oil prices do not coincide with those of China oil prices as shown in figure 2 and 3.The fluctuation of world oil prices, however, are consistent with the changes of oil prices of the major oil exporting countries, as shown in table 1,which are the major countries from which China imports oil as well. This vindicates the uniqueness of oil price movement in China and it is worth explanation.
             Figure 2:  Fluctuation of oil price of China [5]
         
 
Figure 3: Fluctuation of world oil prices [6]
        
 
The oil pricing in China used to be tightly controlled by the government under the central planning economic system. One of the features of 1960s and 1970s is that  major oil producers in China did not need to concern about profits. They were merely expected to complete the production volume set by the government, and all the investment needed would be funded by the central budget. Since the macro-economy of China began to take off in early 1980s, however, the government found its budget extremely tight in dealing with investment needed in almost every sector. Moreover, the production costs also rose along with the inflation, adding insult to injury for ill-funded state-owned oil companies.
 
Table 1:  Selected Crude Oil Prices (Selected Years, 1980-2000) [7]
                                                                                                              (U.S. Dollars per Barrel)

Crude

1980

1983

1986

1989

1992

1995

1998

2000

Refiner Acquisition Cost

30.75

31.40

24.93

16.04

16.10

16.56

14.33

25.29

Iranian Light

30.37

31.20

28.05

12.75

15.50

16.18

14.93

24.63

Oman

 

 

27.35

13.40

15.20

16.35

15.35

24.00

Saudi Arabian Light

26.00

34.00

28.00

13.15

15.90

16.63

15.50

24.78

Saudi Arabian Medium

 

 

27.20

12.30

14.25

15.73

14.90

24.13

Saudi Arabian Heavy

 

 

26.00

11.90

13.15

15.13

14.00

23.48

Indonesia Minas

27.50

34.53

28.53

15.50

18.65

16.95

16.50

24.15

 
A new pricing scheme was introduced in 1985, which broke the crude oil price into three categories, namely, in-quota low prices, in-quota high prices and market prices. The in-quota prices were 115 yuan and 500 per ton respectively in 1988, compared with a much higher 878 yuan . As the energy demand for oil continued to increase, the in-quota prices were also adjusted accordingly. In 1993, the low in-quota price was almost tripled at 300 yuan. CNPC would provide about 70 percent of its crude production to Sinopec to fulfill the quota, while the remaining part would be sold at higher market prices. The reform in refined products [...]