The headline risk here, folks, is that if you wait for your central banker to give you insight into ...
Fuel Shortages Hit Developing World
05/20/2011 9:29 am EST
Caught between rising costs and price controls, China, India, Russia, and other countries face a problem that is much worse...not enough energy to go around.
Cheap gas tomorrow and cheap gas yesterday, but no cheap gas today.
Turns out there are worse things than $4-a-gallon gasoline.
There's driving up to the pump and discovering there's no gas. That's happening across a big swath of the developing world. And it's happening not just with gasoline; diesel fuel and even electricity are in short supply.
The reason is simple: Governments from Russia to China to India to Indonesia to Brazil have pressured or required oil refineries (and other energy companies) to keep consumer prices low, even though their costs for oil (and coal) are rising. That's turned these companies into red-ink machines.
Not surprisingly, they're reacting by cutting production—that's what you do if you lose money on every sale.
They are also reacting by exporting gasoline to countries that pay market prices for petroleum products. And that has resulted in massive shortages of everything from gasoline to diesel fuel to electricity in countries like Russia.
No Gas, Less Growth
The shortages have become large enough to potentially cut economic growth in the economies that the world increasingly counts on for growth—just as central banks are raising interest rates there to slow growth in an effort to fight inflation.
In fact, I'd argue that despite all the worry on Wall Street about how higher US energy prices will hurt the US economic recovery, the biggest danger to economic growth from higher oil prices is in those developing economies trying to control prices without squashing supply.
Russia, the world's biggest oil producer, is a good example of how a developing economy can get caught between a rock and a hard place due to rising energy prices.
At the end of April, gasoline sold for $3.03 a gallon in Moscow. When there was any to sell...
Beginning in February, gas stations across Russia started to experience shortages. That's a direct result of investigations launched by Prime Minister Vladimir Putin into steep price increases in gasoline.
With the government cracking down on rising prices—effectively capping gasoline at a time when world oil prices had soared—Russian oil producers and refiners started to ship more gasoline overseas.
Prices for gasoline and diesel in Russia in March were $70 to $150 lower per metric ton than on world export markets, according to Jonathan Muir, the CFO of the TNK-BP joint venture. The company, Muir said, would have earned $54 million more in the first quarter if it had exported the gasoline it instead sold in Russia.
So guess what? Russian refiners started to do just that—and fuel shortages emerged, first in the country's more remote areas, such as Siberia and the southern Altai region. Then it spread to urban areas, such as St. Petersburg.
In the Altai, more than 700 gas stations have closed. In the Siberian city of Tomsk, gas stations limited customers—even city buses—to 25 liters a day. Because city buses need 80 to 100 liters a day to operate, you won't be surprised if I tell you that 20% of buses didn't run on April 28.
The Russian government (keep in mind that elections for the national legislature are this year, and a presidential election looms in 2012) has responded to this crisis by slapping a punitive 44% tariff on gasoline exports, effectively prohibiting exports and diverting all gasoline to domestic markets.
It's not yet clear whether that means more gas is reaching Russia's gas stations, or if Russia's oil companies are instead changing their refinery mix to produce products other than gasoline that have higher profit margins.
NEXT: A Similar Situation in India|pagebreak|
A Similar Situation in India
In India the scenario is much the same—with the difference that India's oil-marketing companies are government owned, and that India, rather than being the world's largest oil producer, imports 70% of its fuel.
Gasoline in India now sells for 40% more than it did in February 2010, but the price increase would be even higher if the Indian government and the state-owned marketing companies didn't subsidize the price of fuel.
The government's budget for fuel subsidies for the fiscal year that ends in March 2012 is about $5.5 billion. At recent prices, the actual bill for government fuel subsidies could hit $20 billion.
The oil-marketing companies are pitching in, too. Despite the 40% price increase, the state-owned oil companies estimate that they lose almost 40 cents on every gallon sold at current prices. The loss on a gallon of diesel fuel is about twice that.
On the one hand, fuel subsidies don't seem sustainable at these levels. The drain on the government budget is huge, and the burden on state-owned oil-marketing companies immense.
Subsidies keep fuel demand higher than it would be at market prices, and India already runs a trade deficit that came to $22 billion in the third quarter of fiscal 2011. The government certainly remembers that in 1991, a technically bankrupt India had to pledge its gold reserves to secure a loan from the International Monetary Fund.
On the other hand, even with these subsidies, inflation in India was running at an annual rate of 8.7% in April. That's down from 9% in March, but it's still nearly twice the Reserve Bank of India's 4.5% target. And that's after nine increases in benchmark interest rates from the central bank since March 2010. The benchmark rate is now 7.25%.
End subsidies and risk driving inflation up even faster? Keep subsidies and make sure that the Indian economy doesn't improve its energy efficiency as quickly as it would if prices were higher, and risk busting the nation's budget?
It's a truly nasty choice.
Not Just Petroleum
The problem isn't limited to gasoline and oil. The same dynamic is at work in other energy commodities.
Take coal, the fuel for 70% of China's power plants. The cost of thermal coal is up 30% since August 2010. Government-controlled electricity prices are up just 2% over the same time period.
You can guess what's happening now, right?
With utilities facing huge losses ($2.8 billion in the first quarter, according to the China Electricity Council) as a result of this mismatch between soaring costs and stagnant prices, some have reduced their production of electricity. The government frowns on this practice, but utilities seem perfectly willing to tell government officials that they will generate electricity at full capacity, while in practice cutting back on power production.
China almost always has power shortages in the summer, as a lack of rain cuts into production of hydroelectric power. But this year—thanks in part to a dry winter in Southern China—shortages have started earlier, and look especially deep.
Officials say that China could experience its worst shortages of electricity since 2004. Heavy industry—producers of aluminum and steel, chemicals, and construction materials—is likely to take the biggest hit from the shortage, which the China Electricity Council estimates could reach 30 gigawatts this summer.
Power rationing could reduce second-quarter gross domestic product by half a percentage point. The shortage of electricity from the grid has sent Chinese companies scrambling to get their backup diesel generators ready.
I bet you can see where this is headed. More demand for diesel fuel to make up for electricity shortfalls will drive up the price of diesel fuel—especially because some Japanese refineries, a major source of China's diesel imports, were severely damaged in the earthquake and tsunami.
The Chinese government has slapped a complete ban on exports of diesel fuel, so fuel will stay in China's domestic market—and no company will be tempted to export or re-export diesel fuel to global markets, where prices are higher than in China's price-controlled domestic market. (See Russia above for how this works.)
The ban, ordered to "maintain social stability and promote economic development," according to the National Development and Reform Commission, isn't likely to solve the problem if oil prices climb back above $110 a barrel.
At that level, China's oil companies will lose money on price-controlled sales of diesel fuel, and will start to cut back on production in order to reduce losses.
Like India and Russia, China is in the midst of a bruising fight against rising inflation. It's unlikely—nothing is ever dead certain, but I'd say the odds here approach 100%—that the government would remove price controls, or allow a rapid increase in the price of either electricity or diesel fuel, to reduce shortages, even at the risk of accelerating inflation.
NEXT: Why Brazil Is a Bit Different|pagebreak|
Why Brazil Is a Bit Different
These energy shortages don't play out in the same way everywhere in the developing world, or on the same timetable. It's quite one thing to artificially depress gasoline prices in India, which imports 70% of its fuel, and another in Brazil, which, in most years, exports fuel.
But Brazil isn't immune to the impulse to intervene in the energy market to lower prices. On May 12, the state-controlled oil company Petrobras (PBR) announced that its distribution arm BR Distribuidora would cut gasoline prices by 6% in order to help the government fight inflation.
The move will do more damage to competitors such as Ultrapar Participacoes (UGP), where fuel distribution accounts for 75% of sales, than it will to Petrobras, where distribution accounts for less than 4% of EBITDA (earnings before interest, taxes, depreciation, and amortization).
But the impact on the national budget of Brazil is likely to be minimal, and the economic distortion relatively short-lived. The new sugar harvest is expected to cut the price of ethanol—a key ingredient in the blended fuels used by so many Brazilian cars.
China, Russia, and probably India can't look for similarly quick solutions to their energy rock-and-hard-place problem.
- China and Russia are looking at political transitions in 2012, and will be extremely reluctant to risk popular unrest by removing subsidies or price controls before new leaders (in Russia, quite probably an old-new leader in Vladimir Putin), take power.
- In India, the Congress Party government is fighting for its survival. Continued fuel subsidies are the least of the goodies the government is likely to hand out.
Looking at the danger to economic growth and the effort to control inflation posed by rising energy prices, I don't see the need for a radical reshuffling of my May 10 pecking order for investing in emerging markets.
Brazil still comes before China, and India still lags the pack. Russia isn't in the pack, in my opinion. The country's markets are even more subject to arbitrary political intervention than those of its emerging-market peers.
The energy rock-and-hard-place problem, however, does give me one more danger to watch.
The biggest advantage of understanding these fuel trends, is that it gives some useful context, so you don't overreact to any seasonal drop in China's GDP due to a worse-than-usual summer energy shortage. If second-quarter GDP does drop unexpectedly in China, I'll know that is isn't the end of China's economic boom—or of growth in the global economy.
Full disclosure: I don’t own shares of any of the companies mentioned in this column in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund (JUBAX), may or may not now own positions in any stock mentioned in this column. For a full list of the stocks in the fund as of the end of March, see the fund’s portfolio here.
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