Editor's note: At a recent seminar sponsored by China Daily, researchers analysed the influence of rising global oil prices on China, and appraised the country's energy strategy. The following are some of their thoughts:

By Niu Li

Oil prices have been setting new records this year, which come on top of non-stop increases in the past two years. It is estimated that the average price for crude oil for 2005 will be US$58 per barrel, roughly 40 per cent higher year-on-year. This has pushed up the price of processed oil on the domestic market, leaving consumers with the pressure of price hikes across the board.

The big jumps in oil prices on the international markets have complicated reasons. But three are fundamental:

First is the fragility of global supply and demand.

According to the "Short-Term Energy Outlook October 2005" released by the US Energy Information Administration, global daily consumption for crude this year will be 83.7 million barrels, up 1.5 per cent from last year, amounting to 1.2 million extra barrels. Daily production is projected to be 84.3 million barrels, up 1.6 per cent or 1.3 million barrels. Of which, OPEC's daily production increases 3.6 per cent.

Under normal circumstances, there is an extra 4-5 million barrels a day. Currently, due to the limited capacity in crude production, chiefly the 0.9-1.4 million extra barrels daily from OPEC, the balance of global supply and demand is quite fragile. Preliminary estimates show that the factor of supply and demand alone would point to an approximate price of US$40 per barrel.

Second is the "terror premium," which includes various kinds of emergencies.

The Iraq situation has not turned better this year. Incidents of violence have had an adverse impact on oil production in that country. There have been several terror alerts in Saudi Arabia, the biggest oil producer; oil workers in Norway have held a strike; Iran's uranium enrichment programme has intensified the geopolitical risk; and North America has seen natural disasters such as hurricanes. The "terror premium" is estimated to account for US$10-15 in a barrel of crude oil.

Third is international speculation, which has been making waves.

Speculation in the futures market has a palpable effect on this year's price increases. It is estimated that US$15-20 in a barrel of crude is "speculation premium."

Rises in international oil prices can affect China's economy on a grand scale, which manifests itself in the following aspects:

It can hold back economic growth and add to inflation as rising oil prices have a certain adverse impact on the economy and ordinary people's lives. They increase currency outflows, boost corporate and citizens' expenses, and add to the difficulty of managing the economy. According to forecasts, this year's price increases will knock 0.5-0.7 percentage points off China's GDP, bump up 0.8-1.2 percentage points for the domestic consumer price index and 3.2-4 points for the producer price index.

Then there is an extra outflow of tens of billions of dollars in spending as China's economic growth is more and more closely tied to oil prices. Oil is the single commodity that causes the biggest trade deficit, which amounted to US$35 billion last year and is estimated to reach US$55 billion this year. China's import for the year is expected to total 130 million tons or 1 billion barrels. If each barrel costs an extra US$15, it means China has to shell out an additional US$15 billion from its foreign currency reserve.

Private citizens will directly bear the increasing cost as their expenditures rise with oil prices. So far, there have been four price hikes of processed oil on the Chinese market, causing some consumers to tighten their purse strings and others to change their spending patterns.

Besides end users, producers also need to bear the burden of additional costs. As the economy expands, growth in oil consumption has been more than 10 per cent for the past two years. Elasticity coefficient of energy consumption goes up and dependency on foreign oil has reached 40 per cent as every domestic industry feels the shocks from price hikes on the international market.

Transportation bears the brunt because it is a big consumer of oil. In terms of volume of oil consumed, it is next only to manufacturing and it is taking a gradually larger share in total volume of oil consumption.

Agriculture is also adversely affected as oil price hikes are passed on to chemical fertilizers and vehicles for agricultural use.

Petroleum processing and coking has also seen higher costs. Crude usually takes up 80 per cent of the total cost of a processing and coking plant whereas the industry as a whole soaks up 72 per cent of all crude oil produced. As it is directly below crude production on the food chain, it has incurred an industry-wide deficit this year because its sale price is fixed by the State and therefore cannot pass all the cost on to its own customers.

The automobile industry is also hit in its growth phase. As higher oil prices affect consumer behaviour, such as their choice of vehicle types, carmakers have to consider gas-conserving cars, which may become popular in the future.

The chemical industry is affected, but it has higher capability of transferring its cost. The health of the industry is highly correlated with oil prices. In recent years, the industry is in good health and reaping decent profits, but downstream industries such as chemical fibre have to bear the cost.

Exploration of natural gas goes in tandem with crude oil, therefore it has benefited most directly from price hikes of crude. In the first half of this year, the three biggest oil producers had a combined profit of 91 billion yuan (US$11.2 billion), which accounted for more than 10 per cent of profits by all industrial enterprises.

The above analysis shows that skyrocketing oil prices have brought unprecedented shocks to China's economy and people's way of living. It has become an important issue of sustainable growth to design countermeasures in order to stabilize the domestic oil market and ensure oil supplies.

The author is an economist with the Economic Forecasting Department of the State Information Centre