24/7 Wall St.

The shell game of controlling gas and diesel prices in China is not terribly clever, but it has worked. The government and the oil & refinery companies which it controls buy crude and sell the by-products to consumers and business well below market.

Cheap gas helps drive the Chinese GDP. The trucking industry is critical to moving goods around the country and to ports for shipment overseas. Only a tiny faction of the population owns cars. That is changing as household income rises, especially around the big cities. China has local car-makers, but it is a rich market for vehicles built by GM (GM), Toyota (TM), VW, and most of the other large global car companies.

The large difference between crude prices and gas is beginning to show up more prominently in the P&Ls of China’s largest oil operations. According to the AP "China’s second-biggest oil company, Sinopec, says its first quarter profit fell 69 percent due to government controls that bar it from passing on record crude costs to consumers." The firm is offers some subsidies to make up the difference, but they are not enough.

Over the last six months, shares in PetroChina (PTR) and China Petroleum (SNP) ,as Sinopec is known, are well down. SNP has fallen by 30% and PTR by 40%. Shares of Exxon (XOM) are flat over that period.

Public shareholders are being punished for the government policy, but it will not end there. If the economy in China slows, the treasury will find it harder and harder to finance the underwriting of gas prices. China may have to pour more money into the market to support its actions. Or, it may have to let the price of fuel move up.

In a country where inflation already borders on double digits, an oil crisis is brewing. It will be not long until it will moves out into the open.

Douglas A. McIntyre