The drought in southwestern China which began last fall continues to intensify and may be starting to impact world energy prices. So far as many as 25 million people, 20 million acres of crops, and 12 million head of livestock have been affected.

Moreover, the drought stricken area, which is usually well-watered by monsoon rains, is the watershed for the bulk of China’s hydro-electric generating capacity, which in turn provides a substantial share of the power for the industrial plants along the southeast coast. Press reports speak of hydro power output having falling from 70 to 90 percent in some regions. Officials note that unless heavy rains come in the next month, many reservoirs will be empty and power stations will have to close down. For a country attempting to grow its GDP by 11 percent this year, electricity shortages that could run to 10 of 15 percent of national production could be a disaster.

Sixty years ago China could simply let remote villagers suffer whatever befell them, but today’s highly organized industrial China, sitting on trillions in foreign reserves, must do whatever it takes to mitigate the effects of the worst drought in 100 years.

Last year Beijing, the world’s largest coal producer, imported 100 million tons of coal and will likely to increase this total in 2010. In Hubei province where 30 percent of electric power comes from hydro, lower water levels behind the Three Gorges dam has already caused a shortage of 500 million KWh. In March, China increased its crude oil imports by 29 percent year over year to nearly 5 million b/d.

The course of drought conditions is difficult to predict, and the El Niño in the central Pacific which may be behind the drought seems to be disappearing. At the same time, the Chinese are reporting that drought conditions far to the north in Inner Mongolia are worsening.

Should the droughts persist, with hydro-power and food production continuing to fall over the next few months, there are likely to be major repercussions -- particularly efforts to step up energy and food imports. All this suggests that the rapid increase in Chinese oil imports that we have seen in recent months may not be over.

The situation continues to deteriorate with the water level at the Guri dam falling another meter last week and three large thermo-electric generators going out of service. President Chavez announced it had started raining in the Guri watershed, though the national meteorological service said it was only a passing storm and that conditions necessary for heavy summer rains have not yet formed.

With 736 megawatts of thermal generating capacity going out of service in the last month, the situation at the hydro dams becomes even more critical. Government officials continue to reassure the public that the generators will be repaired soon and that new capacity will be installed this year, but most are skeptical. A Venezuelan newspaper reports that last week a group of government-owned generating plants were only operating at 20 percent of rated capacity. If heavy rains do not come by mid-May, there will likely be serious trouble affecting the oil industry by the end of May.

The jump in oil prices to a high of $87 last week has revived discussions as to whether prices will go still higher, thereby endangering the prospects of further economic recovery. Most observers are attributing the recent price increase to improving prospects for the economy; oil prices are rising despite the persistent increase in US crude inventories which should force down prices. Someday it may become apparent that rapidly increasing Chinese demand may have had more to do with the increase than is currently believed. For many months now crude has traded in the Saudi’s sweet spot -- $70-80 a barrel – which is seen as high enough to meet the investment needs of oil producers and low enough to prevent major economic damage.

Now that prices have broken out of that trading range, eyes are again turned to $100+ oil prices. Some people now believe that oil prices will never go much higher the $140 seen two years ago as the demand for oil products would drop precipitously. Others point to the large number of countries subsidizing oil prices as a reason oil could go much higher without a significant reduction in demand. "