On Friday President Obama announced a new 35% tariff on Chinese tires. The International Trade Commission report that provided the legal basis for the tariff used a stipulation in the 1974 Trade Act permitting tariffs when rapidly increasing imports of a certain good from a certain country are doing material harm to U.S. industry.

The case was successfully made without claiming another potential trade violation – oil subsidies. When a government financially assists the production, manufacture, or exportation of a good, the U.S. can impose a countervailing duty.

How do oil prices relate to tires? The main ingredient in tires is, of course, rubber. Natural rubber, which meets about 45% of global demand, comes from the resin in the bark of the Pará Rubber Tree. The other 55% of tire production uses synthetic rubber, which is made from polymers found in crude oil. About 30% of a synthetic tire is crude oil.

On September 10^th rubber prices hit their highest price since last October, $2,371 a metric ton. According to Hisaki Tasaka, a Tokyo-based commodity broker, “Rising oil gave the biggest support to the price of rubber futures.” After OPEC agreed to maintain production quotas, oil prices rose and according to the American Petroleum Institute, reported U.S. stockpiles declined 7.22 million barrels, the biggest drop since Sept. 5, 2008. High oil price forecasts and expected growth in Chinese vehicle sales led analysts to predict that rubber prices would rise as much as 19% by the end of 2010.

Then, in response to intense pressure from industry lobbyists here in the United States, Obama announced the new tariff. Overall, the industry’s decline has cost more than 5,000 jobs, with four tire plants closing their doors between 2006 and 2007. The reason is not lack of demand, however. Tires are simply much cheaper to produce in China. Between 2004 and 2008, China’s tire production capacity rose 152% and is expected to keep growing. Last year China produced 546 million tires, well over 30% of the world’s total. Forty-six million of those tires were exported to the United States. In 2004, total U.S. tire imports were only 14.6 million. That translates to an import increase of 215% by volume and 300% by value between 2004 and 2008.

In response to President Obama’s announcement of the tariff, rubber futures crashed amid concerns that demand for tires would decline in the U.S., also the world’s largest tire market. Though the tariff is likely to cost China no more than three-tenths of 1% of its annual exports to the U.S., China retaliated with threats to slap tariffs on certain U.S. products and called for talks at the World Trade Organization.

The underlying issue in this trade dispute is what some U.S. policymakers consider to be China’s “unfair” advantage in tire manufacturing. Some of that advantage comes from low labor costs and slack environmental standards. But a large chunk may be from China’s artificially low oil prices between 2004 and 2008.

Beijing sets domestic oil prices in order to maintain its promise of economic growth. According to Xinhua, China’s official news service, “Despite the rise in crude oil price over the past three years [2003-2006], China’s NDRC, which regulates domestic prices for processed oil according to changes on the world market, has kept prices relatively low. However, this has also resulted in losses for producers and waste by consumers.”

In May of 2008, gasoline was selling for $4 per gallon in the U.S. and $2.49 per gallon in China. Over the previous year and a half, U.S. prices had risen 77% while China’s only rose 9%. The government regularly pays the country’s refiners, led by Sinopec, the difference between what they must purchase on the global market and what they are permitted to charge their customers.

Subsidized oil prices, therefore, contribute to China’s comparative advantage in tire production. This is compounded by the fact that the actual tire manufacturing process, whether based on natural rubber or synthetic, is extremely energy intensive. The rubber, carbon black, sulfur, and oils are mixed together and go through several stages of intense reheating to keep the batch soft. This requires a tremendous amount of electricity and natural gas, both of whose prices are kept low in China to fuel economic development.

The fundamental issue of energy cost disparity is not going to disappear with tires. After Obama announced the tariff, Leo Gerard, president of the 850,000-member United Steelworkers union that brought the original case against Chinese tires, said “We’re looking at what’s happening in paper sector, glass, cement, steel.” It is not accidental that these are all energy-intensive sectors.

President Obama’s decision to support the International Trade Commission Report may have been partially motivated by the importance of United Steelworkers’ support for the President’s health care agenda. Nonetheless, it is important to consider that countervailable oil subsidies may have been grounds for increasing the tariff’s severity.

From a broader perspective of future U.S.-China environment and trade relations, it would be tremendously beneficial to both parties for China to liberalize domestic energy prices. Many Chinese officials recognize the considerable downsides to artificially low ceilings, including their effect on government spending, the environment, and energy efficiency. However, policymakers are also concerned with inflation and preventing mass unrest in the event of higher prices. The U.S. can help China resolve these issues, and in doing so bring China further into the global marketplace while removing the underlying cause of some of our trade disputes.

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