China Lifts Fuel Prices to New Highs

Price Hike

China's economic planning agency the National Development and Reform Commission (NDRC) has raised fuel prices for the first time in two months, taking prices to new highs. China raised gasoline and diesel prices by 480 yuan/t on 9 November. The NDRC said the price rise was equivalent to 0.36 yuan/litre on 90-ron gasoline and 0.41 yuan/litre on 0# diesel. Jet fuel prices were also raised by 300 yuan/t. The price adjustment was the eighth since the new fuel price mechanism was introduced in December 2008 and took fuel prices in China to around US$3.31/gallon compared to around US$2.68/gallon in the United States.

The fuel price rise demonstrates that the government continues to support the new fuel pricing mechanism despite delays to the recent adjustment, which led to reports by the local press in Beijing, the capital, that the government had "cancelled" the price rise. The fuel price hike was partially prompted by gains in international crude oil prices that have jumped from around US$67/b in late September, when China last adjusted fuel prices, to a current level of just under US$80/b. However, the government has not been rigidly enforcing the fuel price mechanism, under which domestic gasoline (petrol) and diesel price adjustments should be triggered if the moving average of benchmarked international oil prices for 22 days changes by more than 4% from the previous price-setting level. The week-long holiday in October could have had an impact on the timing of the current fuel price adjustment although the NDRC's statement that the domestic economic situation, the refined oil market supply and demand situation, and the capacity of downstream users were all considered before implementing the fuel price adjustment suggests that the administration was careful to weigh up the broader economic and social implications of the fuel price rise before introducing the hike (see China: 9 November 2009: NDRC Hesitates to Implement Fuel Price Rise in China).

One factor prompting the fuel price rise was to the need to shore up earnings of domestic refiners, in particular Sinopec and PetroChina, the two leading refiners in the domestic market. Over the third quarter Sinopec's refining margins tumbled to US$5.20/b from US$9.20/b in the second quarter and the company posted a loss in its refining business in September and October, likely due to differentials between international crude oil prices and domestic fuel prices. For Sinopec, which is heavily reliant on imported crude oil for its downstream operations, these pricing disparities make it particularly vulnerable to financial losses. Indeed, between 2005 and 2008, before the new fuel price mechanism was introduced, Sinopec operated a loss-making refining sector, which also affected domestic supply security as regulated fuel retail prices led to frequent shortages as refiners sometimes lacked the financial capacity to continue selling fuel in the domestic market at a loss. The government is at pains to avoid oil product shortages in the future, particularly given the need to nurture the economy following the global financial crisis that hit China at the end of last year. The fuel price increase will help ensure margins for refiners, particularly as crude oil prices for Brent, Dubai, and Cinta crude (which make up the weighted average price of the three benchmarked international crude oil indices under the mechanism) are still hovering just below US$80/b, suggesting that refining profits are still at the higher level of approximately 5% of the crude oil cost. Reports suggest the government has raised ex-refinery prices of gasoline by 7% to 7,100 yuan/t and the diesel price by 8% to 6,340 yuan/t, while ex-refinery jet fuel prices will rise 7% to 5,190 yuan/t. The ex-refinery price rise will boost revenues and earnings for Sinopec and PetroChina, which are needed in the context of large investments in new refining and petrochemical facilities. Sinopec is now likely to return to profit on fuel sales in the fourth quarter while the increase in ex-refinery prices will give both companies incentives to increase supplies to the domestic market, particularly as the new system puts in place margins for wholesalers and retailers helping to ensure benefits are cascaded down the supply chain.

The government may have gone ahead with the fuel price rise as inflationary concerns have receded somewhat following the global economic slowdown. China's consumer price index (CPI) has declined 1.1% year-on-year (y/y) in the first nine months of this year and China's producer price index (PPI), a measure of inflation at the wholesale level, also decreased 6.5% y/y in the same time period. The fuel price rise was above expectations of a 350-yuan/t increase, suggesting the government believes inflation is under control. Indeed, the government predicts that the fuel price increase will lift November's CPI by 0.12 percentage points, which the government believes will not pose any significant inflationary risk.

Outlook and Implications

The fuel price hike will raise costs for manufacturers, airlines, automobile owners, and other consumers, particularly in Beijing, Chengdu, and Kunming, who are most likely to feel the effects of the raise as retail price ceilings are highest in these areas. However, under the new fuel price mechanism the retail price incorporates road tolls, which were charged separately before, helping to keep costs down for motorists. The setting of retail ceiling prices under the new mechanism, which prohibits prices from rising above the mandated level but allows retailers to set prices below ceiling levels if they choose to do so, could also help mitigate the impact on consumers.

Furthermore, the NDRC has been careful to ensure that fuel price hikes are accompanied by additional measures to protect vulnerable consumers. In its statement, the NDRC emphasised that the government would continue to provide subsidies for select consumer groups to offset increased expenses as a result of the price hike. Given that the ex-refinery prices are above 5,480 yuan/t for gasoline and 5,070 yuan/t for diesel, the central government treasury will fully subsidise two groups of consumers for price differentials above these levels. These consumers include fisheries in coastal and inland waters, state-owned forestry and tree nurseries, and urban public transportation as well as rural road passenger transport. Other consumers such as tax drivers, which have in the past protested against fuel price hikes are being supported by local governments that will either raise taxi fares or collect fuel surcharges to ease the impacts of the fuel price hike with temporary subsidies to be provided in the meantime. Despite the cost of these subsidies and other forms of support overall, the new fuel price system has helped the government to reduce its subsidy burden, as they are now only provided for selected consumers.