Tuesday 9 December 2008
Beijing’s fuel reform compromise still begs questions
Beijing has finally unveiled its long-awaited proposed reform of the retail fuel price-setting mechanism, but hopes that oil refiners will enjoy guaranteed profit margins remain elusive as the government has stated clearly that it holds ultimate control on prices.
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Beijing’s fuel reform compromise still begs questions
Eric Ng
8 December 2008
Beijing has finally unveiled its long-awaited proposed reform of the retail fuel price-setting mechanism, but hopes that oil refiners will enjoy guaranteed profit margins remain elusive as the government has stated clearly that it holds ultimate control on prices.
In addition to a lack of mention of allowable refining margins, previously rumoured details about the degree of control it plans to exert on fuel prices were also left out.
“Yes, it has proposed a cost-plus formula to calculate retail prices by adding refining costs, taxes and reasonable earnings to international crude oil prices,” said CLSA head of China energy research Gordon Kwan. “But what is ‘reasonable’?”
Indeed, last Friday’s announcement on the price setting mechanism reform has largely been foreshadowed by previous media and analysts’ reports and is in line with a proposal made years before.
“This is actually the current and most recent ‘formula’ stated by the National Development and Reform Commission, albeit never implemented as crude oil prices increased over the last few years,” wrote JP Morgan analyst Brynjar Bustnes in a research note.
To the government’s credit, although the NDRC said the state would continue to retain “suitable price regulation”, the new system will give some transparency as to how prices are formed and theoretically give it greater linkage to international oil prices.
However, as no definition was given to the word “suitable”, the degree of liberalisation will only be known in practice, when it is launched on January 1 after a one-week public consultation, especially if oil prices soar again to levels Beijing feels may threaten social stability if fully passed on to consumers.
Indeed, similar reforms had already been made as far back as October 2001, when domestic refined fuel prices were benchmarked to the weighted average prices in New York, Singapore and Rotterdam with a one-month time lag, and an 8 per cent fluctuation band allowed on either side of the benchmark.
The fluctuation band has been cut to 4 per cent in the proposed reform.
Such a system was aimed at providing transparency on price setting, which however was meaningless in periods when it was overridden by government price controls.
“We will still consider this new pricing regime controlled,” wrote Mr. Bustnes. “However, we refer to it as deregulated [and dynamic] compared with the current static pricing scheme.”
It remains unknown whether Beijing will later refine and provide more details on implementation of the proposed system, to give the market more comfort that it will reduce unpredictable fuel price meddling.
Less unexpected intervention would help reduce inefficiencies such as speculative trading by intermediaries and consumers queueing at fuel stations, which happen frequently as mainlanders second-guess government pricing moves.
The implementation details could include possible scenarios floated in a Shanghai Securities News report last month, which quoted industry sources as saying Beijing planned to fully link domestic prices with international ones when oil fetched less than US$80 a barrel.
At crude prices of between US$80 and US$130, refiners would be allowed an unspecified profit margin, while price-setting would be left to the government at prices beyond US$130.
To prevent price shocks, a caveat planned would limit price adjustment in any one month to 800 yuan (HK$902) per tonne and 1,600 yuan in any three-month period, the report said.
Given Beijing has clearly specified it will retain “suitable price regulation” on such a politically and socially sensitive matter, it may not want to be tied down by clear-cut commitments, but rather keep these as possible implementation guidelines.
Last Friday’s announcement said the proposed new system would allow “controlled, indirect” linkage of domestic fuel prices to international levels. It would also reflect scarcity of resources, society’s affordability, as well as energy conservation and environment protection promotion, it added.
While some of these sound in conflict with one another, the system, although on paper not much more liberalised than the existing one, is probably the best compromise Beijing could offer.
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