China fuel price reform starts but where does it end?

BEIJING: As China's long-awaited shift to a new fuel pricing regime took effect yesterday, the biggest question of all remained unanswered - will Beijing really allow pump prices to move with the market?

For the moment the question is moot. Crude oil prices have stabilised on either side of US$40 (US$1 = RM3.46) a barrel since China cut petroleum prices by 14 per cent and diesel by 18 per cent two weeks ago, knocking them roughly into line with global rates.

But further crude oil losses or a rally back to US$50 will put China's policy to the test.

Even after a month of debate, analysts say they're not much clearer on how often China's motorists could see price increases, or how stable profits will be for oil refiners Sinopec and PetroChina.

Those are key questions for a world oil market that will be looking closely for any signs that demand growth is slowing even further in the world's second-largest oil consumer, whose policy of subsidising fuel prices had sharpened its motorists' demand.

"The effectiveness of fuel pricing will only show up when oil prices change," said Yang Fuqiang, former vice president of US Energy Foundation, an energy consultancy.

"The reform package is a small step forward and may prove to be only transitional."

The core of the scheme is clear enough: a sharp rise in consumption taxes will replace road tolls and other charges in an effort to better match the cost of fuel with its use; a revised pricing scheme with a hard cap on retail rates should guarantee a lower but stable profit for refiners.

But hopes that China might fully liberate prices - allowing them to be set by the market or by a transparent, market-based mechanism - were dashed, suggesting policymakers remain skittish about the idea of a liberalised market despite promising for years to encourage energy efficiency and deter wasteful use.

In announcing the overhaul two weeks ago, Beijing said it would change the ceiling price "when changes in international oil prices exceed a certain level for a certain period of time". The government did not disclose either the level or the period.

The National Development and Reform Commission (NDRC), which sets energy policy and fuel prices, said that from January 1 it would follow a formula based on crude prices, processing costs, taxes and reasonable profits.

The formula is similar to one it established in 2006 - and subsequently almost completely ignored.

As oil rallied to a succession of record highs since 2003 China's fuel prices rarely budged, with policymakers anxious to avoid stoking inflation or stirring social unrest.

Such ambiguities have left the market wondering what the government's plan really is, whether it would be seriously implemented this time, and how it would help avoid the kind of shortages that have hurt the economy and consumers in years past, when refiners facing crippling losses cut back sales.

"Observations are best made when oil prices rally," said Qiu Xiaofeng, an oil analyst with China Merchants Securities.

"We do not know every detail including the level and period of crude price changes that the government's decision are based on, nor do we know the frequency of fuel price adjustment that might have been determined."

"Let's wait and see how things go to and find a clue to how the reform is implemented," Qiu said.

For now, motorists are seeing some benefits of lower prices and the competition that comes with them. - Reuters