China Examines Its Oil Pricing Strategy

By  SEP 28, 2012 10:35 AM

In a boon to refiners, Chinese gas prices rise short-term as the government looks for better ways to work with Chinese oil companies and domestic consumers.


China raised fuel prices for the second time in a month last week, with a 6% hike in gasoline and a 6.5% hike in diesel fuel.

Retail gasoline prices at the pump were expected to rise to roughly the equivalent of $4.40 to $4.55 per gallon. The move was immediately seen as a boost to oil companies, which have experienced refining losses this year.

China Petroleum & Chemical (NYSE:SNP), or Sinopec—whose major business is refining—booked a $3 billion loss in its refining segment for the first half of this year. The same period the previous year saw a loss of about $2 billion.

Although Sinopec and other major oil companies in China—such as PetroChina (NYSE:PTR), which posted nearly a $5 billion refining loss—have remained overall profitable, the government’s fuel-price controls have inhibited the companies’ abilities to pass along input costs to end users.

The latest price increase would move fuel prices near their all-time high, which was reached in the early spring of this year. China’s government had been keeping the price down as a way of avoiding pressuring consumers economically, as fuel and food costs are a major part of consumer expenses. Beginning in late spring, the government cut fuel prices, and did so two more times by July.

Demand recently, however, has reached an almost two-year low, led downward by lower industrial demand due to the slowing economy. But the fuel-price increase may further push down consumer demand at the retail end for gasoline at the pump. Tracking Crude
China’s National Development and Reform Commission, or NDRC, uses a tracking formula that takes the 22-day moving average of an international basket of crude prices, including Brent Crude and Indonesia’s Cinta, and a greater than 4% change in this benchmark on crude triggers changes in the government’s pricing.

This is not strictly followed, however, as Beijing is sensitive to inflation and is reluctant to pressure the consumer at all, so sometimes the increases in the crude benchmark are not immediately turned into an increase at the pump.

Crude oil has seen a resurgence globally due to a series of things. The US economy has been edging up, or at least showing small intimations of this, and there has been optimism once again that Europe will make headway on its debt crisis.

Lately, the rise of instability in the Middle East—always a harbinger for higher crude prices—has reared up again. In addition to these developments, the bond-buying guarantees by the ECB function as a stimulus, and the just-announced new round of quantitative easing by the US Federal Reserve are indicators that crude prices may continue to rise.

There has been talk of China going to a system where the tracking would include West Texas Intermediate crude prices pegged on the New York futures, rather than Indonesia’s Cinta, along with changing to a ten-day moving average instead of a 22-day average.

This would cut some of the present lag time in the tracking procedure from when crude oil prices change until those changes are reflected in the adjusted fuel price. This would be seen as another means toward helping the refiners. A Complex Issue
Fuel prices are still controlled by the government, so the end-user prices still don’t fully reflect market conditions. Premier Wen Jiabao has said that the government may allow the CPI to rise by as much as 4%, where its current rate is about 2% now.

Ever wary of inflation for consumers, Beijing will likely offer subsidies, according to the official news agency Xinhua, if global crude oil prices continue to rise. The increases will help refiners some, but will not completely take away the pressure, as the Chinese majors are expected to continue to lose money in their refining segments.

So China has maintained its preferential option toward being more consumer-sensitive than oil company-sensitive on the fuel-price issue. But it is making some strides toward letting more of a market force dynamic trickle into its economy.

Editor's Note: This article was written by Jim Trippon of China Stock Digest.

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