Priced for the market

Zhang Jiansheng, a Beijing taxi driver, recently got a surprise when he refueled his car. He found that the price of gasoline had dropped at some gas stations.

"In the past, price hikes or drops at gas stations were changed only after the government announced a price adjustment, but recently the government didn't announce such an adjustment," Zhang said.

In China, the government sets prices for refined oil. The recent price adjustment in Beijing was made at midnight on October 7. After the adjustment, the cost of 93-octane and 97-octane gasoline stood at 6.37 yuan ($0.93) and 6.78 yuan ($0.99) per liter, respectively.

Zhang said some gas stations that have reduced their gas prices are either privately owned or have foreign investors, and their gasoline price is about 8 percent cheaper than those set by the government. So far, the National Development and Reform Commission (NDRC), which sets oil prices, has not intervened. On the other hand, most state-owned gas stations keep their prices at the government-set level. Zhang said he now only buys from filling stations that have reduced their prices.

Hou Hui, an analyst at the Research Institute of Economics and Technology of the China Petrochemical Corp. (Sinopec), believes that all gas stations could decide their own prices in the near future, because related government departments are ready to reform the country's pricing system for refined oil. The government has completed preliminary research on market conditions and the time to initiate the reform. Hou said the reform would fare well in the present market environment.

At the Energy and Finance World Forum in Beijing on November 3, Dong Xiucheng, a professor at the China Petroleum University, said that the present financial crisis would compel China to launch a new pricing system for refined oil. He believes that under the new scheme, prices should be adjusted more frequently, and enterprises should have more power to set their own prices.

The invisible hand

Not only in Beijing, but also in Wuhan, Tianjin, Jinan, Hangzhou, Xiamen and Xi'an, privately owned gas stations have been reducing their gasoline prices. Faced with the pressure of price reductions at these gas stations, the country's two national oil magnates, China National Petroleum Corp. (CNPC) and Sinopec lowered prices by 5 percent at their gas stations in Kunming and Hangzhou on November 9.

Why did the gas stations decide to lower prices? Dong believes that they reduced their prices to meet market changes. The price of crude oil on the international market dropped to $59.33 per barrel on November 13 from its peak of $147 per barrel this summer, reducing the costs of refined oil on the domestic market, so that wholesale prices plummeted, he said.

At present, the wholesale price of diesel oil in China is 6,000 yuan ($878) per ton, while the retail price is 7,000 yuan ($1,024.89) per ton. The wholesale price of 93-octane gasoline is between 7,000 yuan and 7,200 yuan ($1,054) per ton and the retail price is above 8,000 yuan ($1,171.3) per ton. Refineries in some places such as Shandong Province have lowered the wholesale price of gasoline and diesel oil to about 5,000 yuan ($732.06) per ton. Because the wholesale prices of refined oil have dropped sharply while the retail prices have remained the same, gas stations are making handsome profits.

Dong said oil prices on the domestic market now have surpassed those on the international market, and calls abound for reducing the price of refined oil so that domestic oil prices can be linked with the international market. Under such circumstances, private gas stations have decided to lower prices to attract more customers.

A comparison of oil prices in Singapore and China's Guangdong Province indicates that since October, the price of each ton of oil in Guangdong has been 1,000 yuan ($146.41) more than that in Singapore.

Far from market-oriented

In 2001, China set the principle of pegging domestic prices for refined oil to the weighted average of refined oil prices in New York, Singapore and Rotterdam. When international oil prices fluctuated 5-8 percent, domestic oil prices would not change; but if the fluctuations were greater than this, the NDRC would adjust the benchmark retail price.

According to statistics released by CBI (Shanghai) Co. Ltd., an integrated bulk commodity service provider, in the natural month between September 29 and October 28, the weighted average price of crude oil in Brent, Minas and Dubai stood at $76.61 per barrel. Considering freight, processing costs and other costs, the ex-factory price of gasoline after tax in China was 5,586 yuan ($817.86) per ton and that of diesel oil was 5,380 yuan ($787.7) per ton. If Sinopec links its floating, national average ex-factory prices of gasoline and diesel to the international market, then the domestic prices for gasoline and diesel oil still permit leeway for price reductions of 898 yuan ($131.48) per ton and 692 yuan ($101.32) per ton, respectively, in theory.

While taxi driver Zhang said he knew nothing about the formulation of domestic oil prices or the calculation of the weighted average, there was one thing that puzzled him: In 2006 when international oil prices were lower than $60 per barrel, the retail price of 93-octane gasoline in China was 3.97 yuan ($0.58) per liter. Now that international oil prices are less than $60 per barrel, the retail price of 93-octane gasoline in China is 6.37 yuan ($0.93) per liter. So why is there such a large gap? Obviously, there is still room for oil price reductions in China, Zhang said.

Right time to reform

Domestic oil prices that are divorced from the international market have made the pricing system reform of refined oil become a hot topic in China again. An official at the NDRC's Office of Policy Studies, who asked to remain anonymous because the reform issue is a sensitive one, told Beijing Review that the commission and other related ministries have been researching the reform of the refined oil pricing system. They have completed their preparations and are waiting for the right opportunity, the official said.

Most of the reform participants believe that the first half of next year may be a good time to launch the reform. During this time international oil prices will not increase sharply, and the risk of linking domestic oil prices to the international market will be minimal, the official said.

"When international oil prices rise sharply, oil companies insist on linking domestic oil prices to the international market; when international oil prices drop sharply, consumers insist on linking domestic oil prices to the international market," the NDRC official said. "But in terms of the reform of the refined oil pricing system, we consider it more for the consumers."

Dong said he believes that now it is the right time to carry out the reform. When international oil prices are less than $70 a barrel, China will be able to smoothly carry out the reform, because once the country links its oil prices to the international market, they will decrease, not increase, he said.

The present pricing system set by the NDRC has many problems, Dong said, the biggest of which is the lag in the adjustment of oil prices. The NDRC adjusts domestic oil prices months or even half a year after fluctuations in international oil prices. The lag in setting new prices brings large recessive costs to society. When international oil prices rise and domestic oil prices cannot catch up, suppliers of refined oil lose money. On the other hand, when international oil prices drop but domestic oil prices are high, consumers are unhappy. Therefore, the government should seize the present opportunity to reform the pricing system of refined oil at an early date, Dong said.

Reform with caution

Zhou Dadi, Director of the Energy Research Institute at the NDRC, believes that the key point of the reform of China's refined oil pricing system is to establish a complete set of mechanisms so that the domestic market can withstand both a drop in refined oil prices after international oil prices fall and a price hike in refined oil prices after international oil prices rise. After the government launches the reform, it should reformulate its fuel tax policies so that taxes will be collected on the consumption of oil. China does not levy fuel taxes at present, but there have been calls for such taxes for a long time.

Qi Fang, Vice Chairman of the China Chamber of Commerce for Petroleum Industry, said that when the government reforms the pricing system of refined oil, it also must straighten out its management of the oil market.

In China's oil market, CNPC and Sinopec constitute a duopoly, and private oil companies have to buy refined oil from the two magnates at wholesale prices. At present, there are 80,000 private oil companies, but the number of private oil refineries is only about 100 and their annual refining capacity stands at 10 million tons. Since 2001, private oil companies have been running short of refined oil.

Qi said private oil companies need more security to ensure they can get enough refined oil at reasonable wholesale prices and then ensure fair competition on the petroleum retail market. If the government does not properly resolve this issue when it sets its oil-pricing reform policy, private oil companies may face more difficulties of survival as a result of tougher price competition, he said.