SHANGHAI (Interfax-China) -- In the face of high inflation rates and an eventful year, China is unlikely to bring domestic pump prices in line with their higher international counterparts in the near future. Instead, if crude oil prices continue their bullish run, authorities are likely to continue adjusting fuel prices by small increments periodically, while subsidizing the worst hurt sectors, such as agriculture, fishing and transportation, and state-owned refiners that are producing oil products at a loss.
Under this scenario, the recent and future retail price adjustments will have no significant impact on China's robust oil demand. In fact, rather than curbing demand, the country may see a jump in crude imports in the coming months as higher retail prices offer an incentive for state-owned refineries to resume or increase fuel production.
Chinese refineries have been on the back foot in recent months. The country saw its crude refining volume in May fall by 1.1% year-on-year to 27.78 million tonnes, the first such fall in five years, as refiners tried to trim production to cut losses.
It should also be noted that even after the RMB 1,000 ($145.77) per tonne price hike, the biggest single price adjustment seen in the country in years, domestic fuel prices are still standing at levels significantly lower than those seen on international open markets.
The following table illustrates the differences in price between domestically produced fuel and that imported from Singapore before and after China's June 20 price hike.
Domestic and Imported Fuel Prices Before and After June Price Adjustment, 2008
Source: Guodu Securities
Note: Price of imported Singaporean fuel includes all relevant taxes and transport charges.
Despite this gap, imports are up and China became a net gasoline importer for the first time in May, with imports of 338,527 tonnes and exports of 160,000 tonnes. Though the country's urgent efforts to build its gasoline inventory for the impending Olympic Games undoubtedly contributed to this jump, analysts believe that the upward import trend will soon make the country an absolute gasoline importer, thanks to its ever growing car fleet.
At the same time, car owners from China's affluent middle class, the country's major gasoline consumers, are unlikely to cut back on car usage because of the recent pump price rise, equivalent to $0.95 per liter. Incomes are up, with average salaries in the country's financial and information technology sectors rising by 10.6% and 9.2% last year on the previous year, according to domestic professional salary research portal xinchou114.com.
The subsidies that the government usually provides to the agriculture, fishing and public transportation sectors in tandem with fuel price adjustments will also help maintain robust diesel demand. These sectors account for most of China's oil consumption, and diesel consumption outpaces that for gasoline by a wide margin.
Higher prices could divert some downstream demand towards alternative fuels, such as gas, but the country is also facing a significant shortage of gas. Retail prices for liquefied petroleum gas (LPG), which are relatively market-based in China, have staged rallies since late last year in line with international price spikes.
Other coal-based fuels, such as methanol and dimethyl ether (DME), still lack mature industry standards and distribution channels that would allow them to serve as gasoline and diesel alternatives. As prices for these fuels are pegged to domestic gasoline and diesel prices, there is also little financial incentive for their full-fledged development.
If crude oil prices maintain their strong performance in the latter half of this year, which seems likely with international investment banks predicting crude prices of above $150 per barrel by the year's end, calls of another round of fuel price adjustments will likely loom after the Olympic Games. Hoarding by state-owned and private wholesaling units in expectation of better prices would also likely occur again, leading to widespread domestic fuel shortages.
In this situation, Sinopec Group and China National Petroleum Corp. would again come under pressure from the central government to increase domestic supplies. As gestures that they are answering such calls, the two energy giants would increase fuel imports and return to full refinery runs, despite ongoing hoarding by their wholesaling subsidiaries. Such distortion would again add up to China's apparent oil demand.
What if China Liberalizes Fuel Prices?
However, in line with the gradual reform process China has pursued since the late 1970s, the country is expected to eventually adopt a more market-based fuel pricing scheme that would link retail prices to production costs and international prices. A timetable for such a shift, and the potential steps required, are still unclear, but the potential results are more easily grasped.
After the National Development and Reform Commission (NDRC) raised fuel prices in mid-June, benchmark domestic prices for gasoline and diesel reached RMB 6,980 ($1,011.59) per tonne and RMB 6,520 ($944.93) per tonne respectively. These prices left large gaps of around RMB 4,000 ($579.71) per tonne and RMB 5,000 ($724.64) per tonne respectively between domestic prices and their international counterparts.
This means that, should the government decide to implement a system that pegs domestic oil product prices against international market conditions, gasoline prices and diesel prices would likely rise by up to 58.02% and 78.74% on current levels.
It is hard to carry out an accurate quantitative test on the impact such a shift would have on China's oil demand. However, it seems likely that such a pricing system would significantly curb the country's oil demand, as hoarded product would be released and consumption would fall in the face of much higher prices. In this instance, crude oil demand would remain robust but fuel imports would plunge, as domestic refineries of all sizes would have enough incentive to produce oil products at full capacity.
Impact on Automobile Fuel Consumption
China's automobiles, from private cars to public busses, currently account for around 50% of the country's total oil product consumption, and this figure is growing. As a result, insights into the country's oil product situation can be gained by examining what impact any large increase in prices would have on automotive-based consumption.
The table below details oil product consumption by automobiles in China from 2005 to 2007.
Oil Product Consumption by Automobiles in China, 2005 to 2007
Source: Sinopec Economic and Technical Institute, National Bureau of Statistics (NBS)
As shown above, automobiles account for a significant proportion of oil product consumption in China. Over 80% of gasoline consumption in the country is attributable to automobiles, as well as around 40% of diesel consumption. Additionally, of the 159.8 million automobiles in the country at the end of 2007, 76.09% were owned by individual citizens, according to Ministry of Public Security statistics.
With most sedans and motorcycles fueled by gasoline, and most of China's automobiles owned by individual citizens, it is clear that the automotive activities of individual citizens account for a significant proportion of the country's gasoline consumption. This consumption would likely fall if pump prices rose by over 50%, as could be expected should the country change its pricing system.
Consumption attributable to corporate activity would also likely fall, and economic development slow on such a price rise. Many industries would also be affected, though the precise nature of the impact is difficult to gauge.
Impact on Alternative Energy Products
A number of alternative energy products are being developed globally, as well as in China, though the country's distorted energy market has provided insufficient financial incentives for their full commercial development. An increase in fuel prices would give impetus to develop mature industry standards and distribution channels for alternative fuel products, as well as providing the financial incentives and returns needed to develop related technologies and techniques. In turn, as more consumers turn to alternative energy sources, gasoline consumption would reduce further.
In 2002, China selected four companies to produce ethanol fuel from corn. However, fearing the costs of such development on food sources, the government banned in 2006 new ethanol fuel projects from going ahead that use corn as their raw material, and asked companies to develop new projects fed with non-grain materials.
Forced to compete with artificially low gasoline prices, the development of ethanol fuel in China has been less than successful. The Guangxi Zhuang Autonomous Region is the only region in China widely selling ethanol fuel at the moment, and is the only region to see a non-grain based ethanol fuel project start operation.
If gasoline prices were to rise suddenly and significantly, ethanol fuel would likely take off. Consumers would be drawn to it due to its lower cost, and gasoline consumption would likely decline.
Methanol fuel is being developed in some of China's coal-rich regions, including the provinces of Shanxi and Shaanxi, and the Inner Mongolia Autonomous Region, though a national standard has not yet been released. The government has expressed concerns over the fuel's toxicity, though its supporters say that it is no more toxic than any existing fuel on the market.
Methanol fuel producers need funds to solve technical issues relating to the fuel, and to undertake the work needed to turn it into a viable commercial option. They would likely benefit from an increase in domestic gasoline prices, and the resulting search for new fuel sources.
Also derived from coal, dimethyl ether is in the early stages of development as a replacement for diesel and LPG. The fuel is currently being trialed through a small number of projects around China.
Going off the current gap between domestic and international prices for diesel, which is larger than that for gasoline, dimethyl ether developers would have a lot to gain from a new pricing system for diesel that would bring it into line with international levels. With the promise of financial returns, developers could push the fuel strongly thanks to its cheaper production costs.
Just like dimethyl ether, coal-bed methane (CBM) has a long way to go before it can be considered a mature automotive fuel. There is great interest in the fuel, however. A Shanxi Province-based company is currently developing a transportation fleet fed by CBM, which is abundant in the province, but the results and potential financials of the fuel are still unclear.
CBM developers could be given some help from increased fuel prices, under which demand for cheaper fuel would grow alongside the potential financial rewards.
Key Variables for Chinese Oil Demand
Although an internationally-linked pricing system for oil products would likely curb China's oil demand, there are a few variables of that could support ongoing and strong oil product consumption.
China posted average daily gasoline demand of approximately 1.3 million barrels last year, compared to the 9 million barrels a day seen in the United States, according to a report by investment bank Lehman Brothers. The report foresees China overtaking the United States as the world's largest car market as early as 2017, and home to a car fleet of 300 million by 2024.
However, some experts have said that the Chinese government would likely move to prevent such growth from occurring, wary of the pressure the country's large population could bring on mounting environmental and pollution challenges with such a fleet of cars.
Continual economic growth is another key variable when assessing the country's energy future. Although the domestic economy is expected to slow this year and next, down from the double-digit growth rates seen in recent years, it is likely to maintain annual growth rates of at least 6% over the next five years, thereby promising strong energy demands in the near future, according to a report by the State Council's Research Center.
China's recent retail price hikes for gasoline and diesel, of 17% and 18% respectively, caused international crude oil prices to plunge by as much as $4 the following day, illustrating market concerns that higher fuel prices could curb demand from the world's second largest oil consumer, a key worry for producers in the midst of the current global economic slowdown.
Interfax finds, however, that periodic price adjustments are unlikely to curb the country's oil demand, as the state's tight grip on energy prices has created complexities that cannot be understood through the pure market principals of price or demand. In our opinion, only the establishment of a new pricing system, that brings domestic prices up and in line with those on the international market, is likely to alter the country's immense energy appetite.
(c) Interfax-China 2008. For more intelligence on Chinese metals and mining, contact David Harman in Hong Kong at firstname.lastname@example.org.