Beijing’s oil angst

You have to feel sorry for the Chinese leadership. Just as officials were hoping that this year’s surge in the price of pork, eggs and grain was receding, oil prices leapt up to US$100-a-barrel level.

For your portly correspondent, rising food prices is largely a personal issue: No one likes a scrawny serpent. But for those running the country, rising prices are a pressing political concern. With consumers being forced to pay more for their daily staples, the government had promised not to increase fuel prices before the end of the year.

Beijing holds down oil costs to ensure gas station prices remain stable and affordable, which it views as essential for maintaining social stability. But the spike in global oil prices forced the government to raise prices by nearly 10% – an embarrassing U-turn for a regime that has staked its credibility on helping the poorer sections of society. It is now feared that rising fuel prices will help to stoke widespread inflation, compounding the problem of high food prices.

The sudden change in government policy was precipitated by widespread fuel shortages after many smaller refiners, unable to bear the gap between international crude prices and domestic prices for refined fuel, shut down production.

State-owned giants PetroChina and Sinopec, which account for 85% of domestic refining capacity, were able to bear the losses thanks to profits from upstream oil production and state compensation for selling fuel at artificially low prices.

However, there are signs that, as the cost of offsetting global oil prices grows, Beijing is becoming impatient with subsidizing the domestic oil giants. It was a viable practice when the cost of imported oil was low and large Chinese oilfields such as Daqing provided the majority of the country’s supply. But this year, for the first time, China will import more oil than it produces.

With annual oil demand matching GDP growth and crude prices approaching record highs, the policy is no longer sustainable. Price liberalization – letting the market set the price of domestic fuel – seems to be the only economic solution.

The problem, of course, is political. A sudden and sharp increase in fuel prices, in a country long insulated from international price fluctuations, would represent a genuine threat to public order and to the Communist Party’s authority.

Price deregulation, when it comes, will have to be introduced incrementally. Your correspondent’s sources tell him that refiners will likely be given a wider price band, allowing refined fuel to be sold at 3% either side of state prices. This band could then be widened even further over time, eventually giving refiners the freedom to set their own prices.

Areas of the population hit particularly hard by price increases, such as farmers and taxi drivers, could receive targeted subsidies – a much more efficient use of public money than subsidizing the entire population.

Letting the market set the price of fuel would also prove a vital step forward in helping the government reach its much vaunted – but consistently missed – energy intensity targets. Under the 11th Five-Year Plan, Beijing has committed itself to reducing the energy use per unit of GDP by 20% come 2010.

As with water and electricity, rare commodities for which prices are also controlled by state fiat in the interest of social stability, consumers cannot be expected to cut down on oil consumption until they are required to pay the full market cost for it.