Having fallen below US$60 a barrel on November 11, the price of crude oil on international markets continued to drop. On November 21, the price of light crude oil futures for January delivery settled at US$49.93 a barrel on the New York Mercantile Exchange (NYMEX). In fact, the price of crude oil has dropped more than 60% from the record high of US$147.27 a barrel on July 11. With prices in free fall, the supply-demand balance in China’s oil product market also began to shift. According to oilgas.com.cn, the supply-demand ratio in domestic gasoline market has reached a balanced level of 19:10 since September, and the ratio of domestic diesel is now 16:10.
In addition, the continued fall of international oil prices also highlights the firmness of China’s domestic fuel prices. Regular gasoline pump prices in Toronto fell nearly 26% to CAD0.833 (US$0.693) per liter on November 15 from CAD1.128 (US$0.938) per liter two months earlier. US gasoline prices also closely followed the decline, with the average pump price falling to US$2.3 per gallon, which equaled RMB 4.15 (US$0.6) per liter according to the exchange rate on November 14. However, grade 93 (the most commonly consumed gasoline grade in China) was actually selling at RMB6.25 (US$0.91) per liter in Guangdong province - making Chinese gasoline 50.6% more expensive than its US counterpart.
Media reports in China claimed that authorities had drawn up three proposals aimed at lowering the retail price of oil products and the price cut plans were expected to go into effect by mid-November. However, the plan never materialized and the cuts have since been dismissed as mere rumors. Nevertheless, as international oil prices continue to slide and supply and demand for domestic fuel returns to normal, now is the best time to reshape China’s fuel pricing mechanism. Simple artificial price adjustments would only kill off such a great opportunity.
Reform of the domestic fuel pricing mechanism has actually been ongoing since 1998. However, after more than 10 years and despite numerous rounds of talks, little real progress has been achieved. According to government officials, the reason behind the difficulties in implementing price reform is a fear of continued high international oil prices, which could drive up local fuel prices and aggravate domestic inflation.
However, the current domestic prices of oil products are already higher than the international average. To put in place a market-oriented fuel pricing mechanism at this point would mean a downward correction of domestic oil prices. This would not only ease domestic inflation, but also significantly dampen the blow of such price-lowering reforms.
If the previous reluctance to reform stemmed from a fear of elevated international oil prices and domestic inflation, how can such reforms now be held back at a time when international oil prices have been halved and when there is such a strong demand to ease domestic inflationary pressure?
From a long-term perspective, the market-oriented reform in fuel pricing should be implemented urgently. Around the world, interest rate cuts by major central banks point directly towards a zero interest rate climate in the future. In a rare move on November 5, the Bank of England slashed its key interest rate by 1.5 percentage points to 3% - the lowest since 1955. On the same day, the European Central Bank decided to lower its benchmark interest rate by 50 basis points to 3.25%.
Economists predicted that the Bank of England needs to continue to cut interest rates aggressively - even down to zero - in the near future. It is also expected that the European Central Bank will cut key interest rate by another 50 basis points this December. Under such loose monetary policies, once market confidence is restored, a large amount of low-cost capital may flood into commodity markets once again, triggering another round of bull runs in international commodity prices.
As China, India, Brazil and other major developing countries speed up industrialization, an upward trend in the price of resources and materials could resume. Although the financial market kept tightening credit conditions, it’s not all doom and gloom as Dr. Henry Kissinger, former U.S. Secretary of State, recently pointed out that it’s no use for the banks to keep all their money. Once economic conditions improve and confidence returns, funds will scramble to find a way out. Money stays at a cost. Financial institutions can seek safe havens by hoarding large amounts of cash for a short period of time, but ever-increasing liquidity and earnings pressure will eventually drive these funds back into the real economy and commodity markets.
If, by this stage, the domestic fuel pricing mechanism has not been reformed, China will be once again locked in a situation where it gives huge subsidies to energy companies and still be prone to oil shortage and artificially high oil prices. According to Ha Jiming, Chief Economist at China International Capital Corporation Limited, the government’s implicit subsidies to oil companies alone exceeded RMB220 billion (US$32.1 billion) in 2007, accounting for 0.9% of China’s gross domestic product (GDP).
Based on current price levels of local oil products, if the international crude oil price reaches US$200 a barrel, 7% of China’s current GDP or more would be taken as subsidies. Based on China’s GDP in 2007 (RMB24.7 trillion, US$3.61 trillion), the subsidies needed would be as high as RMB1.73 trillion (US$253 billion). With China’s fiscal revenue totaling only RMB5.1 trillion (US$745 billion) in 2007, such amount of subsidies is clearly an overwhelming fiscal burden. In the first half of this year, a number of Asian countries, including India and Indonesia, were forced to raise oil product prices under increasing pressure from a huge amount of energy subsidies.
Therefore, as the international price of crude oil has fallen to the level of US$50 a barrel from the high of US$147.27 in July, coupled with the normalization of domestic oil supply and demand, fuel pricing reform in China now stands an excellent chance. It would not aggravate inflation and would effectively mitigate the negative effects on the domestic economy of future bull runs in commodity markets. If this moment is not an ideal time for market-oriented fuel pricing reform, then when is?
