China fuel hike shakes up markets
By Olivia Chung

HONG KONG - International oil prices fell, shares of Chinese petroleum-related companies jumped and many of the country's motorists rushed to fill up their tanks after Beijing's unexpectedly early decision on Thursday night to raise petrol and diesel prices by upwards of almost 17%.

More price hikes may follow in the next six to nine months as the increased prices still remain below international levels, analysts said. An increase had been expected after the Beijing Summer Olympic Games concluded in August.

The retail price for petrol was raised 16.7% to 6,980 yuan (US$1,014) a tonne, effective on Friday, by the National Development and Reform Commission (NDRC), which sets the

 

mainland's economic policy. The diesel price was raised by 18.1% to 6,520 yuan a tonne and the wholesale price of jet fuel was pushed up 25.2% to 7,450 yuan a tonne. Retail electricity prices were raised by 0.025 yuan per kilowatt-hour, except for northwest China's Xinjiang Uygur Autonomous Region and earthquake-hit areas, from July 1.

The increases came after international crude oil had soared to record price levels since Beijing last raised fuel prices, by 9% to 10%, last November 1. The combination of the rising cost of crude and government-imposed limits on the prices of retail products had squeezed profit margins of refiners such as state-run China Petroleum & Chemical Corp (Sinopec), leading to reduced output from refineries and shortages of fuel in the mainland, the world's second-biggest consumer of oil.

The NDRC said its decision was aimed at ensuring domestic supply and eventually "normalizing" the gasoline/diesel price. "Due to the sharp rise in international oil prices, some refineries had to be shut down, with queues at petrol stations and rationing re-emerging in some regions," the NDRC said on its website. "Appropriate increases in fuel prices will help raise supply and promote energy conservation," it said.

Sinopec, Asia's largest oil refiner, jumped as much as 5.9% to HK$8.46 on the Hong Kong bourse, before closing up about 1.13% at HK$8.08 on Friday. Oil producer and refiner PetroChina gained 1.55% to HK$10.46.

The increases could add further to inflationary pressures in the country, which Beijing earlier sought to mitigate by capping as of June 19 the wholesale price of coal, a key fuel for power generation. The government also pledged to subsidize vulnerable groups. That will cost the government an additional 19.8 billion yuan in subsidies, with 12 billion yuan going to the fishing, forestry, public transport and taxi sectors and 7.8 billion yuan given to farmers, Beijing announced on Friday.

A 10% increase in the diesel price should raise China's headline consumer price index (CPI) by about 0.4 percentage points, Frank Gong, an economist at JP Morgan, said, while "the electricity price hike is expected to influence the CPI by around 0.3-0.5 percentage points".

Before the price increases, June CPI was expected to show a 7.3% gain this month and in July a 6.4% rise, Gong said. June and July CPI inflation "is still expected to be less than 8% and thereafter it should still trend downward and more price liberalization/hikes should be down the road," Gong wrote in a note.

The fuel price rise, while adding to pressures to increase energy efficiency, may boost inflation by as much as 1 percentage point this year, Bloomberg reported, citing a survey of seven economists. The survey's bottom estimate suggested a 0.13 percentage point boost.

Yi Xianrong, finance researcher with the Institute of Finance and Banking under the Chinese Academy of Social Sciences, said the increase, although adding to inflation, is a rational move as the government needed to balance market pressures. He declined to quantify the impact of the price hikes on the CPI.

In Hong Kong, Lian Ping, chief economist of the Bank of Communications, said in an interview with ET Net that the price hikes are likely to directly push CPI up by another 0.2%, but their indirect impact on inflation is hard to estimate at this stage.

Lian’s estimation is based on an earlier study by Bank of Communications that concludes that even if domestic oil prices reach the international level, China’s CPI would only go up by one percentage point as oil prices do not weigh heavily in the CPI. The average price increase for oil products this time is just 8% and given various subsidies to offset the influence, therefore, the direct impact on CPI should not be very big, Lian said.

However, production costs for  industries and enterprises that do not qualify for government subsidies will inevitably go up, and they will have to increase prices of their products, with the impact on the CPI showing up later in the year.

China Aluminum, China’s largest aluminum producer and listed in Shanghai and Hong Kong, immediately announced that it may have to raise prices this year on the back of the electricity price rise, supporting the view of some analysts that the fuel price increase makes Beijing’s target to control CPI under 4.8% for the whole of this year almost a "mission impossible".

Inflation eased to 7.7% last month from 8.5% in April after hitting 8.7% in February, and the government action demonstrates its confidence that inflation is less of an issue now, Jun Ma, chief economist from Deutsche Bank Hong Kong, wrote in a research note. The resulting easing of the power and oil shortages should also be positive for the normal operation of the economy and reduce uncertainties for firms' operating environment, he wrote.

The fuel price increases may, on the other hand, help ease those pressures in other countries, including in the US, if they reduce mainland consumption of fuel. International oil prices fell sharply after the Chinese government announcement, with crude oil futures in New York falling 2% to US$133.97 a barrel by 11.30 pm (Hong Kong time) on Thursday, and falling further to $132.50 on Friday afternoon.

Beijing's decision to increase fuel prices comes two days before oil suppliers and consumers meet in Saudi Arabia to discuss the 94% jump in crude oil prices in the past 12 months and in the same week that  US Treasury Secretary Henry Paulson met Chinese officials as part of a regular dialogue between the two countries.

The sudden oil-price announcement by the NDRC late on Thursday prompted speculation that Beijing had yielded to Washington’s pressure. In the just-closed fourth round of Sino-US Strategic Economic Dialogue, the US pressed China to increase prices of oil products. Zhang Xiaoqing, NDRC’s deputy director, who participated in the SED, told Chinese media that China would deal "extremely prudently" with the issue. China will not change the direction of linking domestic oil prices to international ones, but the key to adjust prices "is to choose the proper time and take proper measures", he said.

The net impact on the overall Hong Kong share market should be positive, according to Ma. The total market cap of key winners, including China's leading oil companies Sinopec and PetroChina and independent power producers within the Hang Seng China Enterprises Index, amount to about US$570 billion, "much bigger that that of losers at $200 billion (including coal, aluminum, expressways, and airlines)," he wrote. Shenhua Energy Corp, the mainland's largest coal producer, slid 4.3% to HK$31.30 on Friday. China Southern Airlines, which has been assigned by regulators to launch direct flights to Taiwan, dropped about 6.27% to HK$3.44. In Shanghai, Eastern Airlines declined 3.82% to 6.29 yuan.

The Shanghai Composite Index, which at one point was up more than 5% in late morning trading in reaction to the news, gave up some of the early gains to close up only 3.01% at 2,831.78. Analysts said investors came to see the oil-price increases were not enough to boost substantially the profitability of listed oil companies and did not indicate an easing of the government's macro-economic controls or of its determination to fight inflation.

CPI inflation could fall to about 6% in the second half of the year and this "will provide a further opportunity for the government to increase oil prices and power tariffs for the second time this year", Ma wrote.

In Shanghai, long queues formed at many filling stations on Thursday night in the hope of getting oil before midnight. A driver waiting outside a gas station complained the oil prices were so high that it was not cost effective to keep a car. Before long, some filling stations were posting "No Fuel" signs. Even so, China's motorists will still be paying about 25% to a third less than their counterparts in the US and India, and JP Morgan expects more energy price rises to come.

Gong, at JP Morgan, said the NDRC made it clear that China's goal is to eventually "normalize" gasoline/diesel prices, which this means full liberalization down the road. "We expected this to happen within the next six to nine months," he wrote in his research note on Friday.

Brynjar Eirik Bustnes, analyst at JP Morgan, estimated about two more energy price hikes are needed to help refiners in China to become profitable from loss-making as the energy price rise is not enough to create a profitable refining environment for them.

"Refining is still hugely loss-making. We estimate that we need close to two more of these price hikes in the current environment to get into a price framework which is profitable to refiners in China," he wrote.

Olivia Chung is a senior Asia Times Online reporter.

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