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ON June 19, the National Development and Reform Commission (NDRC) announced that prices for petrol and diesel would rise by RMB 1,000 per ton the following day. Liu Su was driving to his suburban home when he heard the news on the radio. He immediately headed for the nearest gas station, but a long line of cars had already formed when he arrived.

The increase saw prices at petrol pumps go up by more than half a yuan per liter for all grades of fuel. Liu Su drives a Bora Volkswagen with a 1.6-liter engine. The car consumes around 10 liters for every 100 kilometers traveled, amounting to an extra RMB 2,000 annually that Liu needs to now spend on petrol. “Petroleum expenses already account for about 12 percent of my annual spending,” he sighs. “Not to mention maintenance fees and fines for occasional traffic violations.”

Why Are Petrol Prices Rising?

The NDRCs announcement represented the biggest petrol price hike for several years. In the statement announcing the increase, the commission pointed out that the international price of oil has spiked recently, while domestic oil prices have remained too low. Enterprises importing crude oil have had to bear big losses.

“The government outlays a huge amount in subsidizing refined oil domestically, especially since energy prices on the world market have shot up,” says Wu Ying, a researcher with Guodu Securities. He claims domestic plants lose RMB 1,600 to 1,800 on every ton of refined oil they produce. With world oil prices rising, figures for the first quarter of 2008 indicated the government was going to have to spend RMB 150 billion in subsidies this year if domestic prices were not adjusted. “The government had no choice, but to increase the price,” says Wu.

Domestic petrol prices rose by RMB 500 per ton last November, which along with the June increase saw prices at petrol pumps jump by 16 to 18 percent in little over half a year — much higher than forecast. This reflects a sharp jump in international petroleum prices, which have doubled in 12 months.

Wu attributes the dramatic rise internationally to many complicated factors. U.S. foreign policy has contributed to instability within oil exporting nations such as Iraq, Iran, Venezuela and Sudan, and generated tension between these countries and the U.S. As a result global oil output has not been stable. In addition, petroleum trade is commonly conducted in U.S. dollars, but the currency has experienced a sharp drop lately, due to the sub-prime mortgage crisis. Oil-producing countries have had to raise prices simply to maintain profits. Rising demand in the West and booming economies in certain developing nations, notably China, have meant global demand for oil has risen sharply alongside declining supplies.

However, speculators have contributed most to price hikes, says Chen Naixing, a researcher at the Institute of Industrial Economics with the Chinese Academy of Social Sciences. To avoid losses incurred by the falling U.S. dollar, they have invested heavily in gold and oil futures, driving up the prices of these commodities.

Limited Influence on CPI

Chinese people are not just paying more for petrol. The price of everything from rice and vegetables to manufactured commodities has spiked since the end of 2007, placing considerable pressure on ordinary Chinese households. In the first five months of 2008, the average inflation rate was 8.1 percent. Are these inflationary pressures fueled by the rising price of oil? And how are rising prices affecting Chinese indutry?

“As an upstream product, oil has an obvious influence on the PPI (producer price index), and that will feed into the CPI (consumer price index),” explains Han Wenke, deputy director of the Energy Research Institute of the NDRC. However, he believes the recent petrol price adjustment will have a limited effect on Chinas CPI, pushing it up by 0.5 percent at most. “Although petrol prices have gone up, the government provides heavy fiscal subsidies to urban public transport, including taxis, and passenger transport in the countryside.” Consequently, higher petrol prices will have little impact on agriculture and transportation, which account for 30 and 17 percent, respectively, of the CPI.

In fact Wu Ying believes the domestic price of petroleum still has room to rise, given the present international oil price of around US $140 a barrel. “The price of refined oil could rise by RMB 2,000 to 3,000 per ton,” he argues. “If the CPI continues to hover between 7 and 7.5 percent over the next two to three months, the possibility of another adjustment cannot be excluded.”

“The adjustment will also encourage energy saving and the reduction of emissions,” says Chen Naixing. In a recent online survey more than half the respondents said they will use their cars less to save energy and money. In addition, 57.6 percent of respondents claimed they had postponed future car buying plans in response to rising prices. If they did buy, they expressed a preference for cars with lower emissions.

In addition, high energy consuming, high emission and high polluting industries will probably be pushed to either cease production or increase their efficiency, says Chen, as costs rise and fiscal subsidies for heavily polluting industries fall. In this way, it is hoped the price hike will push Chinese industry onto the path of sustainable development.

Reforming the Petrol

Pricing Mechanism

Researcher Wu Ying regards the petrol price rises as part of the long-term reform of Chinas pricing system, which he argues is necessary to guarantee future supplies. Its rapidly expanding economy has placed China second only to the U.S. in terms of oil consumption. However, the country relies on imports for around half of its crude — in 2007 the figure reached 52.3 percent. The International Energy Agency (IEA) forecasts Chinas demand for oil products will increase by 5.6 percent this year, requiring 7.96 million barrels a day. Given this level of demand, reform of the domestic pricing system is vital for Chinas future economic health, says Wu.

The country has experienced three reforms of the refined oil pricing system since 1998. Authorities are gradually moving toward a market-determined pricing system based on the price of crude oil plus costs, directly linking the retail price of oil products with the cost of Brent crude and prices in oil-producing centers like Dubai and Minas.

This will inevitably see petrol prices rise, which is why the NDRC slowed down the pace of reform in 2007 in an attempt to rein in the soaring CPI. As a result, compared to the skyrocketing price of crude worldwide, the hikes in China have been comparatively small.

Continued moves towards a market-driven pricing structure are inevitable however, and Chinese consumers can expect petrol prices to fluctuate more frequently in the future, in line with international price shifts. “A market-oriented pricing system requires many conditions, including consideration of whether consumers can afford it, a competitive domestic market, a structure for governmental supervision, and tax regulation,” says Chen Naixing. He admits conditions in China remain immature, but says the country is moving in the right direction. Market-determined prices are an inescapable part of Chinas integration with the world market, he adds.