China Cuts Fuel Prices to Boost Growth

Sectors:Oil and Gas
By: Reuters | 18 Dec 2008 | 11:13 PM ET
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China will cut domestic fuel prices on Friday for the first time in almost two years as it revamps its regulated pricing regime, passing along a share of oil's over $100 slump to help revive flagging economic growth.

Crude oil gained moderately after Beijing announced a 14 percent cut in refinery gate gasoline prices and 18 percent drop in diesel prices, plus a nearly one-third cut in jet fuel.

The cuts were not unexpected after China announced last month that it would push ahead a long-stalled effort to allow its domestic prices to fluctuate in line with the global market.

China also confirmed on Thursday its previously announced tax increase on a range of fuels to curb "unreasonable" consumption in the world's second-largest oil user, whose determination to keep its petrol cheap had aided the rapid oil demand growth that helped drive crude to a record $147 in July.

But modestly lower prices are unlikely to do much to boost oil demand, which shrank last month for the first time in almost three years, as the economy takes a bigger-than-expected hit from the deepening recession in its main export markets.

"The price cuts and reforms will support oil demand in China but the impact of the financial crisis on the country may be more than we expected a few months ago," said Ehsan Ul-Haq, head of research at JBC Energy in Vienna.


After China announced the fuel price cut, the U.S. January light crude contract, which sank to $39.19 on Thursday, was trading up 65 cents at $40.71 a barrel by 1202 GMT. London Brent crude for February rose 85 cents to $46.38.

"We're seeing a little bit of a recovery, and it could be that China price cuts are playing a part, but I think the market has seen its low when we dipped under $40," said Christopher Bellew at U.S. brokers Bache Financial in London.

But oil, which fell sharply after China raised prices in June on fears that it would temper consumption, is still stuck near an over four-year low around $40 a barrel, after OPEC's biggest ever production cut failed to offset a deepening economic gloom.

The price cut came some sooner than expected -- most believed the new rates would come into effect along with other reforms on Jan. 1 -- and was milder than some analysts were anticipating.

"We expected it to be as high as 20 percent," said David Johnson, an analyst at Macquarie in Hong Kong.

The price cut and tax hike will eat into the earnings of refiners Sinopec and PetroChina, which had finally begun turning a profit as crude oil plunged from its July peak of over $147, helping offset the billions of dollars in losses they endured earlier in the year when Beijing resisted raising prices.

The NDRC said pump prices would not rise on Jan. 1 when the tax element of the reform kicks in, implying that refiners will have to bear the burden of increased tax from that date.

China has been careful to sell the reform package with a week-long "consultation period", which it said showed support from the "great majority" of its people, while refiners will now be able to sell fuel at closer to international prices.

Pump prices will fall by about 0.91 yuan ($0.133) per litre of gasoline and 1.08 yuan ($0.158) per litre of diesel from midnight on Thursday, said the National Development and Reform Commission (NDRC), China's top economic planning body.

Including a newly introduced fuel tax, retail prices may fall by only around 13 to 17 percent, based on calculations against prevailing Beijing prices.

Tax at the Pump

After five years of infrequent and unpredictable price adjustments by Beijing, policymakers are now taking advantage of the collapse in global rates to address its domestic pricing system, which has kept prices cheap to maintain social stability at the cost of encouraging wasteful consumption and pollution.

The government sweetened the reform, which means motorists will pay a sizeable amount of tax at the pump for the first time, by promising the price cut.

The deeper cut in diesel prices will aid farmers ahead of the spring harvest, while Chinese airlines such as flagship Air China will get relief from the 32 percent cut in jet fuel costs, which had been allowed to rise much more swiftly than motor fuel prices earlier in the year.

The cuts were possible because of the huge gap between international crude oil prices and the outgoing state-set pump prices, which are roughly equivalent to $83.50 crude.

Consumption tax on gasoline and diesel will rise five-fold and eight-fold, or by 0.8 yuan and 0.7 yuan per litre respectively. Tax on other fuels will rise by a similar amount, but no figures have yet been given.

China eventually raised rates by 17-18 percent in June, although they still lagged below global prices. It has not adjusted prices since then, angering Chinese drivers who were paying 50 percent or more than those in the United States.

But demand in the United States, the world's bigest consumer, is declining even though gasoline prices have slumped by nearly two-thirds as a deep recession looms. And at about $3 a gallon, China's new gasoline prices may be relatively modest compared to Europe but are still double those in the United States.

"The cuts in pump prices may not be sufficient to offset the impact of a recession in the world," said Wood Mackenzie analyst John Waterlow.