By Zhang Xiangdong, Xi Si, Jiang Lei, Ouyang Xiaohong
Published: 2008-06-25

Cover story, issue no. 373 June 23, 2008
Translated by Ren Yujie
Original article:

Two state-owned enterprises have played a pivotal role in the recent price hike for domestic fuel prices in China, the EO has learned.

The National Development and Reform Commission (NDRC) announced at 10pm on June 19 that prices of petrol and diesel would go up by 1,000 yuan per ton starting the next day, and that prices for electricity would be increased 0.25 yuan per kilowatt-hour onJuly 1.

However, the NDRC had claimed just ten days before the hike that fuel prices would remain unchanged for social and economic stability. The EO learned that the ultimate decision was made at a special meeting of the NDRC, and that oil giants Sinopec and PetroChina had influence in the reversal.

Smokescreen Verses Timing
Though the about-face came as a surprise, word had begun to circulate since the afternoon of June 19 that prices would rise. When the confirmation finally came at 10pm, petrol stations in Beijing were clogged by long queues as drivers trying to beat the deadline for petrol to cost between 0.86 and 0.92 yuan more per liter.

The NDRC stated soaring global oil prices as the main reason for the hike, as domestic fuel prices had remained static since November last year while global crude oil prices hit above 130 dollars per barrel.

Some market analysts believed the earlier announcement for fuel prices to remain unchanged was a smokescreen to prevent hoarding, as fuel was already in short supply; but an official from the state energy office said it was decided after close monitoring of the Consumer Price Index (CPI), and upon seeing signs of it abating, the authorities thought the timing was right for a price rise.

However, based on interviews with officials from various departments, the EO learned that the interests of Sinopec and PetroChina were of key importance. The two state-owned enterprises had submitted report after report since February to alert the authorities of their losses due to price surges in the global oil markets.

Those reports centralized around the two's incapacity to ensure sufficient production and supply to the market due to prolonged loses. The reports also claimed private enterprises and individuals had been hoarding supplies in anticipation of higher prices.

To present a stronger case, the reports also included cases of shortage nationwide to prove that the public and agricultural activities had been affected. For instance, there had been reports of shortage-sparked clashes at petrol stations in Shandong and Guangdong which led to police intervention.

If prices remained unchanged, the two companies would face cash flow problems, explained Cao Xiaoxi, assistant chief engineer of Sinopec's Research Institute for Economics and Technology.

A source from the Ministry of Finance (MOF) told the EO that the Sichuan earthquake last month had added pressure to the government's financial standing, and that the Ministry was reviewing subsidy payouts for expenditure controls.

To keep domestic fuel prices low, the government had been paying huge subsidies. According to Morgan Stanley's estimation, this year alone, the Chinese government had spent over 100 billion dollar for various fuel-related subsidies.

During the fourth Sino-US strategic economy dialogue on June 17, the US representatives urged China to loosen the controls over oil prices.

Losers and Winners
Indeed, a day after China announced the price hike, the global oil price dropped by 4 dollars. The Chinese stock exchanges' indexes in both Shanghai and Shenzhen too increased.

These initial positive indicators, however, could be temporary, said Cao, who added that Sinopec had been losing close to 5,000 yuan for every ton of oil processed, and that 1,000 yuan increment would not fix the problem.

"Moreover, despite the price rise, if the government cut subsidies at the end of the day, the oil companies are still at the losing end," he said.

However, an official of MOF stressed that it would be wrong to assume that the government would subsidize all of the oil giants' losses. He added the companies might suffer in the oil refinery segment but continue to make high profits in other segments, such as making petrochemical products.

"We analyzed the two companies' incomes and profits quarterly to decide on the appropriate amount for subsidies," said the official.
The long-delayed price rise was mainly due to concerns for inflationary pressure. One NDRC official said: "Though the CPI in May has dropped, the Production Price Index (PPI) has shot up. This could trigger a re-bound in the former and thus make inflation controls tougher."

Therefore, to curb inflation, the NDRC announced that prices of public transportation, including railway, public bus and taxi, must remain unchanged and that the government would provide financial support to them.

In addition, the price hike for electricity excluded residential usage to prevent direct contribution to consumer prices. Moreover, the NDRC also introduced temporary price intervention policies on coal until year-end.

Despite the above, there remained concerns that PPI would continue to climb with the price surges mainly affecting the commercial sector; and the rise in cost of productions could be transferred to consumers later, thus affecting the CPI in six to nine months.

A Morgan Stanley report said if China raised oil prices by ten percent, it would push up inflation by 0.3% to 0.4%.

However, China International Capital Corporation Limited (CICC) estimated that if energy prices remained unchanged, China's inflation rate would go up to 8.7 percent in 2009. If China upped oil prices by 50% in 2008, it said, the inflation rate could decline to 7.3 percent.