China’s recent energy price rises: why now and what next?

You should always expect the unexpected in China. The opaque system of government allows major decisions to be sprung on its own population and on the rest of the world with little or no notice. Whilst this mode of operation may indeed constrain speculative behaviour on the part of domestic market players, it hardly makes for effective long-term policy and leaves everybody wondering why the action was taken and what are the likely implications.

On 20th June 2008 China’s government surprised us by announcing a round of price rises for energy products. Retail prices for diesel, gasoline and jet fuel were raised by 17-18% with immediate effect, taking gasoline to about 75 US cents per litre. Freight rates on the railways rose by a similar proportion. At the same time the government put in place a range of measures to ensure that the poorer sections of society were not unduly affected. Subsidies to farmers, payable by unit area of land, would be raised, as would payments per person to poor families in both urban and rural areas. Passenger fares for rail, for urban and rural public transport and for taxis would be unchanged.

From 1st July 2008 wholesale electricity tariffs were allowed to rise by 5%. The burden of these tariff increases is likely to be borne mainly by the industrial and commercial sectors, as rural and urban households will be protected.

Yes, we had thought that tariffs for oil products and electricity had to rise soon in order to keep pace with prices for crude oil and for coal, but we had expected the government to delay until after the Olympics. So why did it bring forward the announcement? Was it a desire to push forward with the ongoing energy efficiency policy and constrain demand by raising end-user energy prices, was it a need to reduce the fiscal burden on the government, or was it rather a desperate attempt to ensure reliable energy supplies during the summer of the Olympic games? The answer draws on observations in my columns from earlier this year.

By April 2008 it was clear that the unwillingness of the government to raise oil product prices was constraining the output of the domestic refiners. The major state-owned refiners were operating at reduced capacity as they were ‘carrying out routine maintenance’, and most of the small-scale, private sector refiners had stopped operations entirely as they were unable to sustain their losses. Shortages of gasoline and diesel were appearing across the country.

In order to raise the output of oil products the government agreed to a higher level of subsidy payments for both Sinopec and PetroChina, and these were then payable monthly and not annually as before. The subsidy paid to Sinopec in April 2008 alone amounted to one billion US dollars. Though the government is unlikely to agree to pay such subsidies to the small Chinese private sector refiners, it is reported to be in talks with foreign investors such as Total, Saudi Aramco and Exxon who will be suffering losses just as the domestic refiners do. In addition, the government has been granting 75% rebates on the 17% VAT chargeable on crude oil imports. For Sinopec this has been yielding a monthly benefit of more than one hundred million US dollars.

In response to the recent price increases, both Sinopec and PetroChina announced that they would be raising their refinery throughputs and doing their best to ensure adequate supplies throughout the summer.

As in the oil sector, power shortages were appearing across the country during March 2008, despite the massive and ongoing investment in new power generation capacity over the last five years. In part these shortages were caused by the severe winter weather in the southern part of the country. But a further cause was the unwillingness of power generators to operate at a time of rapidly rising coal prices and static electricity prices. The recent increase in wholesale tariffs will provide some compensation to the power generators, but the industry argues that a further rise of 50% would be required to match the amount that coal prices have risen over the previous twelve months.

Thus it would appear that, in raising energy prices, the government’s top priority is to maintain stable and sufficient supplies of energy to support the economy, and particularly during the Olympics. In other words, the short-term aim is to raise the production and consumption of energy, not to reduce them. Prices have been raised in such a way that energy suppliers receive some, albeit very modest, compensation for their financial losses. At the same time most individual consumers have been protected from the direct impact of these price increases. Thus the risk of social disturbance caused by the rises has been constrained.

It is also possible that the government was responding to international criticism over its failure to raise domestic energy prices, and chose to announce the tariff increases just before the international meeting on energy held in Jeddah in late June.

A strong government fiscal position ensures that China is indeed able to continue paying large subsidies to the oil refiners if it chooses, unlike some other developing countries which have been obliged to raise consumer energy prices dramatically for budgetary reasons. Indeed, if it fails to change its policy, the continued rise of international oil prices will oblige the Chinese government to continue raising the level of subsidy payments, not only to the refiners but also to the relevant sections of the population.

The situation in the electrical power sector is slightly different, because the power generators receive no direct subsidy to compensate for their financial losses. Also, there have been local shortages of coal supply to power stations as the rail network struggles to transport ever increasing quantities of coal. Therefore the impact of the 5% tariff increase is likely to be very limited.

The government may indeed be treating this latest hike in energy prices as a warning to citizens that the good days are over, and that further substantial price rises are on the way, after the Olympics. If the government wishes to take significant steps to constrain rising energy consumption without resorting to rationing, then they will need to bring the truth of world energy prices to the attention of their citizens through the price they pay for energy. To date, it appears that substantial sections of Chinese society are oblivious. For example, the fastest growth in private vehicle sales in the first four months of 2008 was for SUVs.

Yet it may be outside forces that eventually constrain China’s rising demand for energy. As economic gloom deepens in OECD countries, the risk to China’s economy grows. GDP growth for 2008 is likely to be 1% down on last year. In the first few months of this year the industrial output and the export of energy intensive products are down, indeed the overall trade surplus is down. Both China’s government and the World Bank appear to be confident that that the national economy remains strong and will prove resilient to the global downturn, and that this decline in GDP growth represents a desirable return to a more sustainable rate of growth.

Yet it is too early to discount the possibility of a major downturn in the Chinese economy resulting from recession in its primary export customer nations. This would indeed severely constrain the rate of growth of demand for energy in China. Though this country has proven adept at countering outside threats to its economy by raising domestic investment at national and local government levels.

Philip Andrews-Speed is Director of the Centre for Energy, Petroleum and Mineral Law and Policy at the University of Dundee, UK

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