Taiwan Betting on Lower Crude Oil Prices

UNCLAS SECTION 01 OF 03 TAIPEI 004229

SIPDIS

INFO AMEMBASSY TOKYO
AMEMBASSY SEOUL
AMEMBASSY SINGAPORE
AMEMBASSY BEIJING
AMCONSUL HONG KONG
AMCONSUL SHANGHAI
AMCONSUL GUANGZHOU
AMCONSUL SHENYANG
AMCONSUL CHENGDU

PLEASE PASS AIT/W AND USTR
USTR FOR TWINELAND AND AWINTER

SENSITIVE
E.O. 12958: N/A
TAGS: ECON EPET ENRG TW
SUBJECT: Taiwan Betting on Lower Crude Oil Prices



1. (SBU) Summary: Taiwan's first gasoline price war broke
out in September after world crude oil prices reached record
highs. Privately owned Formosa Petrochemical Corporation
(Formosa) raised prices by almost 10 percent because of
increased costs. However, government owned Chinese
Petroleum Corporation (CPC) held gas prices steady. CPC
continues to sell gasoline below cost and, by its own
estimate, is losing NT$200 million (US$6 million) a day.
The government has tried to ease CPC's losses by providing a
three-month tax holiday on gasoline. This will allow CPC to
keep gas prices artificially low until elections in
December. Taiwan expects crude oil prices to decrease in
the future. End Summary.

Background
--------------


2. (U) State-owned CPC lost its monopoly on gasoline sales
in 2000. Formosa jumped on the chance, quickly capturing
nearly 30 percent of the market. Formosa is a publicly
traded company controlled by the sprawling Formosa Plastics
Group, the tenth largest chemical company in the world in
terms of sales. Since then, CPC and Formosa have settled
into a comfortable arrangement with Formosa holding on to
one third of the market and CPC holding the rest.


3. (U) Until August 2005, both companies charged the same
price for wholesale gasoline and diesel. Both companies
also moved their wholesale prices in virtual lock step,
usually announcing price changes within hours of each other.
This situation held steady for the last 19 price
adjustments. But in August 2005, Formosa notified dealers
of a 9.7 percent increase and, remarkably, Chinese Petroleum
did not follow suit.


4. (U) Formosa stood fast despite criticism from customers
and gas stations. K.Y. Lin, Director of the President's
Office at Formosa said that retail sales by the company's
gas station franchisees dropped by 60 percent. By the end
of September, CPC had 90 percent of the domestic gasoline
market.


5. (U) On September 29, 2005, a month after Formosa
announced its price increase, Premier Frank Hsieh announced
that Taiwan would slash commodity taxes on gasoline, diesel,
and fuel oil by 25 percent. Hsieh said the temporary
measure would last for three months until December 31.
Taiwan's Ministry of Finance reported that the three-month
tax holiday would cost NT$6 billion (US$180 million) in tax
revenue. Soon after the announcement, Formosa said that it
would re-enter the domestic market and bring down wholesale
prices to match CPC's wholesale prices. As of October,
Formosa is regaining its market share and retail gasoline
prices have stabilized at the fixed price of NT$2.54 per
liter (US$2.88 per gallon).

Gas prices being kept artificially low in Taiwan
-------------- ---


6. (U) Gasoline prices in Taiwan have typically been the
lowest among the East Asian economies; Korea, Singapore,
Hong Kong and Japan. A year ago, the average price for
gasoline in Taiwan was NT$22.60 per liter (US$2.56 per
gallon). In comparison, at the same time last year, the
price of gasoline in U.S. dollars per gallon in Hong Kong
was US$5.62, in Seoul US$4.71, and in Tokyo US$3.84. Over
the past year gasoline prices in Taiwan have climbed NT$3
(US$0.09) to NT$25.40 per liter (US$2.88 per gallon). Until
this past August, the reason for the low price had nothing
to do with government subsidies. Dr. Bor Yun-chang,
resource economist at the Chunghua Institute for Economic
Research, a non-profit think tank, explained that gasoline
prices are low in Taiwan because Taiwan's gasoline taxes are
the lowest in Asia at approximately NT$7-8 per liter
(US$0.80-0.90 per gallon).


7. (SBU) This has all changed since August when crude oil
prices reached record highs. Since then, gasoline prices in
Taiwan have been artificially held down through government
intervention. Dr. Bor estimates that without government
control, gasoline in Taiwan would cost NT$30 per liter
(US$3.40 per gallon). CPC officials have reported in the
Taiwan media that they are losing money on gasoline sales as
long as crude oil prices stay above US$60 a barrel.

Formosa's smart business tactics
--------------


8. (SBU) Dr. Chi-Chao Wan, a professor at Tsinghua
University and a member of the Executive Yuan's new energy
task force, explained how Formosa's hardnosed business
strategy forced Taiwan officials to reduce gasoline taxes.
When supply shortages pushed refined gasoline prices higher
in August 2005, Formosa realized that it could make a
windfall exporting gasoline instead of selling it in Taiwan.
The international refined gasoline market was at an all time
high in August. As a result, Formosa raised wholesale
prices to decrease domestic demand. It then exported the
gasoline at a higher price to other countries.


9. (U) Formosa's move angered customers and, more
importantly, the hundreds of franchisee gas stations that
were locked into long-term contracts with Formosa. These
gas stations had no choice but to raise prices and watch CPC
affiliated gas stations take their business. Taiwan media
reported angry gas station owners threatening a mass rally
at Formosa headquarters. However, Formosa skillfully ended
any protest by reimbursing gas station owners for their
losses. Formosa calculated that even with the
reimbursement, they were still turning a profit.


10. (U) K.Y. Lin told AIT that exporting gasoline was an
unavoidable business decision. He told AIT, that with
skyrocketing crude oil prices, it cost Formosa US$64.50 to
purchase and refine a barrel of oil. But with gasoline
prices holding steady, their return on every barrel of oil
was only US$61. Once the spot market in refined gasoline
reached US$70 a barrel, Formosa realized it could reimburse
gas station owners and still make a profit.

CPC's larger market share leads to greater losses
-------------- --------------


11. (U) K. Y. Lin also said that Formosa knew that if they
priced themselves out of the domestic market, it would force
the Taiwan authorities to act. Since CPC was selling
gasoline at a loss, the more business Formosa gave them, the
more money CPC would lose. Eventually, the Taiwan
authorities would have to intervene to help CPC. Dr. Bor
agreed with K.Y. Lin's assessment and explained the process
in more detail. He told AIT that if CPC needed to supply
gasoline to all of Taiwan it would start a chain reaction
that would lead to exponentially greater losses. CPC has
long-term crude oil contracts that only guarantee a certain
volume of crude oil. Once that volume is exceeded, CPC
would need to buy from the international spot market to make
up the difference. The spot market is even more expensive
and would lead to even greater losses.

12. (U) For CPC, holding gas prices down was a political,
not an economic decision. CPC is government owned and
CPC's president is a political appointee. In response to
questions about CPC's mounting losses, Kuo Ching-tsai, the
company's chairman was reported by the Taiwan media to have
said "there is something of higher concern than the short-
term loss reflected in its financial report. CPC is
obligated to take more care of people's need and the
overall national economic development."

Taiwan reduces taxes to help CPC and entice Formosa back
into the domestic market
-------------- --------------


13. (U) On September 29, 2005 Premier Frank Hsieh announced
that Taiwan would reduce commodity taxes on gasoline and
diesel by NT$1.8 (US$0.20 per gallon) for three months.
K.Y. Lin believes that the reason the government decreased
taxes was because it wanted to stop CPC's losses. Since CPC
did not decrease prices after the tax break, the tax break
amounts to a NT$1.8 increase in profits for CPC.
Essentially, the government is transferring the tax income
to CPC.


14. (U) K.Y. Lin said that Formosa's gas stations are now
able to compete because of a combination of decreasing world
crude oil prices and Taiwan's tax largess. Since the spot
market in refined gasoline is no longer as high as it was in
August, it is no longer as profitable for Formosa to export
the gasoline and reimburse gas station owners. Dr. Bor said
that Formosa may not want to antagonize Taiwan officials
because there are many other business projects that Formosa
is working on that need approval. For example, Dr. Bor said
that Formosa has been negotiating with Taiwan to allow it to
build a naptha cracking plant in the PRC.


15. (SBU) Shih-Ming Chuang, Director of Division of Policy,
International Affairs, Information Statistics at the Bureau
of Energy told AIT that he believes Premier Hsieh is
prepared to keep reducing taxes to keep gasoline prices low.
Chuang said that if crude oil prices do not come down by
December, "Hsieh may remove all commodity taxes."

Tax decrease timed to December elections
--------------


16. (SBU) Dr. Bor said that there are also political reasons
for the tax decrease. The tax decrease is being timed to
keep prices low until the end of the elections in December.
Bor explained how the ruling party wants to avoid handing a
political victory to the opposition party. Bor said,
Formosa is "like the Microsoft of Taiwan." Y.C. Wang, the
founder of Formosa, is respected and admired by many in
Taiwan because of his rags to riches success story. Bor
said if the government did not find a way to draw Formosa
back into domestic gasoline market it would be evidence that
the ruling party is bad for business. Bor said that "if
Formosa is giving up on Taiwan, than people are worried."


17. (SBU) Comment: Taiwan is bent on keeping gasoline prices
locked at NT$25.40 per liter (US$2.88 per gallon),at least
until after the elections in December 2005. Taiwan will
accomplish this through a combination of gasoline tax
reductions and having government owned CPC sell at a loss.
The breaking point for the Taiwan authorities will be when
Formosa finds it more profitable to export gasoline rather
than sell it to the domestic market. End Comment.