CHINA/ENERGY: TENSION AMID SHORTAGES AND PRICE HIKES

UNCLAS SECTION 01 OF 02 BEIJING 006936 SIPDIS SIPDIS SENSITIVE STATE FOR EAP/CM PSECOR, AND EB/ESC SIMONS AND HAYMOND DOE OEA FOR CUTLER, NAKANO TREASURY FOR OASIA DOHNER, CUSHMAN USDOC FOR 4420 USTR FOR STRATFORD/WINTER/ALTBACH/MCCARTIN E.O. 12958: N/A TAGS: ECON ENRG EINV PGOV EPET EFIN CH SUBJECT: CHINA/ENERGY: TENSION AMID SHORTAGES AND PRICE HIKES REF: Beijing 1734 -------------- SUMMARY -------------- ¶1. (SBU) Amidst fuel shortages and even the death of a line-jumper at a gas station in Henan Province, China's National Development and Reform Commission (NDRC) has raised refined oil prices by USD 9/barrel and gasoline/diesel prices at the pump by 20 US cents per gallon. The goal is to encourage domestic oil refiners to increase production. Oil refiners, unable to pass through increased costs for imports, have recently faced significant losses. Government-run refiners have continued to produce under pressure, but the independents, which account for around 15 percent of the country's refining capacity, have moved away from gasoline/diesel and will likely find today's price hike insufficient to resume production. Another headache for the government may be consumer outrage at paying higher prices amid continued shortages. END SUMMARY. -------------- BEIJING UNEXPECTEDLY RAISES OIL PRICES -------------- ¶2. (U) Late evening October 31, the NDRC unexpectedly announced an 8 percent price increase effective today for refined petroleum products: RMB 500 per metric ton, or approximately USD 9/barrel (converted at USD 1 = RMB 7.5). This rolled back a 4 percent price reduction from January and came as gasoline and diesel shortages, the worst in two years, have been spreading throughout China's coastal provinces and recently showed signs of moving inland, with anecdotal reports of diesel shortages even in Beijing. Media quoted local police in Henan Province as reporting that a customer was killed at a service station on October 30 in Xinyang after angering another customer by jumping in line. ¶3. (SBU) The government action is meant to encourage refineries to produce more gasoline and diesel in response to the shortages. A Citibank analyst estimated that the oil companies recently have lost approximately USD 10/barrel of oil they refine due to the large gap between China's regulated prices and international oil prices. The price increase addresses about half of this loss, but will still leave refiners losing USD 4-5/barrel of oil they refine, said our �0A;contacts. (Comment: The firms do not benefit from the full price increase because not all of their output is sold at regulated prices as detailed below. Also of note, to the extent that the price change leads to increased refinery activity, it may in the short-term raise China's demand for imported oil, adding to global price pressures. End Comment.) -------------- -- NATIONAL FIRMS PRODUCING UNDER PRESSURE, BUT... -------------- -- ¶4. (U) Prior to the price increase, Beijing had been cajoling China's national oil companies (NOCs) into maintaining refining production levels despite sharp increases in the international price of oil. (Note: China is second to the US in petroleum use and imports around half of its consumption. End Note) In September, the NDRC resisted calls by the NOCs to raise prices, noted that the NDRC was closely monitoring retail prices nationwide to ensure compliance with price controls, and publicly warned the NOCs not to decrease their refinery production rates, even as their losses mounted. Although this largely kept the NOCs in line, Beijing has been unable to force the country's independent refiners to maintain production levels, a direct cause of the current shortages at the pumps. -------------- ... INDEPENDENTS HAVE NOT PLAYED ALONG -------------- ¶5. (U) Industry experts estimate that China's independent oil refiners, with around 1 million barrels per day of refining capacity, produce 10-20 percent of the country's gasoline and diesel. They have cut production in the face of high international prices. In many cases, they have also increased production of products unaffected by price controls, such as naphtha (often used for chemical and fertilizer production) or have simply shut their plants down to avoid losses. These products, free of price controls, in general account for an estimated 40 percent of refinery output. The NOCs have relied on unregulated products as well to BEIJING 00006936 002 OF 002 soften the blow from losses on price-regulated production. Industry analysts told clients today that it is unclear if the NDRC's price increase is enough to change this dynamic. -------------- PRICE PRIMER IN DOLLARS AND CENTS -------------- ¶6. (U) Chinese media suggests that the price increase will raise consumers' gasoline and diesel prices at the pump by around 20 US cents per gallon. Prior to the price increase, consumers in Beijing paid USD 2.40/gallon for premium gasoline and USD 2.00/gallon for diesel. The reports also indicate that the NDRC estimates China's monthly consumer price index (CPI) will increase by .05 percentage points as a result of the price increase. Some of our contacts maintain that many Chinese consumers already feel they pay too much for gasoline and diesel. -------------- TOUGH LESSON FOR THE LEADERSHIP -------------- ¶7. (SBU) JP Morgan China Economist Grace Ng commented in a research note that Premier Wen had just last week announced after a State Council meeting that China would not raise any prices over the rest of the year that would affect the CPI. Ng believes the NDRC was looking to reform prices for a long time but was blocked by senior officials who were waiting for oil prices to fall. The lesson for them, in her view is that "they cannot time the market and the government has to do what is inevitable if it is serious on energy conservation, market based mechanisms, and staying on the course of reform." -------------- PRICING WAS ALREADY AN ISSUE -------------- ¶8. (SBU) As we reported in reftel, China has been looking to integrate domestic and global petroleum prices. Concerns about harming consumers, rural residents, taxi drivers, and oil refiners have slowed this process. Consequently, the NDRC has continued to rely on administrative pricing, forcing it to subsidize the oil companies' refinery losses while at the same time incurring public and media wrath when gasoline prices do not fall during periods when global prices decline. Our contacts have told us that a new pricing mechanism is pending that will guarantee domestic refiners a profit while shielding consumers from major fluctuations. It will supposedly incorporate elements of market-based pricing but remain highly controlled overall and potentially vulnerable to speculation. -------------- --- COMMENT: TOO EARLY TO TELL IF MOVE IS SUFFICIENT -------------- --- ¶9. (SBU) The NDRC's price increase is probably insufficient to immediately abate current gasoline and diesel shortages. Our contacts tell us that the move's most immediate effect will be to reduce NOC refining losses, but for now, it may fall short of reenergizing the independents. To address the shortfall in the short term, the NOCs will have to ramp up their refining production and go abroad in search of refined products for direct sale into China. Meanwhile, consumer outrage at lining up for even more expensive fuel is possible, and this makes further price increases needed to return independents to the market unlikely. Bottom line: Beijing now has a new reason to hope for a fall in international oil prices to bring the independents back into the market. RANDT