China Price Reform Update – 1H2014

Last November the Chinese Communist Party made an unprecedented step forward in market reforms when it made a commitment to allow the market to play a decisive role in resource allocation (使市场在资源配置中起决定性作用) by the end of 2020. In China the market determines all prices with a few important exceptions. For example, the price of petroleum, natural gas, water, electricity, and the deposit interest rates remain under government influence. Making these prices market determined would by reducing waste and over-investment improve the long-term growth of the Chinese economy. The objective of this article is to introduce an analytical framework to track the progress of market price reforms to energy, water, and capital on a semi-annual basis:

Energy

Petroleum

Although the price of crude oil is market determined, the Chinese government sets the retail price for refined petroleum products. Since 2004 retail prices have often not been allowed to keep pace with the increase in the price of crude oil. This policy reduces the profits of oil refining companies and effectively subsidizes users of petroleum products – mostly in the industrial sector. For example, both Sinopec and PetroChina posted substantive losses on their refining operations in 2007, 2008, 2011, and the first half of 2012 .

China is making good progress on reforming the price of refined petroleum products. In January 2009, China introduced a more market determined pricing system whereby retail prices would be adjusted every 22 working days if an index of international crude prices fluctuated by more than 4 percent except if international prices rose over $80 a barrel. This was adjusted again in March 2013 when the National Development and Reform Commission (NDRC) reduced to price adjustment period from 22 to 10 working days and raised the cap from $80 to $130 a barrel. Movements in the retail price of gas deviate only slightly from changes in the international crude oil price. For example, 2014 the average monthly change in the price of retail gasoline was on average within 15 basis points of the monthly change in a composite of Brent, Cinta, and Dubai prices.

Chart Petroleum Products

Natural Gas

The Chinese government sets the domestic price of natural gas periodically. Historically, this policy has lowered profits for China’s upstream natural gas companies and thus subsidized natural gas users particularly in industry, particularly on imports of LNG (now 50 percent of total imports). For example, PetroChina’s losses on importing natural gas in 2013 reached $7.9 billion.

Recently the government made some progress on natural gas price reforms but not enough to reduce losses on LNG imports. In March 2014, the government announced that local governments should begin to charge urban households higher prices for higher natural gas consumption by the end of 2015. This follows reforms in June 2013 which raised the price of natural gas for non-residential users by 15.4 percent and introduced a two-tier pricing system in which incremental consumption above the level of the previous year would be subject to higher prices. However, the average price is still low relative to the cost of import natural gas, especially liquefied natural gas (LNG). For example, in Shanghai the cost of importing LNG was on average 1.6 times higher than the city-gate price in 2014. Even taking into account gains from incremental consumption, importers of LNG are likely still losing money.

Page 1 of 3 | Next page