contextualizing china’s fuel pricing announcement

Cross-posted on the ICCT Staff blog.

A few days ago, China’s National Development and Reform Commission (NDRC) announced a new pricing policy for higher quality fuels. The policy calls for the prices of China IV gasoline and diesel (50ppm sulfur content) to be increased by 290 and 370 RMB/ton, respectively. The prices of China V gasoline and diesel (10ppm) are to be raised a further 170 and 160 RMB/ton, respectively. The new pricing changes are designed to encourage and assist China’s refineries to meet the fuel quality improvement timeline announced by the State Council earlier this year. That timeline calls for nationwide supply of China IV gasoline by the end of 2013, China IV diesel by the end of 2014, and China V gasoline and diesel by the end of 2017.

The pricing changes appear to be the first steps in implementing State Council calls in October 2011 and February 2013 to use progressive fiscal policy to encourage the supply of higher quality fuels. Additional fiscal policies, for example a fuel tax adjustment differentiated by fuel quality, will likely be announced separately by the Ministry of Finance (though the timing of any additional MOF policy announcement is uncertain).

To understand better and contextualize what the NDRC pricing numbers actually mean, let’s look at the answers to some relevant questions:

1) What does it mean for the NDRC to set the price of fuel per ton?
The price of fuel in China is controlled by the NDRC, rather than being market-driven (though China has been slowly revising its pricing policy to better reflect the international price of crude). The NDRC sets the prices, per ton, to be paid to refineries in China for a variety of different petroleum products including gasoline and diesel used in motor vehicles.

2) How is the per-ton price of fuel linked to the per-liter cost to consumers at the pump?
Changes in the per-ton prices set by the NDRC usually directly result in changes in per-liter prices at the pump. For example, in their 9/13 regular fuel price adjustment notice, the NDRC announced the per-ton price change while also directly estimating the impact on prices at the pump. But in that case, the price changes were due to recent changes in the international crude price, a slightly different case.

Regarding the upgrading to China IV and V fuels, the NDRC explicitly stated in a follow-up Q&A that refineries and consumers should both bear a portion of the cost of the higher quality fuel. Although the NDRC has not detailed what those portions should be, the recent announcement implies that the cost burden to be absorbed by the refineries is not included in the announced price changes. This would imply that the primary burden of the additional price will be passed on to consumers. Even so, in their original announcement, the NDRC noted that additional subsidies and fiscal incentives may still be used to ensure that the cost burden of the higher quality fuel is not too great, especially for poorer consumers. Therefore, it’s unclear now what the final per-liter pump price increases will be.

3) What is the current price of fuel in China?
The price of fuel varies by region in China. The current, per-ton prices for gasoline and diesel in China are around 9500-9700 and 8700-8900 RMB/ton, respectively. (Note: the prices are higher in cities like Beijing and Shanghai which have already upgraded their fuel quality.)

A ton of gasoline yields about 1379 liters. A ton of diesel, which is denser, yields about 1190 liters. Assuming average nationwide per-ton prices of 9600 RMB for gasoline and 8800 RMB for diesel, we can roughly estimate per-liter prices of about 6.96 RMB/liter for gasoline and 7.4 RMB/liter for diesel ($4.35/gallon for gasoline and $4.62/gallon for diesel). (Note: the the WSJ reported Tuesday slightly lower nationwide weighted average pump prices of $4.21/gallon (gasoline) and $4.36/gallon (diesel).)

4) If the increased price per ton is passed entirely to consumers, what will the impact be on prices at the pump?
The total NDRC price increases for upgrading from China III to V gasoline and diesel are 460 and 530 RMB/ton, respectively. This is equivalent to 0.33 RMB/liter (0.21 USD/gallon) for gasoline and 0.45 RMB/liter (0.28 USD/gallon) for diesel. If these price increases are entirely passed to consumers, they will result in cost increases of about 4.8% for gasoline and 6.0% for diesel.

5) How did the NDRC determine the price increases?
In the Q&A posted on their website, the NDRC explained that the price increases were based on comprehensive investigations and audits of Sinopec and PetroChina refineries which have already been upgraded to be able to produce China IV and V fuel, as well as experience from Beijing and Shanghai. (Beijing has already implemented China V fuel, while Shanghai is currently transitioning to China V.) The NDRC’s nationwide price adjustments for the China III->V transition are identical to the price adjustments used in Beijing and Shanghai for upgrading from China II to China V.

6) Are the price changes enough to cover the increased cost of refining higher quality fuel?
A 2012 ICCT study suggested that the additional cost to produce China V (10ppm) fuels in China would be just 0.04 and 0.11 RMB/liter for gasoline and diesel, significantly less than the NDRC’s announced price increases. This implies that the announced price adjustments should be way more than adequate to cover the required refinery upgrades and increased production costs for China V fuel. Even before additional fiscal policy measures from MOF are implemented, this pricing certainty will be instrumental in incentivizing China’s refineries to move ahead with the upgrades in order to meet the fuel quality timeline.

7) What about compliance and enforcement?
Finally, it’s important to note that the NDRC announcement included an entire paragraph on the importance of and mechanisms for ensuring compliance and enforcement of the fuel quality. In addition to asking multiple ministries (MEP, MOFCOM, SAIC, AQSIQ, NEA, and others) to work closely together, the NDRC even calls on the media and public to play a role in supervising improvement efforts and calling out illegal activity. Combined with the price increases, this further underscores the Chinese government’s deep commitment to ensuring the fuel quality timeline is met and commensurate air quality improvements are achieved.

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