VZCZCXRO4031
OO RUEHCN RUEHGH RUEHVC
DE RUEHBJ #2433/01 1720941
ZNR UUUUU ZZH
O 200941Z JUN 08
FM AMEMBASSY BEIJING
TO RUEHC/SECSTATE WASHDC IMMEDIATE 8103
RHMFIUU/DEPT OF ENERGY WASHINGTON DC IMMEDIATE
RUEATRS/DEPT OF TREASURY WASHDC IMMEDIATE
RUCPDOC/DEPT OF COMMERCE WASHDC IMMEDIATE
INFO RUEHOO/CHINA POSTS COLLECTIVE
RHEHNSC/NSC WASHDC

UNCLAS SECTION 01 OF 02 BEIJING 002433 
 
SIPDIS 
SENSITIVE 
 
STATE FOR EAP/CM AND EEB/ESC 
TREASURY FOR OASIA/DOHNER 
USDOC FOR 4420 
STATE PLEASE PASS USTR FOR STRATFORD 
 
E.O. 12958: N/A 
TAGS: ECON ENRG EINV EPET EFIN PREL PGOV CH
SUBJECT: CHINA/ENERGY: SIGNIFICANT AND SURPRISING PRICE HIKES 
 
REF: BEIJING 2331 
 
SUMMARY 
------- 
 
¶1. (SBU) In a surprise move that came late on June 19, China's 
National Development and Reform Commission (NDRC) announced 
significant energy price increases.  Effective June 20, gasoline 
rose 16.7 percent, diesel 18.1 percent, and jet fuel 25.2 percent; 
effective July 1, electricity will rise an average of 4.7 percent, 
although household consumers, the agriculture sector, and areas 
struck by the Wenchuan Earthquake in Sichuan will be exempted.  The 
change in energy prices was driven by shortages caused by refiners 
finding it unprofitable to place fuel on the market as a result of 
rising global oil prices.  The move was unexpected given recent 
inflationary trends, remarks last week by a senior official that 
subsidized fuel prices were important for social stability, and 
reports from economists that emphasized China's ability to maintain 
subsidies given its strong fiscal position.  The price increases 
could add a fraction of a point to the consumer price index (CPI), 
but if food price inflation continues to slow, the overall CPI may 
actually show a decline nonetheless.  Higher fuel prices could drive 
up demand for imported oil in the short term as refiners supply more 
fuel to a market presently facing shortages.  In the longer term, 
however, the movement away from subsidies should slow demand growth 
for finished fuel products, and it is this anticipated effect that 
led to global oil prices falling 3.5 percet in response to the 
pricing news from China. Customers at a local filling station told 
Embassy staff they believe price increases will change car buying 
and driving patterns.  END SUMMARY 
 
FIRST PRICE HIKE SINCE NOVEMBER 
------------------------------- 
 
¶2. (SBU) The NDRC announced significant energy price increases in a 
surprise move late on June 19.  Effective June 20, gasoline rose 
16.7 percent, diesel 18.1 percent, and jet fuel 25.2 percent; 
effective July 1, electricity will rise an average of 4.7 percent, 
although household consumers, the agriculture sector, and areas 
struck by the Wenchuan Earthquake in Sichuan will be exempted. 
Natural gas prices were not raised, while coal prices were capped at 
their June 19 rates for the remainder of 2008.  China's policy of 
moderately subsidizing gasoline and diesel has insulated the public 
here from global oil price increases since the last price hike, a 10 
percent rise in November 2007 when oil was trading around USD 
90/barrel. 
 
¶3. (SBU) Although domestic shortages have led to mounting pressure 
to raise fuel prices, this week's adjustments were greater and came 
sooner than many economists expected.  Less than two weeks ago, NDRC 
Vice Chairman and Head of the National Energy Bureau Zhang Guobao 
was quoted by Xinhua stating that China's current finished oil 
prices are conducive to the country's social and economic stability 
and that raising fuel prices too quickly would have a significant 
impact on the domestic economy. 
 
PRICING DECISION DRIVEN BY SHORTAGES 
------------------------------------ 
 
¶4. (SBU) The NDRC told media the increase came as a result of rising 
international oil prices that had led to refineries shutting down, 
creating lines at filling stations and even limits on purchases in 
some parts of the country.  State-owned refiners Sinopec and 
Petrochina have over recent months faced massive losses on sales of 
gasoline and diesel at below-market prices.  According to local 
media reports, in the first quarter of 2008, fiscal subsidies to 
Sinopec reached RMB 7.4 billion due to rising international oil 
prices.  In April alone, Sinopec received fiscal subsidies of RMB 
7.1 billion.  Meanwhile, Sinopec reported that the subsidies were 
covering less than half of its total losses on refining operations. 
China, the world's second largest petroleum importer, brings in just 
over half of its needs, thus forcing its refiners into an 
unprofitable situation where they must pay global prices for a 
significant portion of the crude they process but then sell their 
output at capped rates (Note: Sinopec relies more on imports than 
Petrochina. End Note.)  The result has been widespread spot 
shortages, particularly for diesel, impacting transport by truck. 
 
MARKET IMPACT 
------------- 
 
¶5. (SBU) Global oil prices fell 3.5 percent following the pricing 
announcement, in anticipation that a movement away from subsidies 
 
BEIJING 00002433  002 OF 002 
 
 
should slow demand growth for finished fuel products.  Of note, NDRC 
Vice Chairman Zhang Guobao in recent weeks has dismissed the idea 
that rising demand in developing countries such as China and India 
is to blame for the surge of oil prices, arguing that investments by 
hedge funds and other speculators have played a key role in driving 
up prices.  Independent Beijing-based economist Andy Xie supported 
this argument in a recent article in the economic journal, Caijing, 
in which he argued that unusual supply and demand dynamics, low U.S. 
interest rates, and speculative capital have come together to create 
today's oil price bubble. 
 
SHORT-TERM: MORE IMPORTS, GRUMBLING 
----------------------------------- 
 
¶6. (SBU) The new pricing should be an incentive for greater refinery 
production and may, ironically, lead to greater imports as pent-up 
demand is satisfied, according to RBS Economist Ben Simpfendorfer. 
But it is unclear whether the price hikes are sufficient to bring 
independent refiners, which account for as much as 15 percent of 
domestic production capacity, back into the market.  Whatever the 
case, Chinese consumers and even state-controlled media have over 
time demonstrated significant irritation with high fuel prices, and 
the grumbling is likely to continue. 
 
¶7. (SBU) An LES employee queried customers at a Beijing Sinopec 
station near the Embassy on June 20.  Asked about the government's 
decision, younger drivers reluctantly accepted the price increase, 
stating that they understood that the decision is a result of higher 
international oil prices.  Older drivers said they were surprised by 
and unhappy about the price hikes, adding that the price increased 
too rapidly.  Most drivers said that this week's price increases 
will make them more inclined to use public transit and will 
encourage consumers to purchase smaller, more fuel efficient 
vehicles.  (Note:  The persons queried were probably among Beijing's 
more affluent population.  Emboffs have not yet been able to gauge 
reaction among the city's poorer residents. End note.) 
 
LONGER-TERM: MORE RATIONAL ENERGY USE, MORE INFLATION 
--------------------------------------------- ------- 
 
¶8. (SBU) One of China's top economic and environmental priorities in 
the 11th Five Year Plan is reducing energy intensity by 20 percent. 
With car ownership exploding here, there have been widespread calls 
for subsidy reform to bring proper price signals to the market. 
Higher gas prices should have an impact.  By contrast, the top 
short-term economic priority of the government is combating elevated 
inflation, running around 8 percent over recent months.  Raising 
fuel prices could add to this figure but this may not be noticed if 
food prices -- the overwhelming cause of recent inflationary trends 
-- continue to stabilize.  Gasoline makes up a small part of the 
basket of goods used to measure inflation so the impact of fuel 
price increases on CPI is expected to be relatively small.  Goldman 
Sachs economist Hong Liang expects the direct impact on CPI to be 
around 0.13 percent, while UBS economist Wang Tao estimates the 
impact on CPI to be about .5 percent.  Hong Liang notes that a more 
pronounced impact is likely to be seen in declined profitability of 
downstream industries.  Nonetheless, the price increases and 
resultant increase in fuel and power supply to the market could 
improve prospects for industries that were previously threatened by 
the possibilities of oil product shortages and power outages. 
 
MORE TO COME? 
------------- 
 
¶9. (SBU) RBS economist Ben Simpfendorfer estimates the new spread 
between locally capped priced and international market prices for 
refined fuels to be 37 percent.  UBS economist Wang Tao estimates 
that China's new oil product prices would be at an import parity of 
about USD 90/bbl.  This suggests that further hikes are likely, 
especially if international prices continue to rise.  Of note, 
however, the Chinese Government's fiscal position remains strong, so 
it is capable of choosing the time and pace of any further price 
hikes.  Morgan Stanley economist Qing Wang claims that China is 
well-positioned to maintain subsidies compared to its peers in the 
region due to its low government debt levels.  With concerns about 
inflation and social stability still running strong, the Chinese 
Government will be inclined to carefully monitor public response to 
this week's price increases before making further adjustments. 
 
PICCUTA