On Friday the Chinese government unveiled plans to drastically increase taxes on transportation fuel at the pump. What effect, if any, should this have on global crude prices?
First the tentative plans: Road tolls, water management tariffs and other fees will be abolished, but the consumption tax on gasoline will increase fivefold from 0.2 yuan (roughly 3 cents) to 1 yuan per liter, while the tax on diesel will rise eightfold (!) from 0.1 yuan to 0.8 yuan per liter. However, prices at the pump will not increase and the extra tax will be charged not to consumers but to producers. Before our Chinese readers wipe their brows in relief, they should question why prices aren’t falling at the pump like they are across the globe.
Oil Energy Money readers should remember that the Chinese government sets pump prices at will, unlike most markets where wholesale prices dictate the numbers. Thus, while prices spiralled at the start of 2008, pump prices in China didn’t increase until June. This put considerable pressure on Chinese refiners who claimed to be losing money when prices were above $65 a barrel. Now that prices are back down, the refiners are making much larger profits on pump transactions. So instead of reducing retail prices, to benefit motorists, the government has chosen to keep retail prices the same and increase taxes, which it intends to use for infrastructure development and support for farmers who are losing out because of aforementioned tariff reform.
How does this relate to global prices? Well, some analysts consider Chinese demand the last barrier between us and $25 prices on NYMEX. If Chinese motorists reduce consumption due to prices at the pump, the knock on effect could be severe. Fortunately, the International Energy Agency forecasts a 4% growth in Chinese oil products demand over the next five years, so no fall in retail prices shouldn’t dent demand, on a national and thus global level.
To further mitigate the risk of a demand drop, the Chinese Government intends to impose a ceiling on prices. The reforms are open to public feedback until December 12th, after which they will be finalised with the aim of putting them into practice by January 2009.
All told, the tax reforms could encourage drivers with the removal of road tolls and support farmers with the increased tax revenues. While not exactly bullish, by maintaining demand the reforms will be one less bearish force on prices in the new year.
