When Fuel Prices Rise in the Land of Production

By Katie Hayes
Chen Gan left his family in An Hui Province to become a truck driver, hoping to provide a better life for his family. On June 19, the Chinese government increased the price of diesel by 18 percent. This increase in price will ultimately mean a pay cut for Chen, because the company he works for does not cover gasoline costs associated with trucking.

Editor's Note: Excerpts from this story appear in the August 2008 edition of the China Economic Review. The article can be found here (subscription required).

In a vast and gritty Shanghai truck yard, Chen Gan, 39, toils in stifling heat, performing routine maintenance on his large diesel truck. Among Chen and the other truckers inhabiting the parking lot the mood is grim. The day before, China’s government raised domestic diesel prices 18 percent, and gasoline prices 17 percent, after holding them steady since November despite soaring global crude oil prices.

“Of course it’s going to affect my business, but what can we do about it?” asks Chen. “The government decides everything.”

As the largest producer of the world’s goods, a change in China’s domestic fuel prices will raise transportation costs and could have ripple effects on the price of retail goods both in China and abroad. Beijing’s move to raise fuel prices comes at a crucial time as the country has faced fuel shortages for the last three months threatening social stability before the Olympic Games, while inflation threatens undermine the economy’s rapid growth.

In Shanghai, more truckers gather around Chen’s truck to voice grievances and conspiracy theories about why there has been a fuel shortage in China for the last several months. Fu Zhen, an older man with a flattop haircut, who owns his own truck, blurts out that the U.S. invasion of Iraq has driven the cost of oil up around the world and it’s costing the government too much. No one here mentions increasing demand from construction, China’s rising middle-class, or the large losses that refineries must absorb when fuel prices are held artificially low.

Since mid-March, truckers have often spent hours waiting at diesel stations that had cut their business hours in response to supply shortages.

China is second only to the U.S. in fuel consumption. As its red-hot economy continues to expand at a furious pace, demand for fuel is only likely to increase apace. The move to raise domestic fuel was meant to ease demand for fuel by raising prices, but analysts question the extent to which demand will actually decrease as refineries begin to produce more thus making more fuel available for the thirsty market.

It is clear that China’s domestic transportation industry will be squeezed, and that higher costs will eventually be passed on to manufacturers and consumers.

The added cost to independent truck drivers in Shanghai is significant and will likely be too much for the drivers to bear without passing on the costs to either retailers or manufacturers.

“The fuel for a round trip from Shanghai through Chengdu and Chongqing in Sichuan Province will cost me around 6,000 yuan ($882),” Han says about the 3,000-mile trip. That’s 1,500 yuan a month ($221) more than before.” Han aslo says his gross monthly income hovers around 10,000 yuan or $1471.

Han adds that it’s unclear how long he can remain in business under the current circumstances. At some point, the higher fuel prices must be passed down the supply line.

“The cost to run the company is higher than before, but so is the cost of materials for manufacturers, even though retail prices have remained stable,” says Shao Xu, owner of the three-truck Hangzhou Transportation Company in a phone call. “We’ll try to tolerate the prices for now, but if we can’t we’ll have to charge our customers more. Production, transportation and retail are all connected. One cannot be affected too much without affecting the other two.”

“The transportation industry was very profitable five years ago because diesel was 3 yuan per liter. Now it’s about 6 yuan per liter,” Shao says. “Transportation companies charge less because the industry has become more competitive, so it’s really difficult to earn money.”

The official Xinhua News Agency reported that the price adjustment was made to ensure supply in the country by reducing the gap between international crude prices and state-set domestic oil prices.

“Clearly, every dollar paid to subsidize energy purchases is one less dollar that can be used for something else, and in a country that has huge needs,” Foss says. “Part of the subsidy is charged to the Chinese oil companies—the companies with refining operations, mainly PetroChina and Sinopec—are losing money in their "downstream" businesses,” Foss adds. “The consequence is that investment in modern refining capacity in China has not been happening fast enough to satisfy growing demand. This puts ever more pressure on global oil prices, because the Chinese companies are always trying to buy enough of both things—crude oil and refined products—to meet requirements in their country.”

Global oil prices fell more than $4 a barrel the day after China announced its price increase.

“Should Beijing bring domestic prices inline with international averages, we’d expect apparent demand to increase, rather than decrease,” Trevor Houser, a China oil specialist at Rhodium Group in New York said in a report.

“As long as the refining sector is losing money, independent producers will stay offline and Sinopec and PetroChina will be slow to add new capacity,” Houser said. “Beijing can try to strong-arm the oil majors into increasing throughput as much as they want, but the market will stay tight so long as refiners are in the red.”

Beijing has been under international pressure to let the market control domestic fuel prices, but they have been delaying raising prices, concerned that higher fuel prices could lead to inflation or civil unrest from oil shortages. In a move to soften the blow, the government set aside $2.9 billion to subsidize farmers, taxi drives, and others most affected by the price hike. It also exempted Sichuan, Shaanxi and Gansu Provinces, the areas most affected by the May 12 earthquake, from the price change.

“Almost certainly, China will raise prices of exported goods at least somewhat in order to pass along increased costs,” said Michelle Foss, chief energy economist and head of the Center for Energy Economic sat the University of Texas at Austin's Bureau of Economic Geology in an e-mail interview.

The price hike will be another contributing factor the the creeping rise of prices at major retailers such as Wal-Mart in the United States.