China Announces Dramatic Energy Price Reforms

China will raise the prices of gasoline and diesel prices at the pump by 17 to 18% and aviation kerosene by 25% starting today (June 20), and of electricity by some 4.7% starting July 1, according to the website (Chinese only) of the National Reform and Development Commission (NDRC). See also the news report by Xinhua.

These dramatic announcements coincide with the week-long high level fourth US-China Strategic Economic Dialogue (SER) in Anapolis, Maryland, USA, perhaps partially as a symbol of goodwill on China’s part. (Incidentally, the announcements also coincide with China’s annual publicity week for energy conservation.) The parties also committed to negotiate a 10 year cooperation agreement on energy and the environment. China Environmental Law reviews the basic framework of the agreement.

Pump and electricity prices in China are set by the government. These prices have been criticized as being artificially low, subsidizing China’s growing appetite for energy, and have been blamed (perhaps a little unfairly) for fueling the hike in world energy prices. Other than an 11% in crease in prices at the pump in November of last year, the government have been largely reluctant to raise prices for fear that it may exacerbate inflationary woes and hit the pockets of the poor.

On the other hand, we have already received indication from government policy statements and the draft Energy Law that some form of energy price liberalization can be expected. Though Beijing has stopped short of saying that it would allow energy prices to be completely subject to supply and demand, it will take such market prices into to account in setting its prices. The announcements come two days after China Environmental Law ran an excellent review of a recent and prescient Caijing article lamenting the missed opportunities in electricity price reform. Recently, I have also discussed to the need for energy price reforms.

So the NDRC has responded. It is not a complete liberalization of energy prices, but it is a better than expected start, i.e. a green leap forward.

Surging Crude Oil Prices

The recent precipitous run-up of oil prices from US$100 to nearly US$140 per barrel since February and the continued massive losses incurred by state oil refiners, especially Sinopec, which has to purchase crude oil on the open market at market prices but can only sell refined gasoline in the China market at fixed, low prices, is perceived as a major impetus to NDRC’s price hike move.

The NDRC has assured the public that the fares for railway passenger transport, urban public transport, rural road passenger transport and taxis will not be affected. These safeguards are to be commended as it sends a policy signal that public mass transit (okay so taxis don’t count) are energy saving transportation modes to be encouraged. The NDRC also made clear that liquefied petroleum gas, natural gas prices would not be affected.

Coal Power Also Getting More Expensive

On the electricity side, a Q&A (in Chinese only) on the NDRC website reveals that part of the rationale of electricity price increases is the reflection of the increased adoption of renewable energy power by the grid, and the need to cover the higher costs of such energy sources. If that is indeed true, I am encouraged. I have previously argued that central to the policy adopting feed-in tariffs, which is considered the most successful renewable energy policy as proven by its track record in Europe, is the sharing of the higher costs of renewable energy power across all users of power. This cited rationale for the electricity price hike send the message that the government is indeed willing to push the sharing of the cost burdens of renewable energy, true to the black letter law of the Renewable Energy Law of 2006, and gives me optimism that we shall one day see feed-in tariff policies in China.

The other stated reasons for the electricity price hike are the to rising costs of the country’s power plants, including rising coal prices (the NDRC also announced that it will cap coal prices starting at the end of this year, leading some analysts to forecast increased Chinese coal exports), increased costs on desulphuration facilities and investment in grid upgrading. The cynic in me believes these direct pressures on the coal power industry is a more likely reason for the electricity price hike (coupled with the coal price caps) than the desire to promote renewable energy. Still, I am not complaining.

To mitigate inflationary concerns, the electricity price hikes are also subject to significant exceptions. Urban and rural residents and sectors of farming and fertilizer production, as well as the quake-hit provinces of Sichuan, Shaanxi and Gansu, will be exempt from the electricity price rise. Thus, the hoped for behavioral changes really target commercial and industrial enterprises rather than individual consumers. Nevertheless, consumers may still feel the pinch to the extent that businesses are able to pass the increased energy costs of producing/providing their products/services to consumers.

Inflation Concerns and Opportunity for Productivity Gains

However, one observer believes that rather than hurting the pockets of cosumers, higher energy prices offer an opportunity for industry to boost productivity. Says Robert Bohlm, an investment banker, in a China Daily op-ed:

Will high oil prices cause China’s economic growth to slow? … Not unless the high oil prices are inflationary, in other words, not unless they increase too fast the demand for money whose supply is controlled by the central bank and is reflected in how low interest rates are. But China is capable of further massive improvements in efficiency (think of the huge potential for eventual large-scale industrial farming) that can more than make up for the impact of any price increase on inflation..Accordingly, companies have two ways to face cost increases—raise prices to customers (and risk inflation) or increase efficiency and productivity.

The more companies can pass through cost increases by raising prices, the greater the risk of inflation. The more companies can offset cost increases by increasing the amount of output per unit of higher-cost input, the less likely inflation is…China has huge still-untapped productivity improvement potential far more basic than the benefits of the Internet economy. These should enable China to experience non-inflationary domestic price increases, while rising income from the growing economy enables consumers to pay higher prices and still consume and save more.

My question is–can’t we have our cake and eat it too? Can’t we increase productivity and energy efficiency, while also consuming less?

UPDATE 7/2:  Daniel Ikeman of the Cato Institute says these price hikes are simply not enough in The Far Eastern Economic Review.