Analysts expect energy pricing reform after NPC

Relatively low fuel prices offer Beijing window to enact changes before inflation picks up

PUBLISHED : Monday, 04 March, 2013, 12:00am
UPDATED : Monday, 04 March, 2013, 5:42am

Operators and investors in the mainland's energy sector will be eager to scour Premier Wen Jiabao's annual government work report tomorrow for the key words "price reform".

Their appearance would set the tone for the pace of energy price reform this year, which has been lagging behind the industry's expectations, partly due to the once-a-decade leadership change.

Beijing has often vowed to reform the way electricity, fuel and natural gas prices are formulated to better reflect supply and demand. They are currently stipulated by the state.

"We will make the price of electricity better reflect the price of coal," Wen said in his work report at last year's meeting of the National People's Congress. "We will reform the prices of refined oil products and proceed with the price reform of natural gas."

But in 2011, Wen added a caveat to a similar statement about Beijing's resolve on energy price reform: "We need to fully consider the ability of the people, particularly low-income people, to bear price reforms."

The need to balance Beijing's desire for energy prices to be more market-oriented and the need to keep them affordable has meant progress on reform has proceeded at snail's pace, at times appearing to have gone two steps forward and then one step back.

For example, in late 2004, Beijing launched a mechanism to link power and coal prices, under which power prices would be raised whenever coal prices rose by five per cent or more over six months, so that power producers would bear only 30 per cent of the higher coal costs, with the rest passed on to distributors and end-users.

But in the following four years, sharp rises in coal prices - partially liberalised - meant the mechanism was not enacted properly, and electricity prices rose much more slowly and more moderately than coal prices. That led to years of falling profitability or losses for power producers. After temporary relief in 2009 and 2010, losses or low profits returned in 2011 and the early part of last year, which saw Beijing impose a blanket price control on coal.

It was not until late last year, after coal prices fell sharply due to weak demand and increased supply, that Beijing relinquished its control on coal prices and announced a new indicative pricing formula that purports to more closely link electricity and coal prices.

Again, it included a caveat, saying it retains the right to intervene in coal price-setting if extraordinary market conditions result in sharp price rises.

And Beijing retains its firm grip on electricity pricing, despite having issued a policy circular a decade ago and conducted brief field trials on eventually letting power producers and buyers determine prices.

Meanwhile, the mainland's increasing reliance on imported crude oil (accounting for 56.7 per cent of consumption last year) and foreign natural gas (25.6 per cent) also exposed domestic oil refiners and gas importers to high price volatility.

Crude oil and natural gas importers are sandwiched between government policies to rein in inflation to protect the poor, and rising free-market world prices.

China Petroleum and Chemical (Sinopec), China's largest oil refiner, reported 15 billion yuan (HK$18.5 billion)of refining losses in the first nine months of last year, following a 35.8 billion yuan loss in 2011.

PetroChina, China's largest gas producer and importer, lost 21.4 billion yuan in 2011 on the sale of imported gas. US brokerage Sanford Bernstein estimates last year's loss at 30 billion yuan.

Despite a lack of action from Beijing last year, confounding expectations, analysts expect pricing reform to take place this year, after the NPC meeting.

They said relatively low crude oil and coal prices presented the government with a golden window to carry out reforms before inflation picks up in the second-half of this year.

"Recent efforts to liberalise coal prices and allow for a cost pass-through to power tariffs suggest that the government is willing to raise energy prices over time, so long as the price increase is gradual," a research report by British bank Barclays said.

Analysts at Nomura Securities pointed to a 13 per cent rail freight tariff increase that took effect on February 20 as a precursor of energy price reform.

"Now that growth has recovered while inflation remains low, the window for energy price reform has reopened," they said.

Sanford Bernstein's analysts expect fuel price reform to take place soon after the NPC meeting, kicking off more energy price reform.

CLSA's analysts tip an average 15 per cent rise in the price of natural gas this year, with a two-province trial last year to partially link the domestic price of natural gas to the price of oil expected to be rolled out to more regions.