Decoding China Pt 12

Gasoline refining margins have taken a knock in the past week. But what do falling prices on the Chinese spot market in oil products signal? Not necessarily a great deal about consumption, it turns out. Chinese consumers are driving and spending more than ever before.

Beijing introduced an unnecessarily complicated system for setting gasoline and diesel prices in 2009, which it has modified only marginally since then. The aim of this system is to retain ultimate control of pricing while allowing the market to allocate resources as efficiently as possible — essentially, China wants to have its cake and eat it.

The way it works is this: top economic planning g body the NDRC applies various costs and taxes to a weighted basket of Brent and WTI crude futures prices and physical Dubai, chucks in a 5pc profit margin, and uses the result to set a maximum pump price and a guidance ex-refinery price. China’s spot market prices for gasoline and diesel are supposed to bob in the average $15/bl gap between ex-refinery baseline and retail cap. The volumes involved are immense. This system is responsible for the distribution of much of China’s 6.3mn b/d of gasoline and diesel demand.

But it ran into trouble almost from the off, as China’s enterprising products traders reverse engineered the government’s formula and began to anticipate price adjustments. This problem continues to undermine the ability of the Chinese spot price to send a strong signal about the state of demand. Trading companies stop buying gasoline in China when the crude price is falling, because they know the government will respond by cutting the price cap on gasoline.

As a result, gasoline refining margins have halved to around $10/bl in the space of a month (see Argus China Petroleum, 25 June). But the data show demand is actually up by over 11pc this year, or 270,000 b/d, making it one of the fastest-growing markets this year.

Part of the surge in demand is necessity: the exorbitant cost of real estate in major cities forces many workers to commute long distances. But partly it is choice. China’s growing middle classes would far rather drive than pedal to work or take the bus as their parents did. And consumer confidence in China is ebullient, despite gloomy talk of economic headwinds, according to a new report from the Boston Consulting Group (BCG), which found that a growing percentage of “high-speed” consumers expect 11pc income growth this year. Car sales slowed to 1.6mn units in May but growth was still 1.2pc, year on year.

“When they make purchasing decisions, Chinese consumers pay more attention to rising incomes than to slowing economic growth,” the BCG survey concludes. The falling oil price, and the strong correlation between upstream and downstream prices in China, means these optimistic car owners are still paying 20pc less at the pump for gasoline than they were a year ago.

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