China's proposed new fuel-pricing mechanism, which better aligns domestic prices with those in free markets, will translate into more fuel price cuts in the coming months with global crude rates plunging in the second half of the year.

But the jury is still out as to how big refining margins oil companies can enjoy as there is a lack of detail about the new cost-plus model, particularly as the government has said it will retain suitable price regulations, analysts say.

According to a proposal by the National Development and Reform Commission on Friday, China will raise the consumption tax on gasoline and diesel while abolishing some fixed road fees from next month. Since the government said there will be no increase in retail prices as a result of the tax hike, car drivers are paying effectively about 14 percent less.

China hasn't adjusted fuel prices since June, when crude soared to over US$140 a barrel, so it has room to cut retail diesel and gasoline prices by 26 percent and 37 percent, according to Goldman Sachs. Crude was below US$50 yesterday, making China's retail prices more than 60 percent above the level in the United States.

A Shenyin & Wanguo Securities report said China may cut fuel prices by 600 yuan (US$87) a ton, or 9 percent, next month, while China International Capital Corp said price cuts would come in several rounds.

The NDRC also proposed changing the mechanism for setting retail prices to a cost-plus formula, which provides closer links between domestic fuel prices and international oil prices while ensuring a reasonable profit for Sinopec and PetroChina Co.

Factory-gate fuel prices will be formed based on crude prices, refining costs and taxes and a "reasonable profit" for refiners, the NDRC said, adding that a ceiling would be imposed on retail prices.

"Although China hasn't defined what is a 'reasonable' profit margin, PetroChina and Sinopec should both be happy that this new pricing mechanism should prevent a repeat of their massive refining losses suffered in the first nine months this year," Gordon Kwan, an analyst with CLSA, a brokerage and investment group, said.

Shanghai Securities News has reported that China may allow a full link between domestic prices and international ones when oil is below US$80 a barrel, while ensuring an unspecified refining margin for oil firms when crude is between US$80 and US$130, and prices will be set by the government when it is above US$130. CLSA is forecasting US$60 and US$75 a barrel for Brent crude for 2009 and 2010.

Sinopec rose 2.19 percent and PetroChina grew 2.42 percent in Shanghai trading yesterday. China's refining industry posted huge losses in the second half of last year and earlier this year.

(Shanghai Daily December 9, 2008)