Energy price strategies that will matter

Zhang Chengliang / China Daily

Stable costs for energy can help China achieve future prosperity and growth with less guesswork

Though China has signaled its intention to let the market play a decisive role in allocation of resources, it would need to make considerable progress on energy pricing to achieve tangible results in the long term.

Decisive steps on energy pricing will also help reiterate the government's strong commitment to reforms, and indicate the way forward for energy producers and consumers.

Since 1984, China has dabbled with energy reforms in one form or another. While the focus of these reforms has been to move away from a centrally monitored pricing mechanism to a more market-driven approach, the pace and scale of reforms have differed for various types of energy.

Among these reforms, the coal-pricing mechanism that has drawn much attention, especially in terms of pace and scope. The first major reform in this sector was the dual pricing system, which was introduced in 1984. Enterprises were required to sell a quota of coal at prices that were set by the central government and the rest at prevailing market rates. In 1993, the central government decided to adopt a pricing mechanism based on usage patterns.

Under the dual-pricing system, coal prices for non-utility use - the so-called market coal - were determined by the market. But the price of coal for utilities - the so-called power coal - was based on the guidance price set by the National Development and Reform Commission, often at rates lower than prevailing market rates.

In 2004, the commission decided to use price bands for fixing coal prices. Though the mechanism involved extensive discussions with coal producers and electricity generators, it was scrapped in 2006.

The commission also proposed, in May 2005, that it would consider a coal-electricity price "co-movement" mechanism that would allow power tariffs to be raised if coal prices rose by 5 percent or more over a six-month period. The scheme also allowed power generators to pass up to 70 percent of the increased fuel costs to grid companies.

However, in December 2012, the State Council announced the abolition of the dual pricing system for coal, and shifting to market-based pricing.

At the same time, it tweaked the coal-electricity price co-movement mechanism and allowed adjustment in power tariffs if coal prices fluctuated by 5 percent or more in a 12 month-period and permitted electricity generators to pass up to 90 percent of increased fuel costs to grid companies, instead of the existing 70 percent threshold.

Like coal, a dual pricing system for crude oil was introduced in 1984, and was virtually eliminated in 1993. Since 1998, domestic crude oil prices have tracked international prices, but refined oil product prices have not.

To address this disconnect, the government has, since May 2009, implemented a pricing mechanism by which it can adjust domestic petroleum product prices if the moving average of a basket of international crude oil prices, on a composite basis, rise by more than 4 percent within 22 consecutive working days.

To better reflect refiners' costs and adapt to fluctuations in global crude oil prices, in March last year the commission launched an automatic petroleum product pricing mechanism, shortening the 22-working-day adjustment period to 10-working-days and removing the 4 percent threshold. The government also decided to adjust the composition of the basket of crude to which oil prices are linked.

Reforms have also been undertaken for natural gas prices. A breakthrough in the reform area has been changing the existing cost-plus pricing to the "netback market value pricing" in Guangdong province and the Guangxi Zhuang autonomous region.

Under the new pricing mechanism, pricing benchmarks are selected and pegged to prices of alternative fuels to establish a price linkage between natural gas and its alternative fuels. Gas prices at various stages will then be adjusted accordingly.

Before introducing the Guangdong and Guangxi pilot reform program to the entire country, the commission plans to implement three-tier-tariffs for household use of natural gas across China by the end of next year. These price reforms and the pilot scheme in Guangdong and Guangxi help to establish a market-oriented natural gas pricing mechanism that fully reflects demand and supply conditions.