The declining price of oil in the international market has caused people to question the domestic pricing mechanism, as prices in China have not followed this trend. Wang Zhen, Director of the China Energy Strategic Research Institute at China University of Petroleum addressed this issue in an interview.

Why are international oil prices falling?

Can you briefly explain the reasons for the sustained decline of oil prices in the international market?

Wang Zhen: The price of oil in the international market has recently dropped by 20 percent. The main reason for this is the absence of any serious disaster in the US during the hurricane season which raised oil inventories to a record high. The relatively peaceful geopolitical situation has also contributed to the decline. Funds usually play an important role in the rise and fall of oil prices. It is difficult to predict whether oil prices will continue to decline. While OPEC has cautiously reclaimed its role as the biggest player in the oil market, the northern winter is approaching and this means a significant increase in oil demand.

Lawrence Eagles, head of the International Energy Agency (IEA) Oil Industry and Markets Division said that this is low season for oil. As demand peaks in winter, oil demand in the fourth quarter is expected to be extremely high. Temperatures this winter may be even lower than expected leading to a greater need for oil. Winter is approaching and this must be taken into account.

The link between domestic oil prices and international oil prices

What is the link between the domestic price for oil products and international crude oil prices?

Wang Zhen: Since 1998, the price mechanism governing China's petroleum industry has been reformed three times. On June 3, 1998, the former State Development Planning Commission introduced the Oil & Refined Oil Price Reform Program, which stipulates that the price of crude oil be settled in negotiations between China National Petroleum Corporation and China Petroleum and Chemical Corporation. Government referential prices became effective for petroleum and diesel. The former State Development Planning Commission sets a benchmark price for crude oil according to the after-tax cost of crude oil after taking into account domestic circulation fees. China National Petroleum Corporation and China Petroleum and Chemical Corporation can then set the retail price within a 5 percent range of that figure. Although this program is more advanced than that used in the era of the planned economy, a fatal flaw in the current pricing mechanism was revealed just one year after it was adopted; based on this fixed formula, both oil suppliers and consumers can determine the movement of oil prices in advance. This excessive price transparency led to excessive speculation in the domestic oil market.

From June 2000, China tried to keep domestic refined oil prices in line with the international oil market. The Singapore market was used for referential prices at the time.

In November 2001, China reformed the pricing mechanism yet again. At the core of this reform was a severing of the link between domestic oil prices and international oil prices. The oil markets of Rotterdam and New York also began to be used as price references. When the international price of oil is within the scope of 5 percent to 8 percent, China's domestic oil prices will not change. When international oil prices fluctuate beyond that range, the former State Development and Reform Commission will adjust benchmark prices.

Domestic oil price hikes depend on level of consideration

Why did the price of oil rise in line with the international oil market, but not fall with it?

Wang Zhen: Since 2002, the State Development and Reform Commission have adjusted the domestic price of refined oil. However, the lengthiness and the size of the price hike meant that price adjustments were not entirely synchronized with that of the pricing mechanism. As a result, the rising price of crude oil in the international market was immensely profitable to oil companies at the higher echelons of the industry but those in the lower suffered. Consumers were also confused about the increasing price of refined oil products.

China's purpose in implementing this policy change was to stabilize domestic oil prices. At the time, international oil prices were relatively stable. The volume of crude oil that China imported was not significant. Consequently domestic oil prices were relatively free of the impact of fluctuations in international oil prices. Even with the implementation of a refined oil pricing mechanism, domestic prices remain unchanged in the event of minor price fluctuations in the international market. However, rapid and significant price increases were unprecedented. The government chose not to adjust the price entirely in accordance with the established pricing mechanism because it would have pushed up prices enormously, which would have been difficult for people to accept. The State Development and Reform Commission there for chose to adopt a policy of moderate and gradual adjustment. However, the question remains as to whether to lower the refined oil prices after a decline in international crude oil prices. This will depend on the difference between the price of refined oil on the domestic market and crude oil on the international market.

Domestic oil prices to gradually merge with international prices

If there is to be a delay in the alignment of domestic and international oil, how long do you expect this delay to be?

Wang Zhen: My personal view is that we should gradually shorten this time delay until the two entirely converge. It is very important that the pricing mechanism works properly. A market-oriented pricing mechanism will play a big role in pushing forward a rational distribution of resources and energy saving. If prices are gradually straightened out, oil companies will have no reason to blames losses on refining industry policy. The community will no longer have such great expectations of the government in terms of price adjustment. The Chinese government has attached great importance to reforming the oil pricing mechanism. The key here is in opportunities. The consumption of refined oil will have an influence on industrial and agricultural production, transportation and other important industries. The fluctuation of refined oil prices directly influences production and people's lives. A drop in world oil prices would create a rare opportunity for the smooth implementation of a comprehensive reform of refined oil prices.

Editor: Yan