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On Thursday, China dropped a bombshell with the news that it was raising prices on refined products, gasoline and diesel. Detailed reports are confusing, not the least due to the currency and weight units used. The best I could find is gasoline from 5980 to 6980 yuan/ton, diesel from 5520 to 6520 yuan/ton, and jet fuel from 5950 to 7420 yuan/ton. However, those appear to be the wholesale price. The new retail prices are reported to be 7540 and 7040 Yuan/ton for gasoline and diesel, respectively, and represent an increase of 0.8 and 0.92 Yuan/liter.

According to this website, 1 metric ton of gasoline is 1356 liters or 357.8 U.S. gallons (1 gallon = 3.79 liters). Therefore, at the exchange rate of $1 = 6.9 yuan, the new retail price in China (5.56 yuan/liter) is equivalent to $3.05/gallon. While it's over a dollar cheaper than the prices in the U.S., it's reportedly an 18% increase. (As of last December, the price was equivalent to $2.65/gallon, but the Yuan has strengthened since then). The price increase was about 40% for diesel since the same price increase of 1000 yuan/ton is spread over a smaller number of liters (diesel is denser at about 1190 liters/ton).

Prior to this price increase, the Chinese refiners [such as China Petroleum & Chemical Corp. (SNP), and PetroChina Co. Ltd. (PTR)] took a loss on each liter of gasoline and diesel they sold. Although they receive a subsidy from the government, it has not kept up with the rising price of crude. As any rational, profit-maximizing business would do in this situation, they reduced output, resulting in lines at the pump. The New York Times had an excellent report on the situation. One thing to keep in mind is that while high prices in general attenuate demand, since Chinese refiners weren't at full capacity (and presumably now will be), it's not clear that crude demand would immediately be lowered.

I'm very heartened by this development on many levels. It was inevitable, although many thought China would delay it until after the Olympics. I'm glad that they took the pill early, and weren’t bogged down by an artificial deadline. In doing so, they did everyone a favor by removing a distortion in the energy markets. It was a triumph of free markets and a defeat of price controls everywhere. Capitalists everywhere should rejoice.

On a more personal level, I have been buying GuShan (GU) a Chinese biodiesel company that I mentioned in passing in the post on Darling International (DAR). GU is on pace to increase its production capacity to 400,000 tons in 2009 (corporate presentation). I have been averaging down (yeah, I know) lately as it dropped in anticipation of the lock-up period expiring. GU is now up over 16% on nearly four times average daily volume. It has been volatile, but I see it going much higher. For one, Chinese diesel prices are still below international levels. As stated in the New York Times article, the quality of Chinese diesel is appallingly low. On the other hand, GU's products are much cleaner and should be in demand when China raises its fuel standards as well. (See the corporate presentation. Biodiesel is inherently low sulphur.)

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Disclosure:  The author owns GU.

Source: Energy Bombshell: China Raises Oil and Diesel Prices