Korea holding down fuel prices, but it's getting harder
People refuel their cars at a gas station in Seoul, Sunday. Yonhap
During much of the U.S.-Iran war, Korea shielded its economy from the sharpest swings in global oil prices by capping domestic fuel prices and restricting exports of petroleum products. But as crude prices climb again, that buffer is becoming increasingly costly to maintain, analysts said Wednesday.
The government imposed a cap on prices for petroleum products, including gasoline and diesel, in March. Under the scheme, refiners must keep prices below a state-set ceiling even as international crude prices rise, with the government compensating them for the resulting losses.
It has helped ease pressure on household costs. Inflation slowed to the 2 percent range in both June and July, while the cap was estimated to have reduced consumer price inflation by 0.5 percentage points in August, when the headline rate stood at 3.1 percent.
The measure passed its initially announced six-month mark on Sunday, but the government is finding it increasingly difficult to unwind the policy.
Renewed escalation in the Middle East has pushed international oil prices to their highest levels since May 19. Brent crude for November delivery settled at $108.75 a barrel in London on Tuesday (local time), while West Texas Intermediate for October delivery rose 4.38 per cent to $105.83 in New York.
"Crude oil and international refined product prices are soaring, but domestic fuel prices and supplies remain stable without major disruption thanks to the price cap and controls on export volumes," President Lee Jae Myung wrote Saturday on social media.
Analysts say that stability has come at a mounting cost to refiners. The government initially set aside about 4.2 trillion won ($3.06 billion) to run the program for six months, but the industry estimates that cumulative losses have already exceeded 5 trillion won.
The government and refiners are also reportedly at odds over the scale of compensation and the methodology used to calculate losses, leaving even the first round of settlements unresolved.
"Domestic price controls could weaken cash flow if higher crude costs are not fully compensated by the government," said Benson Wu, Korea economist at Bank of America Global Research.
Prolonged price controls also risk weakening incentives to curb demand. Korean gasoline consumption reached 8.86 million barrels in July, surpassing the previous record for the month of 8.856 million barrels, according to data from Korea National Oil Corp.
"Over time, restrictions should have been adjusted to allow the economy to adapt gradually," said Troy Stangarone, a visiting senior fellow at the Korea Economic Institute of America. "The difficulty with continued price ceilings is that they suppress the market signal for consumers to conserve fuel and result in excess consumption."
Wu said the policy is likely to remain in place for some time, adding that it is manageable in the near term. Stronger-than-expected corporate tax receipts, helped by the semiconductor upcycle, had given the government more room to compensate refiners, he added.