Oil price cap freeze raises concerns over market distortions, fiscal strain

A driver refuels a vehicle at a gas station in Seoul, Sunday. Gasoline and diesel prices are displayed at 1,986 won ($1.34) per liter as the government's oil price cap aims to ease energy supply pressures linked to the Middle East crisis. Yonhap

The government’s decision to keep the third-round oil price cap unchanged from the previous level is raising concerns over potential market distortions and mounting fiscal strain amid ongoing volatility in global oil prices linked to the Middle East crisis, analysts said Sunday.

By capping prices, the policy weakens the link between domestic fuel prices and global benchmarks, adding pressure on refiners’ margins, they warned.

The government introduced the fuel price cap system on March 13 to curb a surge in domestic oil prices. It adjusts ceilings on fuel prices supplied by refiners to gas stations and distributors biweekly, based on movements in global oil prices.

The Ministry of Trade, Industry and Resources maintained the third round of price ceilings on gasoline, diesel and kerosene, leaving them unchanged levels for the next two weeks, effective from Friday, aiming to ease the burden of price volatility for consumers.

Under the measure, the maximum prices were kept at 1,934 won ($1.30) per liter for gasoline, 1,923 won for diesel and 1,530 won for kerosene.

The latest decision ran counter to market expectations for a higher price ceiling, as recent trends pointed to upward pressure.

The Mean of Platts Singapore (MOPS), a global benchmark for refined oil prices used by Korean companies, rose over the past two weeks, with gasoline up 1.6 percent, diesel surging 23.7 percent and kerosene gaining 11.5 percent.

Although global crude prices briefly fell following a temporary ceasefire deal between the United States and Iran Wednesday, the two-week average still pointed to an upward trend.

However, the government opted to hold prices steady, citing concerns over the cost of living.

Analysts warn the move risks undermining market mechanisms.

"Like other consumer prices, fuel prices should be determined by the interaction of supply and demand, but the cap system is beginning to distort the market," said Kim Dae-jong, a professor of business administration at Sejong University.

"Fuel demand would typically weaken during an energy crisis, but consumption has instead increased in recent weeks. This adds to the burden on refiners, who are unable to raise prices in line with international market trends," he said.

Unintended consequences are already surfacing on the demand side. Data from the Korea Petroleum Quality & Distribution Authority showed gasoline sales rose 24.7 percent and diesel 16.3 percent in the fourth week of March from a week earlier, indicating that the suppressed prices have weakened incentives for consumers to cut back on fuel use.

The fiscal burden stemming from price controls is also becoming a growing concern, as the government has said it will compensate refiners for losses resulting from the gap between rising global oil prices and capped domestic prices.

The industry ministry has earmarked 4.2 trillion won for the policy, but the burden is expected to grow if the Iran crisis drags on.

Some critics say the price ceiling system, initially intended as a short-term measure, is being extended beyond its intended use.

In a March 23 report, researchers at the Korea Institute for Industrial Economics and Trade said the oil price cap should be used only as a short-term market stabilization tool rather than a long-term policy.

"While the cap may help slow the pace of price surge and ease consumer burden in the near term, it could lead to side effects and reduced supply over the long term,” the report said.