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Rising Oil Prices Impacts Korean Economy Severely

Wednesday, April 13th, 2011

The Oil Price Task Force (TF) pulled out its sword in January with a grim resolution to tackle the skyrocketing oil prices. But the result was disappointing, to say the least. The report – announced three months after the TF’s establishment – was criticized as measures filled with vague and abstract solutions. The 3.9% inflation rate in March, the highest in 21 months, already was making Korean citizens apprehensive, and the TF’s announcement seemed to just pour oil on the flames. Since the TF’s announcement last Wednesday, the public has been urging the government to lower oil taxes to lessen their burden.

In January, President Lee Myung-bak ordered his government to monitor petroleum product prices in the nation’s domestic market. He stressed the need to deal with the price instability and called for a more transparent pricing system. With the highly increasing crude oil prices and soaring inflation prices, the oil industry could not but face the scrutiny of the government. For a more appropriate pricing system, President Lee directed the TF to investigate into the four major local oil refineries – GS Caltex, SK Innovation, S-Oil and Hyundai Oilbank – for alleged price-fixing of oil products and unfair trade actions. So, the biggest issue for the TF was whether it would be possible to lower the oil tax, find price fixing among oil refineries, and determine of there were asymmetries price setting in crude oil.

Not surprisingly, the TF found many asymmetric practices in oil price settings. The oil refiners raised gasoline and other oil prices when international crude oil prices increased, but when the prices fell, they were slow to lower the prices to gain more profit. Lee Kwan-sup, head of energy industry policy at the Ministry of Knowledge Economy, said at a press conference announcing the result of the TF’s findings that “in the recent 30 years, there were six cases of asymmetric practices in Korea.” According to the TF, the domestic oil refineries raised gasoline prices last year by 0.04 dollars per liter more than the global prices, and gasoline prices were up by 0.03 dollars per liter compared with international prices. However, the TF also stated that similar cases of asymmetric price settings were found in America, Canada, and Sweden, and there isn’t any fundamental solution to tackle the asymmetric price settings.

The TF also mentioned that Korea’s domestic oil pricing system is not benchmarked on the New York Mercantile Exchange (NYMEX), but on the Means of Platts Singapore (MOPS). TF also claimed that since oil products are “joint products,” it is difficult to estimate the production cost of oil products. Prices on the MOPS are based on the cost of the refined product, so the refinery cost is included and indexed in it. MOPS has a premium over crude oil prices because the buyer prefers a refined product. Thus, by basing their fuel prices on MOPS, local refiners in Korea set prices higher than those of crude oil. Compared to NYMEX, the public charts of the MOPS prices are not available to individuals, but only to those who purchase it. So, the TF announced that oil prices will be fixed that reflects the national market situation by calculating a standard price, which adds tariffs, taxes, distribution costs, and profit to the MOPS.

The government’s current stance of not lowering the oil tax raises apprehension that these measures will decrease tax revenue. Also, the government did try to lower the oil prices by lowering the oil tax three years ago. In 2008, the government cut the petroleum flexible tax rate by 10 percent, lowering the tax by 0.08 dollar per liter, and lowering the petroleum import tariff rate from 3 percent to 1 percent. On top of that, a government subsidy was issued, drawing up a $4.4 billion supplementary budget to tackle high oil prices and support the low-income bracket. As they were not very effective, these measures ended shortly.

As a temporary measure, starting last Thursday, four domestic oil refineries began to cut gasoline prices by 10 cents per liter. But reports by Consumer Korea, a professional consumer organization, stated that only 22.5 percent of the oil stations were following the price cut measure.

Public and watchdog groups, including Oil Price Watch Consumers of Korea, claim the oil prices can be stabilized by lowering the oil tax. According to Oil Price Watch Consumers of Korea, on the first week of October 2010, the oil tax was 0.85 dollars per liter. However, the tax was increased along with the international oil price increase each week, and on the fifth week of March 2011, the tax was 0.88 dollars. According to media reports, more than half of the oil price money was given to the government as tax, which was more than $11 billion. This amount was a 40 percent increase compared to 2009.

In response to the raging public opinion, the government said that there may be room for lowering the oil tax. Minister of Knowledge Economy Choi Joong-Kyung remarked at the National Assembly yesterday that the government’s policy is to “consider lowering the oil tax when the Dubai crude oil price remains above $130 per barrel.”

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