As the cease-fire between the United States and Iran collapsed and international oil prices surged again, the government is struggling over when to end the oil price cap system. The government has imposed a cap on retail prices of petroleum products since March, after war broke out in the Middle East.
As international oil prices turned downward with progress in end-of-war talks, the government lowered the cap for the seventh time last month with an eye to ending the system. But with the war resuming and volatility in international oil prices growing, the review of when to halt the measure has gone back to square one. For now, the government has settled on a "period extension."
A plan for the government to compensate refiners for losses incurred under the price cap has also hit a snag amid a recent prosecutors' investigation into collusion among refiners. As the government and the refining industry prepared to calculate the size of loss compensation, possible indictments by prosecutors emerged as a variable.
With the resumption of war, the United States re-blockaded the Strait of Hormuz and announced tolls, sending international oil prices soaring again. According to Korea National Oil Corporation (KNOC) Petronet on the 16th, as of the previous day in the Singapore spot market, the international diesel price was $146.78 per barrel, up about 27% from early this month ($115.90).
International diesel prices moved around $70 per barrel early this year, then jumped more than fourfold to as high as $291.80 on Apr. 2. They fell to the $110 level late last month on cease-fire talks between the United States and Iran, then surged again with the resumption of war. Diesel is an essential industrial input used in large freight trucks, construction machinery and manufacturing, so prices are highly sensitive to supply conditions.
International gasoline prices, which fell below $100 late last month, have risen about 11% this month. Gasoline tends to have smaller price swings than diesel.
Considering the downtrend in international oil prices following an end-of-war agreement, the government cut the seventh price cap, in effect since the 27th of last month, by 150 won per liter for both diesel and gasoline. Because this was the first cut since the second round of the cap, some saw it as a step toward ending the system.
However, as the Middle East war has intensified again, the oil price cap is expected to remain in place for the time being. The government has previously cited conditions for ending the cap, including an end to the war in the Middle East, stabilization of international oil prices below $90, and the substantive normalization of transit through the Strait of Hormuz.
The eighth oil price cap to be announced next week is widely expected to be frozen at the seventh-round level, considering inflation pressures. An energy industry official said, "Even if international petroleum product prices rise, it is hard to raise the domestic cap again," adding, "Once the system is ended, it is even harder to reinstate it, so the government appears to be in a difficult position to fix an end date."
Yang Gi-uk, head of the Industrial Resource Security Office at the Ministry of Trade, Industry and Resources, said, "International petroleum product prices jumped suddenly recently, but compared with March, when the war broke out, they are still lower," adding, "We will decide when to end the oil price cap system in light of the overall situation."
Loss compensation for refiners, which the government promised as a quid pro quo for the price cap, is also expected to face difficulties. In March, the government set wholesale price ceilings for refiners and, in return, said it would cover refiners' losses from the budget. It also set aside a 4.2 trillion won earmarked reserve to fund the compensation. The government had planned to launch a settlement committee this month to calculate the loss amount.
But early this month, prosecutors indicted a refiner on charges of colluding to fix prices after the Middle East war broke out, raising doubts about the need for loss compensation itself. Prosecutors reportedly believe refiners inflated costs and have challenged the premise that refiners suffered losses under the price cap.
With legal risk surfacing just as the refining industry and the government were due to begin full-fledged talks on the size of compensation, the industry is keeping quiet. The refining industry has long been at odds with the government over how to calculate losses.
Soaring refining margins during the price cap period, which improved profitability, are also weighing on refiners. According to FnGuide, the four refiners posted a combined operating loss in the low 1.2 trillion won range in the second quarter of last year, but are expected to have booked a combined 5 trillion won in operating profit in the second quarter of this year. With results improving, refiners believe public opinion is not favorable toward compensating their losses.
Kim Tae-hwan, head of a research office at the Korea Energy Economics Institute (KEEI), said, "The longer the oil price cap runs, the greater the government's fiscal burden could become," adding, "The government will make a decision that aligns with policy priorities after comprehensively considering the benefits and drawbacks of maintaining the cap."