The government is maintaining its ceiling on petroleum product prices because it has concluded that holding down inflation is worth the fiscal cost. The Ministry of Economy and Finance said consumer prices would have risen as much as 3.6% last month without the ceiling, implying the measure suppressed inflation by 0.5 percentage points.
But experts warn the costs could outweigh the benefits if the exit strategy drags into winter. The budget set aside to compensate refiners for losses has already reached 5.65 trillion won, and the consumption-curbing effect is weakening as controls persist, raising the risk of damaging the market's price-setting function.
An official at the Ministry of Trade, Industry and Energy said on the 18th that the government decided to freeze the price ceiling on petroleum products despite recent increases in international crude and refined product prices, citing the burden on household budgets and the need for economic stability. A sharp fall in the won-dollar exchange rate has cushioned the oil price shock, and Saudi Arabia's official selling premium for crude sold to Asian buyers remains negative — both factors cited behind the freeze.
An immediate end to the ceiling would deliver a substantial inflation shock. The producer price index stood at 129.64 in August, up 7.9% from a year earlier, according to the Bank of Korea. Producer prices have held at a 7% to 8% year-on-year pace since April. The government also extended its temporary cut in fuel taxes on gasoline and diesel by two months to Nov. 30 from the end of this month, aiming to keep prices in check ahead of the holiday season.
The problem is that side effects are mounting the longer controls stay in place. Domestic gasoline consumption fell 7.4% from a year earlier in April to 1,155,606 kiloliters. The ceiling at the time was in the 1,900-won-per-liter range, and consumption dropped in response to the price signal as retail prices jumped. But since May, with the ceiling largely unchanged, the decline in consumption has stalled at 1% to 2%.
"Consumers respond not only to the price itself but to changes in it," said Son Yang-hoon, an economics professor at Incheon National University. "Had domestic prices been linked to international prices, consumption would have fallen accordingly, but suppressing prices prevented that adjustment from happening properly." An official in the refining industry said it would have been better to target support at vulnerable households hit by higher oil prices rather than lowering prices across the board, adding that the price discovery function faces greater risk of breaking down in winter, when heating demand picks up.
Some also argue that the widening gap between domestic and international petroleum product prices is driving excessive fiscal spending. When the current ceiling was set at the end of June, Dubai crude was trading below $70 a barrel on a spot basis on the Singapore Exchange. This month, as tensions in the Middle East intensified, it topped $100 a barrel on the 2nd and broke through $120 on the 9th. Brent and West Texas Intermediate are also above $100.
The government initially assumed the ceiling would remain in place for about six months this year and allocated 4.2 trillion won for loss compensation in a supplementary budget. It then earmarked 1.4497 trillion won in next year's budget proposal for fourth-quarter compensation, meaning it estimated a total of 5.65 trillion won for three quarters of the ceiling program this year.
Even with the money set aside, the government has been slow to settle the payments. It launched a committee in July to calculate compensation for refiners but has yet to complete even the first settlement, covering March 13 to June 30, because it has not resolved differences with the industry over payment criteria. Refiners argue that compensation should be based on prices for products traded on international markets and cover opportunity costs, while the government maintains it will cover operating losses based on accounting costs. The government plans to collect first-round settlement data from the industry by the end of this month and review compensation amounts by year-end.
