With China's economy increasingly sensitive to oil price volatility in overseas markets, Beijing is considering reforms to ease government controls on pricing for retail oil products.

However, such market-oriented reforms make sense only if Beijing is also willing to open the retail market to more competitors to break the duopoly of the state-owned giants, Sinopec and PetroChina.

China was self-reliant for oil until the mid-1990s. With oil production, refinery and sales monopolized by the government through state-owned enterprises, it was easy for the government to keep a tight grip on pricing. But steadily growing imports have wrought changes in the pricing regime as international oil markets remain far beyond Beijing's control.

China became a net importer of refined oil products in 1993, and of crude in 1996. By 2003, China was importing 1.8 million barrels of crude oil each day on average, with imported oil accounting for 30 percent of domestic consumption. By last year, China was importing more than 40.5 percent of the oil it was consuming.

Imports are growing inexorably. The State Council's Development Research Center projects that crude demand will reach 318 million tonnes for the whole of this year, of which 135 million tonnes, or 42.5 percent, will have to be imported.

China's remarkably fast, but energy-inefficient economic development over the past 26 years, has made it an oil-sucking country. In 1990, domestic crude oil consumption accounted for 3.5 percent of the world's total. But by 2003, consumption had more than doubled to 7.7 percent, making China the world's second largest oil consumer, although it remains far behind the United States, which took 25.7 percent of the global total oil consumption. With the Chinese economy increasingly vulnerable to world market price fluctuations, the rigid pricing regime developed in the command economy has had to be modified. However, as it has with its other reforms, Beijing has been tiptoeing forward cautiously.

In June 1998, the central government scrapped its decades-old policy of setting oil prices and began to give oil retailers a certain amount of flexibility. Under the new policy, Beijing established what it called ``government-guided prices'' which were allowed to float up or down by 5 percent.

Two years later, the government began to link pricing to international markets, using prices in Singapore as a reference in setting ``guided prices'' for the domestic market. The principle was that when Singapore prices went up or down by 8 percent, then China would adjust its guided prices.

Then, in November 2001, China began to eye not one but three overseas markets - Singapore, Rotterdam and New York - using their weighted-average prices as its reference for domestic pricing.

Despite such progress, oil pricing is still largely in the grasp of the government's very visible hand. It is a pricing regime that works when international prices are relatively stable, but when they begin to tumble violently, problems inevitably occur.

Government decisions not only lag market changes, but there are unwelcome political concerns. For instance, Beijing must consider the impact of oil price increases on the country's fledgling auto industry and on public transportation and other economic sectors that may inflame inflation.

When market forces don't determine prices, distortions occur. In the first half of this year as international oil prices soared, domestic oil producers' profits jumped while refineries recorded steep losses because they had to sell their products at suppressed prices.

To reduce potential losses, refineries began hunting overseas markets for better prices. Expecting prices to go up, wholesalers and retailers are also inclined to hoarding and attempts to corner the markets. All this has resulted in the false appearance of an undersupply, as in July, when gasoline and diesel began to run short.

Beijing is now beginning to see the light. At a seminar last week in Changchun, Cao Yushu, deputy secretary-general of the National Development and Reform Commission, the economic planning body which oversees oil pricing, revealed Beijing's projected reforms to eventually get oil pricing into step with real-time changes in international markets.

While the liberalization should be applauded, it may not achieve its goal if the Sinopec-PetroChina duopoly is not broken up. For, after the liberalization, if the two state-owned behemoths continue to control supply, prices will rise easily but fall reluctantly.

The government's work is only beginning. After pricing is liberalized and until the duopoly is broken, the government must keep a close eye on the two companies to see to it that prices will go down as well as up - which means more government supervision. Better to move quickly and break them up and expose them to private ownership. Let the invisible hand take over.

zhong.wu@singtaonewscorp.com