Seventh round of price cap to proceed as scheduled; oil seen staying above $90 per barrel for now; two-to-three-week lag in price pass-through, exchange rate adds uncertainty

Drivers refuel at a gas station in Seocho-gu, Seoul. [Yonhap]
Drivers refuel at a gas station in Seocho-gu, Seoul. [Yonhap]

With the United States and Iran reaching a ceasefire deal, debate is expected to intensify over whether South Korea should end its petroleum price cap — a market intervention the government has maintained for more than three months. The three conditions the government set for lifting the cap — an end to the war, normalization of the Strait of Hormuz, and international oil prices falling to around $90 per barrel — have in effect been met, and calls to withdraw from market intervention are growing louder. The government, however, says it will weigh the timing of any exit comprehensively, noting that oil price changes feed through to domestic prices with a lag and that exchange rate volatility remains a concern.

On Monday, the day the United States and Iran announced plans to sign a memorandum of understanding ending hostilities, Brent crude fell to around $83.80 per barrel on international markets, while West Texas Intermediate dropped to roughly $81 per barrel. Dubai crude — the benchmark for South Korea's oil imports — fell $4.50 from the previous week to $89.70 per barrel.

According to Opinet, the oil price information system run by the Korea National Oil Corporation, the national average retail price of gasoline during the second week of June (June 7–11) was 2,009.9 won per liter, down 0.5 won from the previous week. The average retail price of diesel fell 0.3 won to 2,004.8 won per liter.

The three conditions the government had set for ending the petroleum price cap have in effect been met. Kim Jung-kwan, minister of trade, industry and energy, said at a press briefing on May 27 that the government could consider ending the price cap "once the war ends, the Strait of Hormuz returns to normal, and international oil prices reach an appropriate level of around $90 per barrel."

The Ministry of Trade, Industry and Energy plans to assess whether to maintain the price cap after observing the ceasefire signing ceremony scheduled for Friday local time. The seventh round of the petroleum price cap — set to be announced on Wednesday — is widely expected to proceed as planned, given that the decision will be made before the signing takes place.

A ministry official said the seventh round announcement on Wednesday falls before the ceasefire signing ceremony, meaning "it cannot be said that the Middle East war has ended and the Strait of Hormuz has been fully reopened," adding that the round would "most likely proceed as scheduled."

The petroleum price cap has been in effect for roughly three months since its introduction on March 13, shortly after the Middle East war broke out. The government has set the domestic petroleum retail price ceiling below the crude import cost on six separate occasions. The maximum price for gasoline has been held at 1,934 won per liter for four consecutive rounds — the third through sixth — while the diesel ceiling has been fixed at 1,923 won per liter.

Critics argue that maintaining the price cap for more than three months has distorted market price signals and increased the fiscal burden on the government. When drawing up a supplementary budget, the government set aside 4.2 trillion won (approximately $2.76 billion) in contingency reserves on the assumption that the cap would remain in place for six months. The refining industry has estimated cumulative losses at roughly 4 trillion won.

Despite the ceasefire, many analysts expect ending the petroleum price cap will not be straightforward, given ongoing inflation concerns.

A report released last month by the Korea Energy Economics Institute on international oil and natural gas import price outlooks found that even if a truce or peace agreement is reached, oil prices are likely to remain above $90 per barrel for now.

The impact of higher oil prices continues to show up in domestic prices. The producer price index for April stood at 128.43, up 2.5 percent from the previous month — the highest monthly gain since February 1998, during the Asian financial crisis. The domestic supply price index, which includes imported goods, surged 5.2 percent month on month.

It typically takes two to three weeks for a drop in oil prices to be reflected in petroleum product prices. International oil prices remain well above the roughly $60 per barrel seen before the Middle East war. Even with the price cap in place, domestic petroleum prices surged 24.2 percent last month, pushing overall consumer prices up by 0.92 percentage point. If accumulated price pressures are released all at once after the cap ends, the inflationary shock could be even greater.

The exchange rate is another variable. With the won-dollar rate surging into the 1,500-won range, much of the benefit from lower oil prices has been offset by higher import costs. There is hope that reduced Middle East war risk could stabilize the foreign exchange market, but analysts note that the won's recent weakness has been driven largely by net selling of Korean shares by foreign investors, which could limit any currency recovery.

If the won continues to weaken, higher energy and raw materials costs are likely to feed back into consumer prices. Even if oil prices fall, a high exchange rate means domestic consumers will feel little relief from lower import prices.


oskymoon@heraldcorp.com