Although adopting a market-oriented approach is the ultimate goal of China's refined oil pricing mechanism reform, a government-dominated pricing system in which the market plays an increasingly important role will be in place in the short term.

Recent fuel shortages in some areas were caused by the current refined oil pricing mechanism, according to media reports.

China has reformed its refined oil pricing mechanism three times since 1998.

According to the current pricing mechanism, which was established in 2001, refined oil prices are based on the weighted average prices on three futures exchanges - Singapore, Rotterdam and New York. The National Development and Reform Commission (NDRC), by adding other fees and taxes, set a benchmark refined oil retail price, which could be adjusted by a maximum of 8 per cent either up or down by PetroChina and Sinopec, China's two largest oil companies, to determine the final retail price.

Once the monthly fluctuation ranges of spot oil product prices in the three international trading centres exceed 8 per cent, the NDRC adjusts domestic prices.

In general this pricing mechanism works well, to a large extent attributable to a favourable international environment in recent years with oil prices remaining relatively stable.

But international crude oil prices have kept surging since 2003, increasingly putting pressure on the current refined oil pricing mechanism.

Global crude oil prices are mainly influenced by three factors - oil output, demand and political jostling for the resource. Since 2000, oil supply has only increased by a limited margin while demand has kept growing, which, combined with dynamic political situations, has dramatically changed the landscape of the international oil market.

Now, with the era of low oil prices just a memory, the international community must face up to the reality of high costs.

The dramatic changes have also exposed serious flaws in China's existing refined oil pricing mechanism, which was adopted at a time when prices were relatively stable, and made reform absolutely imperative.

According to statistics, the international crude oil price has more than quadrupled since 1999. The price has soared from US$24 per barrel in 2002 to US$66 per barrel last month.

Responding to these changes, the government has adjusted retail refined oil prices seven times since March 31, 2004. But among those seven rounds of adjustments, only one was a price cut.

Even when the international crude oil price was in a downward spiral for a while last October, the domestic oil price was not adjusted down in line with the shift.

Fearing the likely impact high oil costs will have on the national economy, the government only raises prices in a small range. The global oil price has increased by more than 60 per cent since earlier this year while the domestic refined oil price has only gone up by 22.5 per cent so far.

The relatively low domestic refined oil price misleads consumers, to the detriment of the country's long-term energy supply.

The relatively low oil price does not discourage consumers from buying large-engined cars that burn a lot of fuel.

Under the current mechanism, only China's import crude oil price is in line with that on the international market. But its refined oil price, due to the time it takes for domestic prices to reflect international movements, cannot be promptly adjusted according to changes in the international arena.

Under these conditions, oil refineries' costs soar due to the surging import crude oil price, but because the price of their final products remains unchanged, the more they refine, the more losses they suffer.

The current pricing mechanism is also likely to fuel speculation in the oil market.

Domestic oil retailers can easily judge the basic movements of the domestic refined oil price by observing global trends.

Once they forecast a price hike, they will attempt to stash the inventory and wait for the price to rise, which will distort the market, especially in terms of supply.

But the current refined oil pricing mechanism fails to faithfully reflect the impact international oil price fluctuations have on our domestic oil market. As such, reforming the current mechanism should be high on the government's agenda.

The refined oil pricing mechanism reform should go hand in hand with price controls in order to avoid a likely overall price hike.

As oil is directly or indirectly related to many sectors, price fluctuations will have widespread effects.

If the refined oil pricing mechanism is to be reformed at a time when international prices keep surging, expectations of a hike will result in increased costs of many products and services.

Considering the international oil price is still spiking with significant and frequent fluctuations, it may not be appropriate to introduce a market-oriented pricing mechanism for the time being, although this is the ultimate goal of the oil pricing mechanism reform.

The oil industry is both a competitive and a fundamental economic sector. That means reform of the refined oil pricing mechanism should follow a market-oriented approach but at the same time government regulation is vital.

As energy production is a competitive industry, the refined oil price should in theory be set by market forces.

But for a sector with price fluctuations that have a huge impact elsewhere, reform of the refined oil pricing system should be handled with prudence.

The domestic refined oil market is not yet fully mature and wholesalers are not adequate for the market.

In such circumstances, if the refined oil price were to be decided completely by the market, it would inevitably enable some incumbent oil giants to monopolize and profiteer. In addition, it would also encourage oil smuggling.