China should push forward the pricing mechanism reform of energy products, despite concerns that the move may add to inflationary pressure, economists said.

"It's urgent to continue the reform, as the distortion of energy prices is having an increased impact on the economy," Wang Yiming, vice-president of the Academy of Macroeconomic Research, said. The academy is affiliated to the National Development and Reform Commission.

Energy prices in China are mainly decided by the government. Over the past year, it has managed to hold down the prices of electricity and refined oil products, which is seen as an effort to rein in inflation. But the move has led to the loss of energy producers, which then chose to suspend part of their operation, as soaring oil and coal prices eat into their profits.

Analysts and government officials have long been advocating for a reform of the energy pricing mechanism, which could link refined fuel prices with production costs.

The government moved to test the idea in the electricity sector in 2004, as it decided to review electricity prices every six months and make adjustments if it deemed it necessary. The government said earlier that they would extend the reforms to the fuel sector, which could bring China's under-priced fuel in line with the international market.

Yet, the reform was kept at bay as inflation started to pick up from last March. It shot to a 12-year record of 8.7 percent in February this year. The government worried energy price hikes would translate into a spurt of consumer inflation. Moreover, rising energy costs could deal another blow to the manufacturing sector, which already suffered from weakening overseas demand and rising labor costs.

"The more the energy prices are held down, the more severe the power shortage may become," said Liang Hong in a conference held by the National Bureau of Statistics earlier this month. "And power shortages are also taking a toll on the economy, just like inflation."

Shandong Province, a long-time electricity supplier for neighboring provinces, has suffered from sporadic blackouts since May this year, according to China Business News. In the first five months, the 179 power plants in the province suffered a loss of 3 billion yuan (US$438 million), due to the control on electricity tariffs and surging coal prices. And most plants were unwilling to increase their production, despite the power shortages.

According to the NDRC, the average operation time of coal-fired power plants across the nation declined 50 hours in the first half compared to a year ago, despite the fact the figure had already declined by 133 hours in 2007.

"The current power supply strain is mainly due to the coal shortage, rather than insufficiently installed power generating capacity," Zhang Guobao, vice-minister of the NDRC, who also heads the newly established National Energy Administration, said in a news conference held on Monday.

The NDRC raised the on-grid price of power supplied by coal-fired plants by an average 5 percent from yesterday, but required the retail power price to remain unchanged so that final users would not be impacted. The move will pass some of the cost burden from power plants to State-owned power grid companies, which may receive government subsidies later as compensation.

In June, the government also moved to jack up retail gasoline and diesel prices by 17-18 percent, the first increase in eight months, following months of spreading fuel rationing as refiners cut production to trim deepening losses incurred by record crude costs.

"These are the policymakers' move to correct distortions from price controls that have caused widespread power shortages this summer," Ken Peng, an economist from Citigroup, wrote in a research note. "Economic activity was most likely hurt by the lack of sufficient power supply in July and August, and it may have further slowed down growth in the third quarter."

Analysts say an adjustment of fuel prices may even help curb inflation, as a higher price is likely to curb China's oil consumption, which would also help bring down oil prices in the international market.

(China Daily August 21, 2008)