The two key objectives of energy price control are price stability and clearing the market (supply matching demand). But covering energy shortfalls when there is rapidly rising demand at home and abroad is inconsistent with maintaining price stability. This is fundamentally why the NDRC cannot hold prices stable permanently: and energy shortages have become a larger problem than price rises. But what explains the timing and size of the price adjustment now.

To be sure, there is no simple answer.

Under a price regime like the one that controls China’s energy markets, the policy authorities have to balance several competing voices as they try to achieve two conflicting objectives in a rising market. They would be keenly aware of pressures in the global market and the global wave of protests over rising fuel costs in response. But they also have to deal with active lobbying from domestic oil refineries whose profits are squeezed when the cost of their inputs rises but the price of their product is fixed. Getting this right is a balancing act where no one is left happy.

Yet the interests of the Chinese oil refineries is not so straightforward as it seems. China’s largest fuel companies not only operate the vast majority of China’s refineries, they also produce much of China’s oil and dominate the retail distribution of gasoline. And they are responsible for importing most of the oil not produced domestically.

When Sinopec (0386.HK: Quote, Profile) and PetroChina (601857.SS: Quote, Profile) lobby the NDRC to raise gasoline prices, they focus on the profits and viability of their refining arm, which PetroChina’s 2007 Annual Report described as incurring heaving losses leading to the cessation of production in certain areas.

However Sinopec not only imports oil from other suppliers but also has foreign oil assets of its own. It is a significant player in the international and Chinese oil business dealing in international prices, as well as a supplier to its domestic refineries into controlled markets. From Sinopec’s 2007 Annual Report (pdf), Sinopec’s before tax profit last year was almost RMB83 billion (about AU$13-14 billion). PetroChina has a larger proportion than Sinopec of its business in oil production rather than refining. PetroChina reported in its 2007 Annual Report before tax profits of just over RMB200 billion (around AU$33-34 billion).

So when oil companies complain that prices are too low, consumers in China, like consumers everywhere, point to the Chinese oil companies’ massive profits.

China’s oil prices remain much lower than international market prices. The result of this price spread is higher demand for oil in China (and higher demand for complementary goods such as cars) but less incentive for Chinese refineries to increase production. Sinopec and other large retailers such as PetroChina have been restricting petrol sales for months, sometimes restricting sales to only selling enough for 45km of driving. There’s no profit at this end of the Chinese market for Chinese oil companies. Long queues of trucks waiting for petrol have become common sights in many parts of China. Independent retailers are forced to raise their prices to remain in business, but they only sell to loyal customers for fear of being reported for price gouging (Reuters).

Last week’s price rise will have some impact on the pace of growth in demand. The large refiners will likely allow petrol to flow again, calculating that another price rise is not on the immediate horizon. It may also reduce some of the diplomatic pressure from other oil importing countries on China. And it is another sign that as China becomes more and more enmeshed in the international market, the pressure for market reform at home becomes irresistible. So China will have to deal with the larger problem with its energy markets eventually.

But when and how? That is a problem left for another day, the political economy of which will be at least as complicated as that which saw the lift in Chinese gas prices last week.